Crop Insurance is only Appealing if it's Subsidized
Droughts, floods and other natural disasters can devastate a farmer's crops and bank account, which suggests that insuring a crop against such disasters would be appealing to farmers.
However, crop insurance has notoriously low uptake. The US crop insurance program started in 1938, but prior to the 1990s less than a quarter of eligible acres enrolled in the program. In 1990, the Bush Administration proposed eliminating it. Instead, Congress increased subsidies significantly in 1994 and 2000 to incentivize participation. This excellent paper by Joe Glauber has the details.
Since 2008, crop insurance subsidies have averaged just over $6 billion per year. These subsidies are spread across multiple insurance plans, as I explain below. For comparison, other agricultural subsidy programs averaged about $12 billion from 2009-2018, before increasing dramatically the past two years (as I wrote about in my article two weeks ago). Crop insurance subsidies are now an important part of farm support programs.
Crop insurance is administered by the Risk Management Agency (RMA) of the USDA, but delivered by private insurance companies. These companies sell the policies and share in underwriting gains and losses. RMA reimburses insurance companies for their administrative and operating expenses, which are not included in the above subsidy graph and add another $1.4 billion per year.
RMA sets premiums based on a farmer's production history with the goal of making the policies actuarially fair. The government now pays about 60% of the premium, up from about 25% in 1990.
Crop insurance enrollment jumped after the 1994 increase in subsidies. Since then, about 220 million acres of major crops (barley, corn, cotton, grain sorghum, rice, soybeans, and wheat) have been covered by crop insurance each year. This is more than 90% of planted acres for these commodities. The initial jump in 1995 was almost all in policies that insured against low yield. Over time, the balance has shifted to revenue insurance.
You may have noticed that premiums and premium subsidies have increased substantially since 1995, but covered acres mostly have not. This difference reflects the shift towards revenue insurance, which typically implies more coverage than yield insurance. It also reflects higher revenue earned from these crops since 2008. Insuring up to 70% of expected revenue entails more liability for the insurance company when revenue is expected to be high.
Although the major crops make up the bulk of crop insurance liability, other crops also participate extensively in the program. In the last decade insured liability for specialty crops has averaged about $40 billion, compared to $90 billion in the major commodities.
Participation of specialty crops also means that insured liability spreads far beyond the Midwest.
Drought and flooding are the main cause of crop insurance indemnities. The 2012 drought caused the largest indemnities in recent years, with $14.6 billion paid out for drought losses in that year. Most of that went to corn ($10.6 billion).
So, why did US farmers only buy crop insurance in large numbers after the subsidies increased? One possible answer is that they believe the government will bail them out with ad hoc payments if disaster strikes when they are uninsured, so unsubsidized insurance isn't worth buying. Or perhaps they figure they can ride out the bad years with the help of their banker and knowing that a good year is around the corner. Or maybe they think the unsubsidized premiums exceed expected indemnities. Another (speculative) possibility is that agricultural lenders have become more risk averse and may now require crop insurance before giving operating loans.
These plots and so much more to investigate in our new Crop Insurance data app. I hope to dig into it more in future Ag Data News articles. Huge kudos to UC Davis ARE PhD student Seunghyun Lee for putting this app together.