Cutting the Fat

It Won’t Kill Crop Insurance

December 3, 2015

Cutting the Fat: Reducing the Rate of Return will Reduce Costs

The recent budget agreement calls for a decrease in the target rate of return for crop insurance companies from 14 percent to 8.9 percent. The target rate of return is set in the Standard Reinsurance Agreement (SRA) between the government and companies interested in selling and servicing insurance policies under the program. The SRA establishes a target rate of return the companies would expect to enjoy by determining net underwriting gains and A&O reimbursements. Presumably, the decrease in the target rate of return would be implemented by a cut in the subsidies to companies, which would entail a reduction in underwriting gains and/or in A&O.

The industry and its Congressional patrons are ringing alarm bells about the budget agreement, claiming that crop insurance companies will no longer participate in the federal program, the program will fail and farmers won’t be able to secure insurance.

The facts tell a very different story. Crop insurance companies have more than enough room to cut costs to maintain a healthy rate of return. Companies won’t exit the program. Instead, they will reduce commissions paid to agents and control other costs to boost their rate of return.

In 2014, the industry retained about $8 billion in premiums. The current 14 percent target rate of return on $8 billion of retained premium implies a profit of $1.12 billion a year. The 8.9 percent rate of return on the same $8 billion in retained premium implies a profit of $712 million, which is a drop of about $400 million. The new SRA mandated by the budget agreement must cut revenue to crop insurance companies by $400 million per year to achieve that 8.9 percent rate of return.

Crop insurance costs, however, will decline accordingly because costs reflect the level of government subsidies that flow to the industry. Agent commissions and other costs, which include industry salaries, have increased much faster than they would have if crop insurance were subject to the same market forces as the rest of the industry. Costs are $767 million higher than they would be if crop insurance companies faced the kind of competition that the rest of the industry does (Table 3). In response to a $400 million drop in subsidies, companies would shed enough costs to make the rate of return high enough to ensure that they continue to operate.

Agent commissions would bear most of the brunt of this cost decrease because commissions increased faster than other costs. In 2013 agent commissions were $1.25 billion – 60 percent of total costs. If agent commissions had increased at 3.7 percent per year rather than 9.1 percent per year, they would have totaled $678 million (Table 3). If agent commissions alone absorbed the full $400 million cut in subsidies, they would still be higher than they would be if they had increased at the same rate as civilian compensation between 2001 and 2013.

However, agent commissions would not have to bear the full brunt of the cost reduction. Other company costs have increased at 7.2 percent per year in response to growing government subsidies. The additional revenue has apparently made its way into higher than required salaries and benefits for company personnel. Some proportion of the cost reduction would likely be achieved by getting salaries and benefits more in line with the insurance industry as a whole.