Reduce Subsidies in the Crop Insurance Program

Background

The federal crop insurance program, a permanent program that is frequently updated by the Congress, protects farmers from losses caused by drought, floods, pest infestation, other natural disasters, and low market prices. Farmers can choose various amounts and types of insurance protection—for example, they can insure against losses caused by poor crop yields, low crop prices, or both. The Department of Agriculture (USDA) sets premium rates for federal crop insurance so that the premiums equal the expected payments to farmers for crop losses. The federal government pays about 60 percent of total premiums, on average, and farmers pay about 40 percent.

Private insurance companies—which the federal government reimburses for their administrative costs—sell and service insurance policies purchased through the program. The current Standard Reinsurance Agreement (SRA) establishes a limit for administrative expenses (currently $1.4 billion per year). The SRA establishes the terms and conditions under which the federal government provides subsidies and reinsurance on eligible crop insurance contracts sold or reinsured by private insurance companies. In addition, the federal government reinsures those private insurance companies by agreeing to cover some of the losses when total payouts exceed total premiums. Overall, the Congressional Budget Office projects that under current law the average rate of return to crop insurance companies will be 14 percent through 2020.Under current law, CBO projects that federal spending for crop insurance would total $78 billion from 2020 through 2028.

Option

Beginning in June 2019, this option would reduce the federal government's subsidy to 40 percent of the crop insurance premiums, on average. It also would limit the federal reimbursement to crop insurance companies for administrative expenses to 9.25 percent of estimated premiums (or to an average of $1 billion each year from 2020 through 2028) and limit the rate of return on investment for those companies to 12 percent each year.

Effects on the Budget

This option would save $21 billion from 2020 through 2028, CBO estimates.

A change in premium subsidies would alter the cost of crop insurance to producers. As a result, a producer might make no change, change the type of insurance purchased (for example, switching from revenue coverage to yield coverage, which is less expensive), reduce coverage on particular acres, reduce the number of acres covered by insurance (for example, not insuring every field on the farm), drop insurance coverage altogether, or take some combination of those actions. CBO accounted for each of those possible outcomes, making determinations of likely behavior after consulting with producers, academic experts, people working in the crop insurance industry, and others.

The reduction in premium subsidies in this option would save $17 billion from 2019 through 2028, CBO estimates. Those savings are uncertain largely because the response by producers is difficult to predict. Generally, the more producers drop insurance or switch to lower coverage levels, the more this option would save.

Limiting administrative expenses and the rate of return of crop insurance companies under the option would save $4 billion through 2028, CBO estimates. The savings from an annual restriction on the administrative reimbursement, such as that in this option, would be the difference between the SRA limit and what the option would allow. In addition, CBO estimates that limiting the average rate of return to crop insurance companies to 12 percent would reduce the rate of return by 2 percentage points. As a result, the government would cover less of the companies' losses. Generally, the amount of savings from limiting administrative expenses and the rate of return of crop insurance companies is proportional. For example, each additional 1 percentage point reduction in the limit on reimbursements for administrative expenses as a percent of premiums would save an additional $1 billion over the 10-year period. Similarly, an additional 1 percentage point reduction in the rate of return would save around $0.8 billion.

Other Effects

An argument in favor of this option is that cutting the federal subsidies for premiums would probably not substantially affect participation in the program. Private lenders to farmers increasingly view crop insurance as an important way to ensure that farmers can repay their loans, which encourages participation. Moreover, the farmers who dropped out of the program would generally continue to receive significant support from other federal farm programs.

Another argument in favor of this option is that it would reduce reimbursement rates for administrative expenses to a level more in line with current premiums. Current reimbursements to crop insurance companies for administrative expenses (around $1.3 billion per year) were established in 2010, when premiums were relatively high. Recent reductions in the value of the crops insured (partly the result of lower average commodity prices) have resulted in lower average premiums for crop insurance. However, administrative expenses have not shown a commensurate reduction. A cap of 9.25 percent, or about $1 billion, would be close to average reimbursements during the years before the run-up in commodity prices in 2010. Furthermore, according to a recent USDA study, the current rate of return on investment for crop insurance companies, 14 percent, is higher than that of other private companies, on average.

An argument against this option is that cutting the federal subsidies for premiums would probably cause farmers to buy less insurance and leave them more vulnerable to risk. All else being equal, the option would increase the cost of insurance by 50 percent and could lead to a reduction in insured acres. If the amount of insurance declined significantly, lawmakers might be more likely to enact special relief programs when farmers encountered significant difficulties, which would offset some of the savings from cutting the premium subsidy. (Such ad hoc disaster assistance programs for farmers cost an average of about $700 million annually in the early 2000s.) In addition, limiting reimbursements to companies for administrative expenses and reducing the targeted rate of return to companies could add to the financial stress of companies in years with sizable payouts for covered losses. Moreover, if significantly fewer farmers participate, then some smaller crop insurance companies would probably go out of business.