The Crop insurance safety net
With harsher conditions, growers will lean on insurance more than before. Smart growers have used it as a business backup plan for years.
by David Williams
Tobacco growers today think like businessmen. And it is a smart businessman that hedges his bets and plans for the bad times as well as the good.
So there is not a serious grower who does not think long and hard about protecting his agricultural investment with crop insurance. With this summer’s dry, scorching weather conditions, those thoughts of insurance back in the planning stages of the 2007 crop are paying dividends for farmers who needed a safety net in case their crops suffered.
While corn, soybean and peanut farmers are facing potentially devastating losses and are as much involved with filing claims these days as preparing to harvest, tobacco growers seem to be operating in better conditions. The crop, for the most part, has grown and is being harvested and cured. The dry conditions were not devastating for the crop, which is known for its hardiness in arid environments.
But some growers will experience a loss of quality and a loss of yield, from early weather catastrophes to less humid curing conditions. And crop insurance stands ready to provide a bridge to avoid a catastrophic loss.
In some form or other, crop insurance has been around since the 1920s. Hail insurance was the chief instrument, but generating a market for multi-risk insurance proved unsuccessful for many years.
The federal government has been a partner in the development of crop insurance from the days of the Great Depression. In 1933 Congress restricted domestic production of crops, and gave subsidies for keeping acreage unplanted. The move was aimed at helping family farmers by having limited supply raise prices. The Supreme Court declared the program unconstitutional in 1938.
The first crop insurance program came later that year, the Federal Crop Insurance Act. Backed by the U.S. Treasury Department, it was a multi-risk insurance program that covered several different types of dramatic conditions.
The program was plagued by high costs and low participation by farmers, and it never developed sufficient reserves to pay for catastrophic losses. Changes in the program limited coverage to geographic areas that were least likely to require government subsidies and to protect uninsured farmers.
At the same time, Congress began providing disaster assistance and emergency loans in the event of crop loss due to weather conditions, and farmers had little incentive to buy crop insurance.
In 1980, Congress passed legislation that made crop insurance the primary vehicle for farmers to survive natural disasters. The legislation gave private companies the ability to sell, service and bear the risk of providing coverage (the USDA was the sole provider up till then), and also to produce a program that reduced federal outlays and kept coverage affordable through subsidies. The private sector bore the underwriting risk, and policies they wrote were reinsured by the federal government.
But Congress continued to offer federal disaster assistance and emergency loans, and farmers would use that and not buy insurance. Barely a third of those eligible to take part did so. The crop insurance program cost $900 million in 1994, while payments of disaster relief over six years (1988-1994) averaged $1.5 billion a year.
In 1994, under the banner of reducing federal spending and balancing the budget, Congress passed the Federal Crop Insurance Reform Act. Regulations made it more difficult to justify declarations for disaster aid, forcing farmers to seek insurance programs for risk reduction.
Farmers growing insurable crops would receive essentially free catastrophic coverage for little more than a processing fee. Crops outside the federal crop insurance program were eligible for a special disaster assistance program, with payments triggered by area-wide losses.
A key element of the program was mandatory catastrophe coverage. Crop insurance was tied to price support and loan programs. This widened the pool of policyholders beyond those most exposed to risk.
The 1995 Farm Bill adjusted crop insurance further. Congress struck down the requirement for a minimum level of insurance, as long as farmers waived in writing eligibility for future disaster payments. Those who did not sign would have to carry the catastrophic coverage to be eligible for disaster aid.
The private sector took over the sole servicing of policies, while Federal Crop Insurance Corporation and its Risk Management Agency (RMA) would manage crop insurance, establish insurance policy terms and conditions, set rates and generate payment of claims. The Farm Service Agency administers the noninsured crop disaster assistance program.
In 1996, policies came available to not only insure the crop against loss but also to insure yield and price. The Agricultural Market Transition Act discussed “revenue protection” of the product’s yield and price. It featured pilot programs that responded to fluctuating price levels as well as yield variability, based on Chicago Board of Trade commodity process.
The Agricultural Risk Protection Act, passed in 2000, made it easier for farmers to buy different types of multi-peril crop insurance, including revenue insurance, by increasing government subsidies—$8.2 billion over five years. Eighty percent of that amount was set aside for farmers’ premium expenses.
Jay Boyette, the commodity director for the North Carolina Farm Bureau, explained that today’s grower uses crop insurance as a risk management tool.
“When you talk about tobacco, or other high-value crops, the more valuable the crop is, probably the more likely a farmer would have to use crop insurance as a risk management tool,” he said. “His investment is so high per acre that a catastrophic event or a loss could really have a severe impact on his ability to continue to farm.”
In some ways, applying crop insurance to the overall farm budget is a matter similar to buying other types of insurance. The keys are how much risk a grower wants to insure, and how much is he willing to pay for that assurance against potential loss.
Boyette said that the different number of crops and type of insurance available for each crop makes it impossible to come up with a common standard for cost and risk assessment.
“Most policies pay to a set percentage of the value of the crop,” he said. “For a lot of commodities, farmers have options to buy coverage at certain levels, and the more coverage they have, the more cost and premium is presented to the farmer.”
Tobacco growers can purchase crop insurance that covers up to 75 percent of the crop’s value - and in some states, like North Carolina, policies will pay up to 85 percent. Policies can cover simple natural disasters that affect the crop’s value or the entire destruction of a crop through covered events. Some policies will cover a percentage of loss if a crop is partially saleable.
Roderick Rejesus, assistant professor and Extension specialist for the Department of Agriculture and Resource Economics at North Carolina State University, explained that APH (actual production history) insurance provides payment based in yield history in North Carolina.
“Although there are several types of insurance products and insurance plans available for different crops, for tobacco in particular the APH (actual production history) insurance, based on yield, is recommended,” he said. “If your yield fell below some threshold, then you would get some payment.”
How much insurance a grower purchases is dependent on how much risk he wants to take on.
“Your premiums will depend on how risky you are,” said Rejesus. “The percentage of budget for farmers really depends on your desire to take a risk. If you are a small tobacco farmer and you do not want your income to go below a certain level—because you would starve, for example—then of course you would probably be more willing to spend a greater portion of your budget on premiums.
“It’s a risk management strategy. You just want to cover your bases, so to speak, if for some reason you get a loss.”
The filing of a claim can take many months and can actually continue through to the harvest and sale of the crop. It all starts at the time something happens—drought, hailstorm, flood—that triggers a potential loss.
“Say, you have a drought,” said Rejesus. “Your yields would be affected. If you bought insurance at the start of the season—at, say, 85 percent coverage—and your yield fell below that 85 percent, you would get an indemnity payment. Any peril that is covered by the policy would apply, although not all perils apply. Droughts, frosts, those types of natural disasters, are covered.”
The crop’s ultimate fate always rests in the hands of the grower. A claims adjuster comes out to the farm and does an estimate of the damage or potential yield loss.
“In the policy, you are guaranteed a certain number of pounds, and you are also guaranteed quality based on prices,” said Allen Yeatts, regional claims manager for American Farm Bureau Insurance Services. “Currently for flue-cured, the price is $1.52 as an established price that it is quality adjusted to. We average their whole crop, and they sell it or have loss due to an insurable cause, like drought or whatever. If they average, say, a dollar a pound, we factor that into $1.52 to bring it back up to $1.52.”
The grower has the choice of plowing his crop under after taking a payment on a claim, or he can grow the crop to harvest, sell at less that the insurable yield amount and receive payment up to the quality-adjusted price, dependent on the percentage of coverage he bought.
“We would continue to go back and work with the farmer one –on one,” said Yeatts. “It is up to the farmer what to do with his crop—if he wants to harvest some, we will wait until he harvests what he wants to harvest and we will go back and re-appraise it. He can say that it is too much and decide to harvest some more, or he can take the appraisal and go with it.”
Yeatts, who has been involved with agricultural appraisal for 20 years, said that crop loss is determined on a case-by-case basis. Adjusters have to inspect the tobacco and determine its value.
“That is where we have problems,” he said. “At this point, if it rains, the crop might still make something. You really can’t give up on it, probably not until frost. If you have a leaf out there that has potential to make a normal leaf if it rains between now and frost, you have to count that as being a normal leaf—even through you could look at it today and see that it probably will never be a normal leaf. According to the procedures, you have to count it as a normal leaf.”
Like any type of insurance, there is a group of crop insurance policyholders that has abused the system through fraudulent claims. But the one-on-one approach adjusters take prevents much fraud from happening on a large scale.
“I guess if it happens at all, it’s too much,” said Boyette. “When that sort of thing occurs, it’s really a black eye for all the farmers who are using the product in a responsible way. To the extent they can, the claims adjusters, the companies and FCIC [do] everything that they can to make sure that that does not happen. When it does happen, they aggressively pursue whatever legal recourse there [is] to try and weed out those sorts of people.”
Rejesus said that growers tend to know who is and who is not taking advantage.
“That is nothing new,” he said. “There are people that take advantage, and when it is discovered, they are prosecuted. But based on my research on this for the past five years, the general perception is 1 to 5 percent of people do take advantage of the program in terms of fraud, waste and abuse. That is not quantitatively analyzed, but that is minimal compared to fraud in other types of insurance.
“Growers tend to self-police themselves—this is just anecdotal evidence, but they are very aware of what their neighbors are doing, and in general, they do not want that to taint the reputation of producers getting crop insurance.”
The 1-to-5-percent estimate is significantly lower than in other insurance areas, such as property and casualty or auto insurance.
From the outside, it appears as through growers suffering loss from natural disaster can receive assistance through crop insurance and through ad hoc disaster assistance, which is commonly done after a natural disaster. Several agricultural counties in the Southeast have been declared federal disaster areas already this year for drought and the Easter freeze, which devastated the fruit crops. Boyette said the two programs are similar, but not exact.
“They really run on separate tracks,” he said. “Federal crop insurance for most crops is something that is available in an ongoing basis. If I had a disaster or event on my particular farm that made me eligible due to my losses, I would receive payment on that independent of whether there is any federal disaster declaration or any ad hoc appropriation for a disaster.”
Boyette said that in recent years, Congress has stipulated that to be eligible for federal disaster assistance, a grower must have participated in the federal crop insurance program if it was available for the crop they produced.
“So I think there is a general trend to say to producers, ‘If you want to participate—if there is an ad hoc disaster program—you need to first make sure that you have done everything you could have to manage that risk to begin with,” Boyette said.
“Natural disaster declarations are done in addition to the insurance payments,” said Rejesus. “So if you are insured, you get payments for that, and if there are natural disaster allotments at the federal level, that is in addition to your crop insurance. Remember, crop insurance is not free.”