The risk-sharing arrangement between the government and the companies is spelled out in the Standard Reinsurance Agreement (SRA), which is the contract between the government and the companies that deliver the insurance. Under the SRA, the Federal government acts as a reinsurer by providing insurance for the insurance companies. The government bears a portion of the companies’ underwriting losses (which occur in years when indemnities exceed premiums) on a state-by-state basis, and in return, the government takes a share of the companies’ underwriting gains (which occur when premiums exceed indemnities).
In short, as a reinsurer the government will help shoulder excessive losses in bad years like 2012, but will receive underwriting gains from farmer premiums in good years. That was the case from 2001-2010 when the government saw $4 billion in underwriting gains. Those gains were offset by underwriting losses in 2011, 2012 and 2013, but by 2015, the government once again realized
The government shares in the risk of loss for two reasons. First is the requirement for universal availability of crop insurance. Companies must sell a policy to any farmer who wants one — including higher-risk farmers — at the premium rate set in advance by the Federal government. Companies cannot refuse to provide protection, raise the premium rate, or impose special underwriting standards on any individual farmer, regardless of risk. Due to these restrictions against normal underwriting practices, insurers would consider this to be a textbook example of uninsurable risk. The SRA mitigates this problem by allowing companies to transfer a portion of the risk of policies to the Federal government.
The second reason is that agriculture is inherently risky and the potential for large-scale losses may exceed the capacity of the private sector. Natural disasters can cover wide areas with many individual farms simultaneously incurring large losses, which could bankrupt a private-sector company. The losses in this instance are said to be correlated, or systemic, unlike automobile accidents, which occur independently across a state or region.
Because of the magnitude of risk inherent in U.S. agriculture, combined with the large volume of commodities produced, companies that participate in the crop insurance program are required to have access to adequate capital to meet their financial obligations if disaster strikes the farming sector. These requirements are substantial, dictating that companies must have sufficient capital to absorb a net underwriting loss after Federal reinsurance well in excess of the retained premiums on the policies they sell (technically, at least twice the maximum possible underwriting loss, as specified in Federal Regulations). To help meet these capital requirements, crop insurance companies reduce their loss exposure by purchasing additional reinsurance from the private market.
Given the potential for widespread systemic losses, without the reinsurance provided by the Federal government, private-sector insurance alone would not be affordable to many farmers and widely available as crop insurance is today.
National Crop Insurance Services
8900 Indian Creek Parkway, Suite 600
Overland Park, KS 66210-1567
Phone: 913-685-2767