oversight

Crop Insurance: Opportunities Exist to Reduce Government Costs for Private-Sector Delivery

Published by the Government Accountability Office on 1997-04-17.

Below is a raw (and likely hideous) rendition of the original report. (PDF)

                 United States General Accounting Office

GAO              Report to Congressional Committees




April 1997
                 CROP INSURANCE
                 Opportunities Exist to
                 Reduce Government
                 Costs for
                 Private-Sector Delivery




GAO/RCED-97-70
      United States
GAO   General Accounting Office
      Washington, D.C. 20548

      Resources, Community, and
      Economic Development Division

      B-276150

      April 17, 1997

      Congressional Committees:

      This report responds to the requirement in the Federal Crop Insurance Reform and Department
      of Agriculture Reorganization Act of 1994 (P.L. 103-354, Oct. 13, 1994) that GAO and the U.S.
      Department of Agriculture’s Federal Crop Insurance Corporation (FCIC) jointly evaluate the
      financial arrangements between FCIC and participating insurance companies for delivering the
      crop insurance program to qualified producers. The report contains recommendations to the
      Secretary of Agriculture to reduce the government’s costs for the crop insurance program.

      The U.S. Department of Agriculture’s Risk Management Agency will report on the adequacy of
      return on capital to companies selling crop insurance for the federal government and identify
      alternative reinsurance arrangements.

      We are sending copies of this report to interested congressional committees; the Secretary of
      Agriculture; participating insurance companies; and the Director, Office of Management and
      Budget. We will also make copies available to others upon request. If you or your staff have any
      questions, I can be reached on (202) 512-5138. Major contributors to this report are listed in
      appendix X.

      Sincerely yours,




      Robert A. Robinson
      Director, Food and
        Agriculture Issues
B-276150

Congressional Committees

The Honorable Richard G. Lugar
Chairman
The Honorable Tom Harkin
Ranking Minority Member
Committee on Agriculture, Nutrition, and Forestry
United States Senate

The Honorable Robert F. (Bob) Smith
Chairman
The Honorable Charles W. Stenholm
Ranking Minority Member
Committee on Agriculture
House of Representatives




                    Page 2                          GAO/RCED-97-70 Crop Insurance
B-276150




           Page 3   GAO/RCED-97-70 Crop Insurance
Executive Summary


             Federal crop insurance protects participating farmers against the financial
Purpose      losses caused by events such as droughts, floods, hurricanes, and other
             natural disasters. In 1995, crop insurance premiums were about
             $1.5 billion. The U.S. Department of Agriculture’s (USDA) Risk Management
             Agency administers the federal crop insurance program through the
             Federal Crop Insurance Corporation (FCIC). Federal crop insurance offers
             farmers two primary types of insurance coverage. The first—called
             catastrophic insurance—provides protection against the extreme losses of
             crops for the payment of a $50 processing fee, whereas the second—called
             buyup insurance—provides protection against more typical smaller losses
             of crops in exchange for a premium paid by the farmer. FCIC conducts the
             program primarily through private insurance companies that sell and
             service federal crop insurance—both catastrophic and buyup—for the
             federal government and retain a portion of the insurance risk. FCIC pays
             the companies a fee, called an administrative expense reimbursement, that
             is intended to reimburse the companies for the reasonable expenses
             associated with selling and servicing crop insurance to farmers. The
             reimbursement is calculated as a percentage of the premiums paid,
             regardless of the expenses incurred by the companies. In addition, the
             companies earn profits when insurance premiums exceed losses. FCIC also
             offers catastrophic insurance through the local offices of USDA’s Farm
             Service Agency.

             Concerned about the cost-effective delivery of federal crop insurance and
             recognizing the important role the private insurance industry plays in
             delivering federal crop insurance, the Congress, in the Federal Crop
             Insurance Reform and Department of Agriculture Reorganization Act of
             1994, directed GAO and FCIC to jointly evaluate the financial arrangements
             between FCIC and insurance providers for delivering crop insurance to
             producers. Separately, USDA’s Risk Management Agency will report on the
             adequacy of return on capital to insurance companies and alternative
             reinsurance arrangements between the government and the companies. In
             this report, GAO addresses (1) the adequacy of the current administrative
             reimbursement rate for expenses of participating crop insurance
             companies, (2) the comparative cost to the government in 1995 of private
             companies’ and USDA’s delivery of catastrophic insurance, and (3) the
             advantages and disadvantages of different expense reimbursement
             alternatives. Appendix I provides descriptive information on FCIC’s efforts
             to simplify program administration.




             Page 4                                          GAO/RCED-97-70 Crop Insurance
             Executive Summary




             Federal crop insurance began on an experimental basis in 1938, after
Background   private insurance companies were unable to establish a financially viable
             crop insurance business. In 1980, the Congress enacted legislation that
             expanded the program and, for the first time, enlisted private insurance
             companies to sell, service, and share in the risk of federal crop insurance
             policies. Under a standard reinsurance agreement that identifies the terms
             and conditions for selling federal crop insurance, FCIC pays the insurance
             companies an administrative fee. This fee is a preestablished percentage of
             premiums to reimburse the companies for the expenses of selling and
             servicing crop insurance policies, including the expenses associated with
             adjusting claims. While the reimbursement rate is intended to be set at a
             level sufficient to cover the companies’ costs of selling and servicing crop
             insurance policies, under the current reimbursement arrangement, the
             companies have no obligation to spend their payment on expenses related
             to crop insurance; they can spend the payment in any way they choose.

             For buyup crop insurance, the administrative expense reimbursement has
             declined from a base rate of 34 percent of the premiums on policies sold
             from 1988 through 1991 to 31 percent of the premiums sold from 1994
             through 1996. Prior to 1994, the reimbursement rate for administrative
             expenses changed as a result of negotiations between FCIC and the
             participating companies and budget concerns, but it was not based on
             actual expenditure data. The 1994 reform act requires FCIC to reduce the
             reimbursement rate to no more than 29 percent of total premiums in 1997,
             no more than 28 percent in 1998, and no more than 27.5 percent in 1999.
             FCIC can set the rate lower than these mandated ceilings.


             While this reduction in the reimbursement rate was mandated by the act,
             the established rates were not based on a systematic evaluation of the
             costs associated with selling and servicing crop insurance. Nor have
             participating insurance companies been limited in how they spend their
             administrative expense reimbursement. Moreover, all companies did not
             report detailed expense information for selling and servicing crop
             insurance in a consistent format until 1994, when USDA began requiring
             companies to report data on actual expenses in order to help establish a
             future reimbursement rate that more clearly reflects actual expenses.
             Currently, FCIC is developing a new standard reinsurance agreement,
             including new expense reimbursement rates, that will be completed with
             the companies in June 1997.

             In addition to receiving an administrative expense reimbursement, the
             insurance companies share underwriting risk with FCIC and can earn or



             Page 5                                          GAO/RCED-97-70 Crop Insurance
                   Executive Summary




                   lose money according to the claims they must pay farmers for crop losses.
                   Companies earn money when the premiums exceed the crop loss claims
                   paid for those policies on which the companies retain risk. They lose
                   money when the claims paid for crop losses exceed the premiums paid for
                   the policies that the companies retained. Since 1990, the companies
                   participating in this program have collectively earned $528 million in
                   underwriting gains.

                   The 1994 reform act required farmers who had not previously purchased
                   crop insurance to purchase at least catastrophic insurance coverage if they
                   wanted to participate in federal farm programs. (The Federal Agriculture
                   Improvement and Reform Act of 1996 rescinded this requirement provided
                   that farmers waive any rights to any possible disaster assistance.)
                   Catastrophic insurance was designed to eliminate the need for expensive
                   crop disaster assistance programs. Farmers could purchase catastrophic
                   coverage either from the local office of USDA’s Farm Service Agency or
                   from a local insurance agent representing a participating insurance
                   company. The cost to the farmer is a $50 per crop processing fee whether
                   the farmer purchases coverage through USDA or a private insurer. In 1995,
                   participating companies were compensated with a base reimbursement
                   rate for administrative expenses of about 14 percent of catastrophic
                   premiums, in addition to the $50 processing fee paid by farmers. The 1994
                   reform act authorized the companies to keep the fees they collected from
                   farmers up to certain limits.

                   FCIC had agreements with 22 companies in 1994 and 19 companies in 1995
                   to sell and service federal crop insurance. In 1995, the insurance
                   companies sold about 80 percent of all federal crop insurance, while
                   USDA’s Farm Service Agency sold the remainder. In performing its review,
                   GAO examined expenses at nine companies representing about 85 percent
                   of the total federal crop insurance premiums written by private companies
                   in 1994 and 1995. Companies were selected considering factors such as
                   premium volume, location, and type of ownership.


                   In 1994 and 1995, the government’s administrative expense reimbursement
Results in Brief   to insurance companies was greater than the companies’ expenses to sell
                   and service federal crop insurance. For the 2-year period, companies
                   reported expenses that were less than the reimbursements paid to them by
                   FCIC. Furthermore, GAO found that some of these reported expenses did not
                   appear to be reasonably associated with the sale and service of federal




                   Page 6                                          GAO/RCED-97-70 Crop Insurance
                           Executive Summary




                           crop insurance and accordingly should not be considered in determining
                           an appropriate future reimbursement rate for administrative expenses.

                           Among these expenses were those associated with acquiring competitors’
                           businesses, profit-sharing bonuses, and lobbying. In addition, even within
                           the expense categories reasonably associated with the sale and service of
                           crop insurance, GAO found expenses that appeared excessive for
                           reimbursement under a taxpayer-supported program suggesting an
                           opportunity to further reduce future reimbursement rates. These expenses
                           included agents’ commissions that exceeded the industry average,
                           unnecessary travel-related expenses, and questionable entertainment
                           activities. Finally, higher premiums in the crop insurance program have
                           had the effect of increasing the government’s reimbursement to companies
                           from the time period GAO examined. At the same time, companies’
                           expenses associated with crop insurance sales and service could decrease
                           as FCIC reduces the administrative requirements with which the companies
                           must comply. Combined, all these factors indicate that FCIC could lower
                           the reimbursement rate and still amply cover companies’ reasonable
                           expenses for selling and servicing federal crop insurance policies.

                           In 1995, the government’s costs to deliver catastrophic insurance were
                           higher through private companies than through USDA. Although the basic
                           costs associated with selling and servicing catastrophic crop insurance
                           through USDA and private companies were comparable, delivery through
                           USDA avoids paying an underwriting gain to companies in years when there
                           is a low incidence of catastrophic loss claims. In 1995, the underwriting
                           gain to participating companies for catastrophic insurance totaled about
                           $45 million. In 1996, the underwriting gains were even higher.

                           GAO  identified a number of different approaches to reimbursing companies
                           for their administrative expenses that offer the opportunity for cost
                           savings. Each has advantages and disadvantages compared with the
                           existing reimbursement arrangement. Companies generally prefer the
                           existing reimbursement method because it is relatively simple to
                           administer.



Principal Findings

Current Reimbursements     In 1994 and 1995, FCIC’s administrative expense reimbursements to the
Exceed Delivery Expenses   participating companies selling buyup insurance—31 percent of



                           Page 7                                         GAO/RCED-97-70 Crop Insurance
Executive Summary




premiums—were much higher than the expenses that can be reasonably
associated with the sale and service of federal crop insurance. For the
2-year period, the nine companies GAO reviewed reported $542.3 million in
expenses, compared with a reimbursement of $580.2 million—a difference
of about $38 million. In addition, GAO’s review of the companies’ reported
expenses showed that about $43 million could not be reasonably
associated with the sale and service of federal crop insurance to farmers.
Therefore, these expenses should not be considered in determining an
appropriate future reimbursement rate for administrative expenses. These
expenses included payments to compensate executives of an acquired
company to refrain from joining or starting competing companies, fees
paid to other insurance companies to protect against underwriting losses,
bonuses tied to company profitability, management fees assessed by
parent companies with no identifiable benefit to subsidiary crop insurance
companies, and lobbying expenses. Adjusting for these expenses, GAO
determined, and FCIC concurred, that the expense reimbursement rate for
companies’ expenses reasonably associated with the sale and service of
crop insurance in 1994-95 was about 27 percent of premiums. Similarly, for
1995, GAO found that the compensation to companies selling catastrophic
insurance—including farmer-paid processing fees—exceeded companies’
calculated expenses for those policies by about 2 percent of catastrophic
premiums.

In addition, GAO found a number of expenses reported by the companies
that, while in categories associated with the sale and service of crop
insurance, seemed to be excessive under a taxpayer-supported program.
These expenses included above-average commissions paid to agents by
one large company, corporate aircraft and excessive automobile charges,
country club memberships, and various entertainment activities for agents
and employees, such as sky box rentals at professional sporting events and
company-sponsored fishing trips. While difficult to fully quantify, these
types of expenditures suggest that opportunities exist for the government
to reduce its future reimbursement rate for administrative expenses while
still adequately reimbursing companies for the reasonable expenses of
selling and servicing crop insurance policies.

Furthermore, a variety of factors that have emerged since the period
covered by GAO’s review have increased companies’ revenues or may
decrease companies’ expenses. Crop prices and premium rates increased
in 1996 and 1997, thereby generating higher premiums, which had the
effect of increasing the reimbursements paid to companies for
administrative expenses by about 3 percent of premiums. FCIC’s efforts to



Page 8                                          GAO/RCED-97-70 Crop Insurance
                         Executive Summary




                         simplify the program’s administrative requirements may reduce
                         companies’ workload, thereby reducing their administrative expenses.


Government’s Cost to     In 1995, the government’s costs to deliver catastrophic insurance policies
Deliver Catastrophic     were higher through private companies than through USDA. The basic cost
Insurance Through USDA   to the government for selling and servicing crop insurance was
                         comparable for both delivery systems. However, when private companies
Is Less Than Through     delivered the insurance, they received an estimated $45 million
Private Companies        underwriting gain that did not apply to USDA’s delivery. Underwriting gains
                         are not guaranteed and vary annually, depending on crop losses.
                         According to FCIC, the underwriting gain in 1995 totaled 37 percent of
                         those catastrophic premiums for which the companies retained risk. This
                         1-year underwriting gain substantially exceeded FCIC’s long-term target,
                         which in 1995 was 7 percent of the companies’ retained premiums. In 1996,
                         the underwriting gain was even higher—about $58 million. Beginning with
                         crops harvested in 1997, the Federal Agriculture Improvement and Reform
                         Act of 1996 requires that USDA phase out its delivery of catastrophic crop
                         insurance in areas that have sufficient private company providers. In
                         July 1996, the Secretary of Agriculture identified 14 states where sufficient
                         commercial delivery was available and USDA would no longer sell and
                         service catastrophic insurance.


Alternative              The current arrangement for reimbursing companies for their
Reimbursement            administrative expenses, under which FCIC pays private companies a fixed
Arrangements Offer       percentage of premiums, has certain advantages, including ease of
                         administration. However, expense reimbursements based on a percentage
Potential for Savings    of premiums do not necessarily reflect the amount of work involved to sell
                         and service crop insurance policies. Alternative reimbursement
                         arrangements, such as (1) capping the reimbursement per policy,
                         (2) paying a flat dollar amount per policy plus a reduced fixed percentage
                         of premiums, and (3) paying a declining reimbursement rate as companies’
                         premium volume increases, offer the potential to have reimbursements
                         more reasonably reflect expenses. Some alternatives may also help smaller
                         companies compete more effectively with larger companies and/or
                         encourage more service to smaller farmers than does the current system.
                         While some of the alternative reimbursement methods may result in lower
                         cost reimbursements to insurance companies, some methods may increase
                         FCIC’s own administrative expenses for reporting and compliance.
                         Companies generally prefer FCIC’s current reimbursement method because
                         of its administrative simplicity. FCIC has included the second



                         Page 9                                           GAO/RCED-97-70 Crop Insurance
                         Executive Summary




                         alternative—paying a flat dollar amount per policy plus a fixed percentage
                         of premiums—in its proposed 1998 standard reinsurance agreement with
                         the industry.


                         GAO’s review shows that the 1994 and 1995 administrative reimbursement
Recommendations to       rate for buyup crop insurance—31 percent of premiums—was higher than
the Secretary of         the companies’ expenses reasonably associated with selling and servicing
Agriculture              crop insurance for the 2-year period which GAO calculated at about
                         27 percent of premiums. According to GAO’s analysis, if crop prices and
                         premium rates remain at 1996-97 levels, FCIC could reduce its
                         reimbursement rate 3 percentage points below this 27-percent rate, and
                         companies could still be adequately reimbursed for their reasonable
                         expenses of selling and servicing crop insurance. GAO’s review also shows
                         that in 1995 the compensation to companies for catastrophic insurance
                         was higher than the companies’ expenses associated with selling and
                         servicing this insurance. Finally, an analysis of the government’s 1995
                         costs to deliver catastrophic insurance through private companies and
                         through USDA shows that basic delivery expenses are comparable for the
                         two delivery systems but that underwriting gains to companies made
                         private delivery more expensive. Companies’ underwriting gains to date
                         substantially exceed FCIC’s target.

                         Accordingly, to better ensure that the reimbursement rate to participating
                         companies more closely reflects their actual expenses for delivering crop
                         insurance, GAO recommends that the Secretary of Agriculture direct the
                         Administrator of the Risk Management Agency to

                     •   determine a reimbursement rate for administrative expenses that reflects
                         the appropriate and reasonable costs of selling and servicing buyup
                         insurance and include this rate in the new agreement currently being
                         developed with the companies;
                     •   determine the compensation that reflects the appropriate and reasonable
                         costs of selling and servicing catastrophic crop insurance and include it in
                         the new agreement being developed with the companies;
                     •   explicitly convey to participating insurance companies the type of
                         expenses that the administrative reimbursement is intended to cover;
                     •   monitor companies’ expenses to ensure that the established rate is
                         reasonable for the services provided; and
                     •   closely monitor the experience of the catastrophic insurance program to
                         ensure that over time the underwriting gains earned on catastrophic




                         Page 10                                          GAO/RCED-97-70 Crop Insurance
                     Executive Summary




                     insurance by the companies do not exceed FCIC’s long-term target for
                     gains.


                     GAO  provided a draft of this report to the U.S. Department of Agriculture
USDA and Crop        for review and comment. GAO also provided a draft of this report to
Insurance Industry   National Crop Insurance Services, Inc., which was designated by the crop
Comments             insurance companies included in GAO’s review to respond to this report. In
                     addition, at the request of some crop insurance companies, the American
                     Association of Crop Insurers and the Crop Insurance Research Bureau,
                     Inc. jointly provided comments on a draft of this report.

                     GAO  met with USDA’s Administrator for the Risk Management Agency, who
                     agreed with the information presented in the draft report and its
                     conclusions and recommendations. In its proposed 1998 standard
                     reinsurance agreement with the private insurance companies, FCIC has
                     included changes to the expense reimbursement rate for delivering both
                     buyup and catastrophic insurance. Additionally, in this proposed
                     agreement, FCIC has clarified the types of expenses that the administrative
                     reimbursement is intended to cover, and it plans to monitor companies’
                     expenses in the future as a result of GAO’s review. USDA’s Risk Management
                     Agency noted that the information in this report provides a strong basis
                     for conducting future expense audits to continue verification of private
                     insurance companies’ costs for delivering crop insurance.

                     The crop insurance industry disagreed with GAO’s methodology, findings,
                     conclusions, and recommendations. GAO is confident that its methodology
                     is sound, the report’s findings and conclusions are well supported, and the
                     recommendations offer reasonable suggestions for reducing the costs of
                     the crop insurance program.

                     In responding to GAO’s draft report, the industry raised questions in four
                     broad areas.

                     First, the industry believes that GAO failed to meet the mandate contained
                     in the 1994 reform act because the review focused on the costs to deliver
                     crop insurance and did not consider quality of service. GAO focused on
                     delivery costs because in researching the legislative history of this
                     provision, GAO found that in the context of funding this program and other
                     agricultural programs in a deficit reduction environment, the paramount
                     congressional interest was in controlling the costs of reimbursing crop
                     insurers. Furthermore, GAO confirmed its interpretation of the mandate in



                     Page 11                                          GAO/RCED-97-70 Crop Insurance
Executive Summary




a commitment letter sent to the Chairmen and Ranking Minority Members
of the Senate Committee on Agriculture, Nutrition, and Forestry, and the
House Committee on Agriculture. This letter set forth GAO’s approach for
meeting this mandate including its scope and methodology. Consequently,
GAO’s report focuses on costs incurred by insurers that are reimbursed by
the government in order to provide information most useful to
congressional decisionmakers. Therefore, GAO believes that the report
fulfills the mandate of the Congress. (See ch. 1.)

Second, the industry raised questions about the methodology used in the
review, including the time period GAO examined; the standards GAO used to
judge the allowability of expenses; and the applicability of emerging
factors, such as increased premium rates and higher crop prices, to future
cost reimbursements. GAO examined the costs of the crop insurance
program for 1994 and 1995 to provide a picture of expenses for delivering
crop insurance before and after the implementation of the 1994 reform act.
Furthermore, these were the first 2 years that the industry provided the
detailed data in a consistent format needed to fully analyze the expenses
associated with selling and servicing crop insurance. The industry stated
that GAO was understating administrative expenses by using 2 years in
which crop losses were relatively low. GAO disagrees. Crop losses for
buyup coverage in 1995 were equal to or higher than crop loss experiences
throughout the 1990s, except for 1993. Furthermore, GAO found that high
crop losses did not significantly increase companies’ loss-adjusting
expenses—the administrative cost component most likely to be affected
by high crop losses. Moreover, since the 1980s, the companies have
received additional reimbursements in years of high crop losses. The
standards GAO used to identify reasonable costs for delivering crop
insurance were developed on the basis of a number of different widely
recognized accounting, insurance, and acquisition standards. FCIC agreed
that the standards used were appropriate. Moreover, two factors that have
emerged since the 1994-95 time period that GAO reviewed—higher
premium rates and higher crop prices in 1996 and 1997—should be
considered in evaluating the appropriate future reimbursement rate
because these factors increased companies’ revenues without an increase
in expenses. (See ch. 2.)

Third, without offering specific details, the industry expressed concern
that the implementation of GAO’s recommendations would destabilize the
crop insurance industry. The industry’s profitability is primarily driven by
the difference between premiums received and claims paid—its
underwriting profits. Administrative expense reimbursements are intended



Page 12                                         GAO/RCED-97-70 Crop Insurance
Executive Summary




to just cover expenses. They were never intended to include a profit
margin. GAO continues to believe that a reimbursement rate in the range of
24 percent will adequately compensate companies for the reasonable
expenses of delivering crop insurance. This lower reimbursement rate
should not diminish service to the farmer nor destabilize the program.
Companies will still have the opportunity to realize underwriting profits as
they have since the program began. (See ch. 2.)

Finally, the industry questioned GAO’s methodology for comparing the cost
to the government of the industry’s and USDA’s delivery of catastrophic
insurance. Specifically, it stated that the processing fees paid by farmers
and the underwriting gains paid to companies should not be considered in
analyzing the costs to the government for catastrophic insurance delivery.
GAO disagrees that an analysis of the comparative costs to the government
of company- and USDA-delivered catastrophic insurance should exclude the
processing fee and underwriting gains components. In computing the
overall costs to the government, all revenue and payment components
have to be considered. The industry’s comments also indicate that it
believes GAO’s conclusions might mislead policymakers by implying that
delivery of catastrophic insurance by private industry should be reduced.
GAO does not believe that this is the case. GAO did not conclude or
recommend that the industry should have its role in catastrophic
insurance delivery reduced. GAO continues to hold the view, however, that
the level of underwriting gain paid to the companies should be managed so
that it more closely follows FCIC’s targets. (See ch. 3.)

The industry’s specific comments and GAO’s response are presented in
detail in appendixes VIII and IX.




Page 13                                          GAO/RCED-97-70 Crop Insurance
Contents



Executive Summary                                                                               4


Chapter 1                                                                                      18
                        How Federal Crop Insurance Works Under the Crop Insurance              19
Introduction              Reform Act of 1994
                        The Insurance Companies’ Role in Crop Insurance Delivery               21
                        Recent Federal Crop Insurance Sales                                    24
                        Government Costs Have Increased in Recent Years                        25
                        Objectives, Scope, and Methodology                                     25
                        USDA and Crop Insurance Industry Comments                              28

Chapter 2                                                                                      29
                        Reimbursements Exceed Expenses                                         29
Administrative          Other Reported Expenses Represent Opportunities to Lower               37
Expense                   Reimbursement Rates
                        Emerging Factors Have Increased Companies’ Revenues                    40
Reimbursements Paid     Conclusions                                                            43
by the Government       Recommendations to the Secretary of Agriculture                        44
Exceed Private          USDA and Crop Insurance Industry Comments                              44
Companies’ Expenses
Chapter 3                                                                                      47
                        Cost to the Government in 1995 for USDA Delivery Less Because          47
USDA Delivered 1995       of Underwriting Gain Paid to Companies
Catastrophic            1996 Legislation Directs USDA to Move Toward More Private              50
                          Company Delivery of Catastrophic Insurance
Insurance at Lower      Conclusions                                                            50
Cost to Government      Recommendation to the Secretary of Agriculture                         51
Than Private            USDA and Crop Insurance Industry Comments                              51
Companies
Chapter 4                                                                                      53
                        Four Alternatives to the Current Reimbursement Arrangement             53
Alternative Expense     Each Alternative Has Potential Advantages and Disadvantages            56
Reimbursement           Participating Companies Generally Prefer Current                       60
                          Reimbursement Arrangement
Arrangements Offer      USDA and Crop Insurance Industry Comments                              60
Potential for Savings



                        Page 14                                      GAO/RCED-97-70 Crop Insurance
             Contents




Appendixes   Appendix I: Simplification and Paperwork Reduction                      62
             Appendix II: Companies Included in Expense Review                       68
             Appendix III: Summary of Adjustments Made to Reported                   70
               Expenses of Nine Companies, 1994-95
             Appendix IV: Crop Insurance Companies’ Expenses for Selling             75
               and Servicing Crop Insurance
             Appendix V: Methodology for Comparing 1995 Cost to                      85
               Government to Deliver Catastrophic Insurance Through USDA
               and Private Companies
             Appendix VI: Explanation of Policy and Premium Data Used to             91
               Illustrate Alternative Expense Reimbursement Arrangements
             Appendix VII: GAO-Adjusted Delivery Expenses for Buyup                  92
               Insurance in Relation to Published Data on Commercial Lines of
               Insurance
             Appendix VIII: Comments From National Crop Insurance                    95
               Services, Inc.
             Appendix IX: Comments From the American Association of Crop            115
               Insurers and the Crop Insurance Research Bureau, Inc.
             Appendix X: Major Contributors to This Report                          152

Tables       Table 1.1: Participating Companies’ Gains, Losses, and                  24
               Administrative Expense Reimbursements, 1990-96
             Table 1.2: Total Crop Insurance Premiums Sold by Companies              24
               and USDA by Type, 1994-95
             Table 1.3: Government Cost of Federal Crop Insurance                    25
             Table 2.1: FCIC Reimbursements, Company Reported Delivery               36
               Expenses and GAO Adjustments for Nine Companies, 1994 and
               1995
             Table 2.2: Increase in FCIC’s Projected Market Prices Used in           41
               Determining Crop Insurance Premiums
             Table 3.1: 1995 Cost per Crop Policy for Government’s Cost to           49
               Deliver Catastrophic Insurance Through USDA and Private
               Companies
             Table 4.1: 1995 Distribution of Premiums and Reimbursements,            54
               Total and Average per Policy
             Table 4.2: Potential Savings Depend on Reimbursement Cap                56
               Level
             Table 4.3: Savings Potential for Different Reimbursement                57
               Combinations
             Table 4.4: Savings Potential for Declining Reimbursement Rates          59




             Page 15                                       GAO/RCED-97-70 Crop Insurance
         Contents




         Table II.1: Companies Included in 1994 Review                            68
         Table II.2: Companies Included in 1995 Review                            69
         Table III.1: Summary of Adjustments Made to Reported Expenses            71
           of Nine Companies, 1994-95
         Table IV.1: Company-Reported and GAO-Adjusted Expenses for               75
           Selling and Servicing Federal Crop Insurance, 1994
         Table IV.2: GAO-Adjusted Expenses for Selling and Servicing              77
           Federal Crop Insurance, 1994, as a Percent of Premium and in
           Terms of Dollars Per Policy and Dollars Per Unit
         Table IV.3: Company-Reported and GAO-Adjusted Expenses for               79
           Selling and Servicing Federal Crop Insurance, 1995
         Table IV.4: GAO-Adjusted Expenses for Catastrophic Insurance,            81
           1995, as a Percent of Premium and in Terms of Dollars per Policy
           and Dollars per Unit
         Table IV.5: GAO-Adjusted Expenses for Buyup Insurance, 1995,             83
           as a Percent of Premium and in Terms of Dollars per Policy and
           Dollars per Unit
         Table IV.6: Summary of Federal Crop Insurance Activity for the           84
           Nine Companies in Our Expense Review
         Table V.1: Cost to the Government to Deliver Catastrophic                88
           Insurance Through USDA, 1995
         Table V.2: Cost to the Government to Deliver Catastrophic                90
           Insurance Through Companies, 1995
         Table VI.1: 1995 Premiums and Policies by Type of Coverage               91
         Table VII.1: Delivery Expenses as a Percent of Premium for 1994          92
           and 1995 Adjusted Government Buyup Crop Insurance and
           Published 10-Year Averages for Commercial Insurance Lines

Figure   Figure 2.1: Reported Crop Insurance Delivery Expenses, 1994 and          31
           1995, Nine Participating Companies




         Abbreviations

         FAR        Federal Acquisition Regulation
         FCIC       Federal Crop Insurance Corporation
         FSA        Farm Service Agency
         NAIC       National Association of Insurance Commissioners
         NCIS       National Crop Insurance Services, Inc.
         USDA       U.S. Department of Agriculture


         Page 16                                        GAO/RCED-97-70 Crop Insurance
Page 17   GAO/RCED-97-70 Crop Insurance
Chapter 1

Introduction


               Federal crop insurance protects participating farmers against crop losses
               caused by perils such as droughts, floods, hurricanes, and other natural
               disasters. The federal program—which began on an experimental basis in
               1938 after private insurance companies were unable to establish a
               financially viable crop insurance business—was restructured and greatly
               expanded by key legislation in 1980 and 1994. A major component of the
               1980 legislation was the enlistment, for the first time, of private insurance
               companies to sell, service, and share the risk on federal crop insurance
               policies. In 1994, the Congress further broadened the program by offering
               farmers catastrophic risk insurance. This coverage, established at a
               minimum level, incorporated elements of the former crop disaster
               assistance program into crop insurance provided jointly by the U.S.
               Department of Agriculture (USDA) and private insurance companies.1

               USDA’s Risk Management Agency administers the federal crop insurance
               program through the Federal Crop Insurance Corporation (FCIC). FCIC pays
               the participating companies a fee, called an administrative expense
               reimbursement, that is intended to reimburse the companies for the
               reasonable expenses associated with selling and servicing crop insurance
               to farmers. The reimbursement is calculated as a percentage of the
               premiums paid, regardless of the expenses incurred by the companies. In
               addition to this reimbursement, participating insurance companies share
               with FCIC any gains or losses—known as underwriting gains and
               underwriting losses—that result from the insurance policies they sell. In
               1994, 22 participating insurance companies received $395 million from the
               program—about $292 million in administrative expense reimbursements
               plus about $103 million in underwriting gains. In 1995, 19 participating
               insurance companies received $506 million from the program—about
               $373 million in administrative expense reimbursements plus about
               $133 million in underwriting gains. Expense reimbursements and
               underwriting gains varied by company according to the amount of
               premiums written, the amount of risk retained, and the management of the
               risk retained.




               1
                This report focuses on multiple-peril crop insurance that protects against losses of production. Since
               1995, newer types of crop insurance have become available. These polices are designed to guarantee
               farmers a minimum level of revenue by protecting against production losses and fluctuations in crop
               prices.



               Page 18                                                            GAO/RCED-97-70 Crop Insurance
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                       Introduction




                       Federal crop insurance offers farmers two primary types of insurance
How Federal Crop       coverage—catastrophic and buyup. Both types of coverage are available
Insurance Works        for most major crops under the changes made by the Congress in the
Under the Crop         Federal Crop Insurance Reform and Department of Agriculture
                       Reorganization Act of 1994 (P.L. 103-354, Oct. 13, 1994, title I). This act
Insurance Reform Act   created catastrophic risk insurance as a replacement for expensive crop
of 1994                disaster assistance. Catastrophic insurance provides farmers with
                       protection against extreme crop losses for a small processing fee. Buyup
                       insurance provides protection against more typical and smaller crop losses
                       in exchange for a farmer-paid premium. Participating insurance companies
                       offer both types of insurance, whereas USDA’s Farm Service Agency (FSA),
                       through its local offices, offers only catastrophic insurance. Under the
                       terms of a negotiated agreement, participating insurance companies sell
                       crop insurance and process any claims in exchange for an administrative
                       expense reimbursement and for the opportunity to share in the potential
                       for underwriting gains. The government pays the total premium for
                       catastrophic insurance and a portion of the premium for buyup insurance.
                       FCIC establishes the premiums, terms and conditions for both types of
                       insurance.

                       Under the 1994 reform act, farmers who had not previously purchased
                       crop insurance were required to purchase at least catastrophic insurance
                       coverage if they signed up for USDA’s annual commodity programs;
                       obtained USDA’s farm ownership, operating, or emergency loans; or
                       contracted to place land in the Conservation Reserve Program.
                       Subsequently, the Federal Agriculture Improvement and Reform Act of
                       1996 (P.L. 104-127, Apr. 4, 1996) eliminated this mandatory linkage by
                       permitting farmers, effective for crops harvested in 1996, to forgo crop
                       insurance for any given crop without losing eligibility for other programs,
                       provided they waive all rights to any possible crop disaster assistance in
                       connection with the particular crop.

                       Catastrophic insurance, which protects farmers against extreme losses, is
                       often referred to as minimum coverage because it provides protection at
                       the lowest production and price levels offered. Catastrophic insurance
                       pays farmers only when they experience production losses greater than
                       50 percent of their normal crop. A normal crop is determined on the basis
                       of a farmer’s production history as reported to USDA’s local office or to the
                       insurance agent. For production losses greater than 50 percent, farmers
                       are paid 60 percent of FCIC’s projected market price for the crop.




                       Page 19                                           GAO/RCED-97-70 Crop Insurance
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Farmers desiring protection above the minimum price or production levels
provided by catastrophic insurance can purchase buyup insurance. Unlike
farmers who purchase catastrophic insurance, farmers purchasing buyup
insurance must choose both the coverage level (the proportion of the crop
to be insured) and the unit price (e.g., per bushel) at which any loss is
calculated. With respect to the coverage level, farmers can choose to
insure as much as 75 percent of normal production (25-percent
deductible) or as little as 50 percent of normal production (50-percent
deductible) at different price levels. With respect to unit price, farmers
choose whether to value their insured production at FCIC’s full projected
market price or at a percentage of the full price. FCIC adjusts farmers’
premiums according to the production and price levels selected.

The following example illustrates how a claim payment is determined
under catastrophic insurance, which insures 50 percent of production and
60 percent of the price. A farmer whose normal crop production averages
100 bushels of corn per acre and who chooses catastrophic insurance will
be guaranteed 50 percent of 100 bushels, or 50 bushels per acre. Assuming
that FCIC had estimated the market price for corn at $3 per bushel, the
farmer will be guaranteed a price of 60 percent of $3, or $1.80 per bushel.
The farmer’s total coverage per acre will be $90 (50 bushels x $1.80 per
bushel). This total amount will be paid in the event of a complete crop
failure. Should an event like drought cut the farmer’s actual harvest from
100 to 60 bushels, the farmer will not receive a payment because, in this
example, catastrophic insurance only pays if the yield drops below 50
bushels per acre. If a more severe problem caused the yield to fall to 25
bushels per acre, the farmer will be paid for the loss of 25 bushels per
acre—the difference between the insured production level of 50 bushels
and the actual production of 25 bushels. In this case, catastrophic
insurance will pay the farmer’s claim at $1.80 x 25 bushels, or $45 per acre.

If this same farmer chooses buyup insurance at the 75-percent coverage
level, the farmer will be guaranteed 75 percent of 100 bushels, or 75
bushels per acre. Assuming that the farmer had chosen the maximum price
coverage of 100 percent, and that FCIC had estimated the market price for
corn at $3 per bushel, the farmer’s price coverage will be $3 per bushel.
Accordingly, the farmer will have coverage in the event of a total crop loss
of $225 per acre (75 bushels x $3 per bushel). Should drought or other
perils cut the farmer’s actual harvest to 60 bushels, the farmer will be paid
for the loss of 15 bushels per acre—the difference between the insured
production level of 75 bushels and the actual production of 60 bushels. In
this case, buyup insurance will pay the farmer’s claim at $3 x 15 bushels,



Page 20                                          GAO/RCED-97-70 Crop Insurance
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                     Introduction




                     or $45 per acre. In the event of a more severe loss that reduced production
                     to a level of 25 bushels per acre, the farmer will be paid for the loss of 50
                     bushels per acre—the difference between the insured production level of
                     75 bushels and the actual production of 25 bushels. In this case, buyup
                     insurance will pay the farmer’s claim at $3 x 50 bushels, or $150 per acre.


                     According to a written agreement between FCIC and participating
The Insurance        insurance companies—called the standard reinsurance agreement—FCIC
Companies’ Role in   pays the participating companies a uniform reimbursement for
Crop Insurance       administrative expenses at a preestablished percentage of total premiums
                     to deliver—sell and service—catastrophic and buyup insurance. This base
Delivery             rate can be, and has been, supplemented to provide additional funding in
                     years when administrative costs were high because of excess losses or
                     when other factors require the companies to conduct additional work.
                     Beginning in 1994, as part of the agreement, FCIC required each
                     participating company to report its delivery expenses to FCIC for the prior
                     year to help determine the long-term adequacy of the reimbursement rate.
                     In addition to providing an administrative expense reimbursement, this
                     agreement governs the participating companies’ share of any underwriting
                     gains or losses resulting from the policies they sell.

                     FCIC does not directly reimburse the participating companies for their
                     actual costs of administering the program. Instead, FCIC pays all
                     participating companies a uniform administrative expense reimbursement
                     at a preestablished percentage of total premiums (including the
                     farmer-paid premium, government premium subsidy2 for buyup insurance,
                     and the imputed premium3 for catastrophic insurance). FCIC pays
                     participating companies an administrative expense reimbursement that is
                     intended to reimburse them for the expenses that can be reasonably
                     associated with the sale and service of federal crop insurance, including
                     the expenses associated with adjusting claims. Because the
                     reimbursement is not tied to specific expenses, the companies are not
                     obligated to spend the payment they receive on selling or servicing crop
                     insurance policies; the payments can be used in any way the companies
                     choose. Since 1980, in fact, the reimbursement rate has evolved as a result
                     of negotiations between FCIC and the participating companies and budget


                     2
                      FCIC pays a portion of the premium. The amount of the subsidy varies depending on the level of
                     coverage selected, averaging about 40 percent of the premium.
                     3
                      Farmers are not required to pay any premium for catastrophic insurance. However, for purposes of
                     computing the administrative reimbursement, FCIC credits the companies with sales based on the
                     total premiums that would otherwise apply for this level of insurance.



                     Page 21                                                         GAO/RCED-97-70 Crop Insurance
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concerns and has not been based on a systematic evaluation of companies’
expenses.

For buyup insurance, the administrative expense reimbursement base rate
under the standard reinsurance agreement has declined from a high of
34 percent of total premiums between 1988 and 1991 to 31 percent
between 1994 and 1996. In 1995, the administrative expense
reimbursement for buyup insurance totaled 32.6 percent of buyup
premiums. This reimbursement rate included a base administrative
expense reimbursement of 31.0 percent of premiums and a supplemental
reimbursement of 1.6 percent of premiums associated with extra
adjustments for crop losses in 1995. The 1994 reform act requires FCIC to
limit the reimbursement rate for selling and servicing buyup insurance to
no more than 29 percent of total premiums in 1997, no more than
28 percent in 1998, and no more than 27.5 percent by 1999. While this
reduction in reimbursement rate was mandated by the act, the established
rates were not based on a systematic evaluation of the costs associated
with selling and servicing crop insurance.

For catastrophic insurance, companies were paid a lower base
reimbursement rate—13.8 percent of the imputed premiums—for
delivering catastrophic insurance and were allowed to keep most of the
$50 processing fee paid by farmers. In 1995, compensation for catastrophic
insurance totaled 24.0 percent of catastrophic premiums, including (1) a
base administrative expense reimbursement of 13.8 percent of premiums;4
(2) a retained farmer-paid processing fee of $50, equating to 9.3 percent of
premiums; and (3) a supplemental reimbursement of 0.9 percent of
premiums associated with extra adjustments for crop losses in 1995.

Beginning in 1994, FCIC began to require companies to submit a detailed
expense report in a consistent format following standard industry
guidelines for the prior calendar year—1993. However, not all companies
complied with the new requirement until 1995 when they reported 1994
expense data. This expense reporting has to comply with a number of
guidelines, such as those that the National Association of Insurance
Commissioners issues on allocating expenses among lines of business.
These expense reports do not directly affect the amount paid to the
companies but rather provide support and serve as an indicator for
establishing future reimbursement rates for administrative expenses.
Included in the expenses reported are loss adjustment costs, sales

4
 This equates to 4.7 percent of premiums calculated at the buyup level of 65 percent coverage and
100 percent projected market price.



Page 22                                                          GAO/RCED-97-70 Crop Insurance
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Introduction




commissions paid to local insurance agents, and the general administrative
expenses associated with operating the insurance companies, such as
payroll, equipment, travel, training, and rent. Currently, FCIC is developing
a new standard reinsurance agreement, including new expense
reimbursement rates, that will be completed with the participating
companies in June 1997.

In addition to receiving an administrative expense reimbursement, the
participating companies share any underwriting gains or losses with FCIC
that result from the policies the companies sell. Underwriting gains occur
if the premiums exceed the claims paid on the policies. In the same
manner, underwriting losses occur when the claims paid exceed the
premiums. The participating companies are able to vary the extent to
which they share in the risk. In general, the companies choose to retain
more of the risk on the historically lower-loss producers and share more
of the risk with FCIC for those producers who have a history of more
frequent or more severe loss experience. In addition, to protect
participating companies against high underwriting losses in years with
extreme crop losses, FCIC limits the total loss that participating companies
must share.

The number of companies selling and servicing crop insurance for FCIC has
decreased from 27 in 1990 to 16 in 1996 because of business acquisitions
and changing business relations. Insurance premiums written by
participating companies during this same period increased from
$747 million in 1990 to $1.6 billion in 1996. As shown in table 1.1, FCIC paid
participating companies significantly larger administrative expense
reimbursements than the companies earned in underwriting gains between
1990 and 1996. This reflects the fact that the reimbursement is a fixed fee
based on premiums written, whereas the underwriting gain varies
depending on crop loss experiences.




Page 23                                           GAO/RCED-97-70 Crop Insurance
                                           Chapter 1
                                           Introduction




Table 1.1: Participating Companies’
Gains, Losses, and Administrative          Dollars in millions
Expense Reimbursements, 1990-96                                                                     Administrative
                                                                    Underwriting gain                    expense
                                           Year                                (loss)              reimbursement                   Total
                                           1990                                     $52                      $272                  $324
                                           1991                                      42                       245                   287
                                           1992                                      22                       246                   268
                                           1993                                      (82)                     250                   168
                                           1994                                     103                       292                   395
                                           1995                                     133                       373                   506
                                           1996 (estimate)                          258                       490                   748
                                           Total                                    $528                   $2,168                 $2,696
                                           Source: FCIC.




                                           Between 1994 and 1995, federal crop insurance sales increased from
Recent Federal Crop                        $918 million to over $1.5 billion. In 1995, catastrophic insurance accounted
Insurance Sales                            for $456 million in premiums, and buyup insurance accounted for an
                                           additional $1.1 billion in premiums. Before catastrophic insurance was
                                           available, the program had been generating average premiums of about
                                           $700 million a year. As shown in table 1.2, participating companies sold a
                                           larger portion of federal crop insurance than USDA.


Table 1.2: Total Crop Insurance Premiums Sold by Companies and USDA by Type, 1994-95
Dollars in millions

Insurance                    1994                                      1995                                          1996
type           Companies       USDA        Total     Companies          USDA               Total    Companies         USDA         Total
Catastrophic           $0           $0        $0             $175        $281               $456          $215         $209        $424
Buyup                $918           $0      $918           $1,086             $0       $1,086           $1,397              $0    $1,397
Total                $918           $0      $918           $1,261        $281          $1,543           $1,612         $209       $1,821
Market share          100%            0%     100%                82%          18%           100%            89%             11%     100%
                                           Source: FCIC.



                                           In 1996, federal catastrophic crop insurance sales decreased slightly to
                                           $424 million, while federal buyup insurance increased to almost
                                           $1.4 billion.




                                           Page 24                                                        GAO/RCED-97-70 Crop Insurance
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                                            Introduction




                                            Under the expanded federal crop insurance program created by the 1994
Government Costs                            reform act, program costs increased from over $700 million in the early
Have Increased in                           1990s to about $1.6 billion in 1996.5 As shown in table 1.3, federal crop
Recent Years                                insurance costs paid by the government totaled about $7.2 billion from
                                            1990 through 1996 and were made up of claims paid in excess of premiums
                                            ($1.6 billion), premium subsidy ($2.8 billion), administrative expense
                                            reimbursements ($2.2 billion), and other administrative costs
                                            ($611 million).


Table 1.3: Government Cost of Federal Crop Insurance
Dollars in millions
                         Claims paid in                                     Administrative                    Other
                    excess of premiums                                           expense              administrative           Total government
Fiscal year           and other income Premium subsidy                    reimbursements                      costs                        cost
1990                               $233                      $213                       $272                        $87                   $805
1991                                247                       196                         245                        84                    772
1992                                232                       197                         246                        88                    763
1993                                751                       198                         250                       105                   1,304
1994                                (127)                     247                         292                        78                    490
1995                                188                       774                         373                       105                   1,440
1996 (estimated)                     88                       978                         490                        64                   1,620
Total                            $1,612                     $2,803                    $2,168                      $611                   $7,194
                                            Source: FCIC.




                                            Concerned about the cost-effective delivery of federal crop insurance and
Objectives, Scope,                          recognizing the important role the private insurance industry plays in
and Methodology                             delivering federal crop insurance, the Congress, in section 118 of the
                                            Federal Crop Insurance Reform and Department of Agriculture
                                            Reorganization Act of 1994, directed GAO and FCIC to jointly evaluate the
                                            financial arrangements between FCIC and participating insurance
                                            companies for delivering the crop insurance program to qualified
                                            producers and to address several specific issues. Separately, USDA’s Risk
                                            Management Agency will report on the adequacy of return on capital to
                                            insurance companies and alternative reinsurance arrangements between
                                            the government and the companies. Our review focused on the following
                                            two issues:




                                            5
                                             For 1990 through 1993, crop disaster assistance averaged $1.1 billion annually.



                                            Page 25                                                            GAO/RCED-97-70 Crop Insurance
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    Introduction




•   The adequacy and reasonableness of the current administrative
    reimbursement rate for expenses of participating companies; and
•   The cost to the government of private-sector delivery compared with USDA
    delivery of catastrophic insurance.

    As required by the act, we also reviewed and reported on (1) the
    advantages and disadvantages of alternatives to the current arrangement
    for reimbursing administrative expenses, and (2) FCIC’s actions to simplify
    procedural and administrative requirements. The results of our work for
    these two topics are reported in chapter 4 and appendix I, respectively.

    To assess the adequacy of the current reimbursement rate for
    administrative expenses, we compared participating companies’ reported
    expenses for selling and servicing buyup insurance with reimbursements
    they received from FCIC for 1994 and 1995. Not all participating companies
    reported these expenses to FCIC in a consistent format until 1994;
    furthermore, 1996 expenses for selling and servicing crop insurance were
    not complete at the time of our review. We assessed expense data for crop
    insurance at nine participating companies that represented about 80 and
    85 percent of the crop insurance premiums in 1994 and 1995, respectively.
    To gain an understanding of crop insurance expenditures, we interviewed
    representatives from participating companies and obtained an explanation
    of all reported expenses. In addition, to evaluate the reasonableness of
    reported expenses, we used as guidance FCIC’s listing of allowable
    expenses, the National Association of Insurance Commissioners’
    guidelines, generally accepted accounting principles, federal acquisition
    regulations, and the Internal Revenue Code.

    Within the framework of these standards and guidelines, we made
    judgments about what we considered to be reasonably associated
    expenses for selling, processing, and adjusting crop insurance policies for
    the federal government and discussed these judgments with the FCIC
    officials responsible for administering the program. Generally, we
    considered as reasonable those expenses associated with (1) interacting
    with farmers, (2) reviewing insured property, (3) processing policy and
    claims paperwork, and (4) related overhead and indirect costs, including
    the training and travel of staff. As part of our review, we examined
    participating companies’ complete list of reported expenses. For a
    judgmental sample of these reported expenses, we traced the expenses to
    source documents. Our results reflect only the findings at the companies
    we reviewed and do not necessarily reflect the conditions for other
    companies selling federal crop insurance. We did not specifically validate



    Page 26                                         GAO/RCED-97-70 Crop Insurance
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Introduction




companies’ accounting systems, but we did review each company’s
audited financial statements to ensure ourselves that the financial data
provided were reasonable. Appendix II provides a list of the participating
companies we visited.

To examine the cost differences to the government between USDA and
private-sector delivery of catastrophic insurance, we analyzed the
government’s costs to use participating companies in comparison with the
costs of using USDA. To perform our analysis, we obtained 1995 data on the
costs to deliver catastrophic insurance through USDA, including costs for
USDA’s headquarters in Washington D.C.; its main field offices in Kansas
City, Missouri; and its state, regional service, district, and local offices. We
reduced the costs for USDA’s delivery system by the amount of processing
fees the Department collected from farmers for catastrophic insurance.
We made the reduction because USDA uses these fees to reduce other
government expenditures. To identify the government’s costs to use
participating companies to deliver catastrophic insurance, we obtained
data from FCIC on administrative expense reimbursements as well as
underwriting gains paid to companies that participated in the catastrophic
insurance program in 1995.

To identify alternative methods for expense reimbursements, we
interviewed officials of selected participating companies, trade
associations, and USDA. We then narrowed the compilation down to four
distinct alternatives and analyzed them against the 1995 crop insurance
experience, where reasonable, to measure their impact as if they had been
in place for that year. We also determined qualitative factors associated
with each of the methods through discussions with industry and FCIC
officials.

To determine the status of procedural and administrative simplification,
we reviewed FCIC’s summary of completed and in-progress simplification
and paperwork reduction actions; and we reviewed potential
simplification actions proposed by FCIC and by representatives of the crop
insurance industry. We discussed the potential cost and benefit of these
proposed actions with crop insurance company and FCIC officials. The
information we developed is presented in appendix I.

We conducted our review from March 1996 through March 1997 in
accordance with generally accepted government auditing standards.
Although we did not independently assess the accuracy and reliability of




Page 27                                            GAO/RCED-97-70 Crop Insurance
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                     Introduction




                     USDA’s
                          computerized databases, we used the same files USDA uses to
                     manage the crop insurance program and its local county offices.

                     In December 1996, we provided USDA officials and representatives of
                     National Crop Insurance Services, Inc., the American Association of Crop
                     Insurers, the Crop Insurance Research Bureau, Inc., and several individual
                     companies with a detailed briefing on the results of our review. In
                     March 1997, we provided a copy of our draft report to USDA and to the crop
                     insurance industry organizations for their review and comment. The
                     Department’s and industry’s comments are addressed at the end of each
                     chapter. In addition, the industry’s written comments are reproduced in
                     appendixes VIII and IX.


                     USDA’s  Risk Management Agency found no fault with our methodology.
USDA and Crop        However, the industry associations that received copies of our draft report
Insurance Industry   stated that our review did not fully respond to the Congress’ mandate in
Comments             the 1994 reform act because we focused on delivery costs and did not
                     address other requirements of the act. We focused on delivery costs
                     because, in researching the legislative history of this mandate, we found
                     that in the context of funding this program in a deficit reduction
                     environment, the paramount congressional interest was in controlling the
                     costs of reimbursing crop insurers. Furthermore, we confirmed our
                     interpretation of the mandate in a commitment letter sent to the Chairmen
                     and Ranking Minority Members of the Senate Committee on Agriculture,
                     Nutrition, and Forestry and the House Committee on Agriculture. This
                     letter set forth our approach for meeting this mandate including our scope
                     and methodology. Consequently, we focused on costs incurred by insurers
                     that are reimbursed by the government in order to provide the information
                     most useful to congressional decisionmakers. Therefore, we believe that
                     the report fulfills the Congress’ mandate.




                     Page 28                                         GAO/RCED-97-70 Crop Insurance
Chapter 2

Administrative Expense Reimbursements
Paid by the Government Exceed Private
Companies’ Expenses
                  In 1994 and 1995, FCIC’s reimbursement payments to the nine participating
                  companies in our review were higher than the expenses that can be
                  reasonably associated with the sale and service of federal crop insurance.
                  For the 2-year period, the companies we reviewed reported $542.3 million
                  in expenses, compared with a reimbursement of $580.2 million—a
                  difference of about $38 million. In addition, our review of the companies’
                  reported expenses showed that about $43 million did not appear to be
                  reasonably associated with the sale and service of federal crop insurance
                  to farmers and thus, should not be considered in determining future
                  administrative reimbursement rates. These expenses included payments to
                  compensate company executives for refraining from joining or starting
                  competing companies, fees paid to other insurance companies to protect
                  against underwriting loss, bonuses tied to company profitability,
                  management fees paid to parent companies with no identifiable benefit to
                  subsidiary crop insurance companies, and lobbying expenses.

                  We further identified a number of expenses reported by the companies
                  that, while in categories that can be reasonably associated with the sale
                  and service of crop insurance, seemed to be excessive for a
                  taxpayer-supported program. These expenses included above-average
                  commissions paid to agents by one large company, corporate aircraft and
                  excessive automobile charges, country club memberships, and various
                  entertainment activities for agents and employees, such as stadium sky
                  box rentals at professional sporting events and company-sponsored
                  fishing trips. Although nothing in the current agreement between FCIC and
                  the insurance companies precludes the companies from spending on these
                  items, we believe that these types of expenses suggest that opportunities
                  exist for the government to reduce its future reimbursement rate.
                  Furthermore, a variety of emerging factors, including higher crop prices
                  and higher premium rates in 1996 and 1997, and program simplification,
                  have increased companies’ revenues or may decrease companies’
                  expenses.


                  For 1994 and 1995, companies collectively reported expenses that were
Reimbursements    less than the administrative expense reimbursement they received from
Exceed Expenses   FCIC. For 1994, the reimbursement was equal to the expenses reported, and
                  for 1995, reported expenses were about $38 million less than the
                  reimbursement. After examining the companies’ expense reports,
                  however, we determined that a number of the reported expenses did not
                  appear to be reasonably associated with the sale and service of crop
                  insurance to farmers and thus, should not be considered in determining an



                  Page 29                                        GAO/RCED-97-70 Crop Insurance
                           Chapter 2
                           Administrative Expense Reimbursements
                           Paid by the Government Exceed Private
                           Companies’ Expenses




                           appropriate future reimbursement rate for administrative expenses. After
                           adjusting the expense reports to delete these items, we found that the
                           expenses reasonably associated with crop insurance delivery were about
                           $43 million less than those reported.


Companies Received         In total for 1994 and 1995, the nine companies we reviewed reported
Higher Reimbursements      expenses for buyup and catastrophic crop insurance sales and service that
Than Their Expenses Over   were somewhat less than the administrative expense reimbursement FCIC
                           paid them. FCIC administrative expense reimbursements paid to
2-Year Period              participating companies in 1994 and 1995 were 31 and 31.4 percent of total
                           premiums,1 respectively. This represented $236.5 million in 1994 and
                           $343.6 million in 1995. For these same years, the companies reported
                           expenses of 31 percent, or $236.8 million, and 27.9 percent, or
                           $305.5 million, respectively. Collectively, reported expenses were
                           $38 million less than the reimbursements the companies received.

                           As shown in figure 2.1, the largest component of the expenses reported by
                           the companies went to pay sales commissions to local insurance agents.




                           1
                            In this context, total premiums include the farmer-paid premium as well as the government-paid
                           premium subsidy. For catastrophic coverage, the entire premium amount is subsidized by the
                           government.



                           Page 30                                                          GAO/RCED-97-70 Crop Insurance
                                      Chapter 2
                                      Administrative Expense Reimbursements
                                      Paid by the Government Exceed Private
                                      Companies’ Expenses




Figure 2.1: Reported Crop Insurance
Delivery Expenses, 1994 and 1995,     20.0   Percentage of premium
Nine Participating Companies
                                             17.2



                                      15.0            14.5




                                      10.0


                                                                                                      6.7
                                                                                                              6.2

                                       5.0                                               4.2
                                                                                   3.9
                                                                3.2    3.0




                                        0

                                                Agents’           Loss adjusting     Employee           Other
                                                commissions                          salaries           administrative


                                                Expenses

                                                       1994

                                                       1995



                                      Source: GAO’s analysis of nine participating companies’ data.




                                      The average commission reported for 1995 was less than in
                                      1994—14.5 percent of total premiums compared with 17.2 percent of total
                                      premiums in 1994. The 1995 average commission was lower because in
                                      that year companies combined catastrophic expenses, which have lower
                                      agent commissions, with buyup expenses. With respect to loss-adjusting
                                      expenses, although insurance claims were higher in 1995 than in 1994, the
                                      company reports that showed average loss-adjusting expenses as a
                                      percent of premium actually dropped slightly in 1995.




                                      Page 31                                                         GAO/RCED-97-70 Crop Insurance
                                  Chapter 2
                                  Administrative Expense Reimbursements
                                  Paid by the Government Exceed Private
                                  Companies’ Expenses




Some Reported Expenses            Our review of the nine companies’ reported expenses showed that about
Do Not Appear to Be               $43 million did not appear to be reasonably associated with the sale and
Reasonably Associated             service of federal crop insurance to farmers and thus should not be
                                  considered in determining an appropriate future reimbursement rate for
With Crop Insurance               administrative expenses. Expenses reported by the companies that did not
Delivery                          appear to contribute to the sale and service of crop insurance were
                                  expenses related to

                              •   acquiring competitors’ businesses,
                              •   protecting companies from underwriting losses,
                              •   sharing profits through bonuses or management fees,
                              •   lobbying, and
                              •   reporting errors and omissions.

                                  Each of these types of expenses is discussed below.

Expenses Related to               Among the reported costs that did not appear to be reasonably associated
Acquisition of Competitors’       with the sale and service of crop insurance to farmers were those related
Businesses                        to costs the companies incurred when they acquired competitors’
                                  business. These costs potentially aided the companies in vying for market
                                  share and meant that one larger company, rather than several smaller
                                  companies, was delivering crop insurance to farmers. However, this
                                  consolidation was not required for the sale and service of crop insurance
                                  to farmers, provided no net value to the crop insurance program, and
                                  according to FCIC, was not an expense that FCIC expected its
                                  reimbursement to cover.

                                  We identified costs in this general category totaling
                                  $12 million—$8.3 million in 1994 and $3.7 million in 1995. For example,
                                  one company took over the business of a competing company under a
                                  lease arrangement. The lease payment totaled $3 million in both 1994 and
                                  1995. About $400,000 of this payment could be attributed to actual physical
                                  assets the company was leasing and we recognized this amount as a
                                  reasonable expense. However, the remaining $2.6 million—which the
                                  company was paying each year for access to the former competitor’s
                                  policyholder base—provided no benefit to the farmer and added no net
                                  value to the program. Likewise, we saw no apparent benefit to the crop
                                  insurance program from the $1.5 million the company paid executives of
                                  the acquired company over the 2-year period as compensation for not
                                  competing in the industry.




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                                 In a related instance, the company reported a $3.9 million expense to write
                                 down the value of an acquired company because of liabilities identified
                                 after acquiring that company’s business. These liabilities arose from crop
                                 insurance claims in dispute, crop insurance claims paid in error, premium
                                 adjustments, legal actions, and bad debts relating to the acquired
                                 company’s operations in prior years. This expense reflected a cost that the
                                 company incurred to increase its market share and provided no net benefit
                                 to the program. Although FCIC did not explicitly refer to this type of
                                 expense in its last standard reinsurance agreement with companies, we
                                 discussed this type of expense with FCIC. It agreed that this expense
                                 cannot be reasonably associated with the sale and service of crop
                                 insurance and thus should not be considered in determining a future
                                 reimbursement rate for administrative expenses.

Expenses Related to Protecting   We also found that two companies included payments to commercial
the Companies From               reinsurers among their reported delivery expenses for crop insurance.
Underwriting Losses              These are payments the companies made to other insurance companies to
                                 expand their protection against potential underwriting losses. This
                                 commercial reinsurance allows companies to expand the amount of
                                 insurance they are permitted to sell under insurance regulations while
                                 limiting their underwriting losses. The cost of reinsurance relates to
                                 companies’ decisions to manage underwriting risks rather than to the sale
                                 and service of crop insurance to farmers. Although FCIC did not explicitly
                                 refer to this type of expense in its last standard reinsurance agreement
                                 with companies, we discussed this type of expense with FCIC. It agreed that
                                 this expense should be paid from company underwriting results and thus
                                 should not be considered in determining a future reimbursement rate for
                                 administrative expenses. For the two companies that reported reinsurance
                                 costs as an administrative expense, these expenses totaled $10.7 million
                                 over the 2 years—$5.4 million in 1994 and $5.3 million in 1995.

Expenses Resulting From          Among their reported administrative expenses for crop insurance, some
Sharing Profits Through          companies included expenses resulting from decisions to share profits
Bonuses or Management Fees       with (1) company executives and employees through bonuses or
                                 (2) parent companies through management fees. We found that
                                 expenditures in this general category totaled $12.2 million—$5 million in
                                 1994 and $7.2 million in 1995. We do not believe that bonuses associated
                                 with profit sharing are appropriate for inclusion in a long-term
                                 reimbursement rate. In contrast, we believe that bonuses given to
                                 recognize employee performance, as well as bonuses paid to agents, are
                                 reasonable expenses associated with the sale and service of crop
                                 insurance, and we included them as reasonable expenses.



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                                Profit-sharing bonuses—bonuses linked to overall company profitability
                                for each year—were a significant component of total salary expenses at
                                one company, equaling 49 percent of basic salaries in 1994 and 63 percent
                                in 1995, and totaling $9 million for the 2 years. Total employee salaries at
                                this company, as a percent of premium, were somewhat less than at other
                                companies. However, when the profit-sharing bonuses—paid out of profits
                                after all necessary program expenses were paid—were added to salaries,
                                overall employee salaries at this company were 35-percent higher than the
                                nine-company average. While company profit sharing may benefit a
                                company in competing with another company for employees, the
                                profit-sharing bonuses, which in this particular case seemed excessive, do
                                not contribute to the overall sale and service of crop insurance or serve to
                                enhance program objectives. Additionally, we identified profit-sharing
                                bonuses totaling $2.1 million reported as expenses at three other
                                companies for 1994 and 1995. FCIC agrees that this type of expense goes
                                beyond the reasonable expenses associated with the sale and service of
                                crop insurance.

                                Similarly, we noted that two companies reported expenditures for
                                management fees paid to parent companies as administrative expenses for
                                crop insurance. Company representatives provided few examples of
                                tangible benefits received in return for their payment of the management
                                fee. We recognized management fees as a reasonable program expense to
                                the extent that companies could identify tangible benefits received from
                                parent companies. Otherwise, we considered payment of management fees
                                to be a method of sharing income with the parent company and paid in the
                                form of a before-profit expense item rather than as a dividend. These
                                expenses totaled $1.1 million for 1994 and 1995.

                                Although FCIC did not explicitly refer to these types of expenses in its last
                                standard reinsurance agreement with companies, we discussed these
                                expenses with FCIC. It agreed that to the extent the expenses exceed
                                tangible benefits to the companies, they cannot be reasonably associated
                                with the sale and service of crop insurance and thus should not be
                                considered in determining an appropriate future reimbursement rate for
                                administrative expenses.

Lobbying and Related Expenses   FCIC’s standard reinsurance agreement with the companies precludes them
                                from reporting expenditures for lobbying as crop insurance delivery
                                expenses. Despite this prohibition, we found in our sample of company
                                transactions that the companies included a total of $418,400 for lobbying
                                and related expenses in their expense reporting for 1994 and 1995. The



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                             vast majority of these expenses involved lobbying by crop insurance trade
                             associations.

                             Each company in our review paid membership fees to one or more crop
                             insurance trade associations. Lobbying is one of the services provided to
                             the companies by these associations. In accordance with Internal Revenue
                             Service’s rules, each industry trade association provided information to its
                             members on the extent to which the payments to the association were
                             used to fund lobbying activities. Nevertheless, none of the companies in
                             our review excluded these expenses from their expense reports.

Expenses Reported in Error   We also identified a number of errors and/or omissions in the companies’
and Omitted Expenses         expense reporting. In 1994, the net effect of these errors and omissions
                             was to reduce total company expenses by $8.4 million, whereas in 1995,
                             the net effect was to increase total company expenses by $0.6 million.

                             In our review of companies’ reported expenses, we identified various
                             errors and/or omissions including expenses reported in the wrong year,
                             expenses reported twice, and expenses not reported at all. Also, we found
                             that five companies erred in reporting a total of $1.8 million in state
                             income taxes as an expense of selling and servicing crop insurance in 1994
                             and 1995. State income taxes are the result of successful crop insurance
                             delivery and are not an administrative expense associated with the sale
                             and service of crop insurance to farmers, whether the taxes are based on
                             underwriting gains or on profits made from the delivery itself. To the
                             extent that the taxes are based on profits from the delivery, they are not
                             associated with the sale and service of crop insurance because, according
                             to FCIC, companies are expected to earn profits from underwriting—not
                             from administrative reimbursements. To the extent that the taxes are
                             based on underwriting gains, they should not be recognized as an expense
                             of delivering crop insurance.




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Table 2.1: FCIC Reimbursements, Company Reported Delivery Expenses and GAO Adjustments for Nine Companies, 1994
and 1995
Dollars in thousands
                                                              1994                                    1995
Factors considered in calculating                               Percent of total                             Percent of total
adequacy of expense reimbursement                       Dollars      premiums                   Dollars           premiums             Total
FCIC reimbursements to companies                       $236,544                31.0           $343,632                  31.4       $580,176
Company-reported expenses                              $236,822                31.0           $305,468                  27.9       $542,289
GAO’s adjustments
Expenses related to acquisition of other                 (8,356)                (1.1)            (3,661)                 (0.3)       (12,017)
companies
Expenses related to managing underwriting                (5,416)                (0.7)            (5,322)                 (0.5)       (10,738)
risk
Expenses related to profit sharing through               (4,981)                (0.7)            (7,237)                 (0.7)       (12,219)
bonuses or management fees
Lobbying and related expenses                              (114)                (0.0)              (305)                 (0.0)          (418)
Errors and omitted expenses                              (8,356)                (1.1)               626                  0.1          (7,730)
Total adjustments                                      ($27,223)                (3.6)         ($15,899)                  (1.5)      ($43,122)
GAO’s adjusted expenses reasonably                     $209,599                27.5           $289,569                  26.4       $499,167
associated with selling and servicing crop
insurance
FCIC’s reimbursements in excess of                      $26,945                  3.5           $54,063                   4.9        $81,008
reasonable program expenses
                                             Note: Totals may not add because of rounding.

                                             Source: GAO’s analysis of nine participating companies’ data.



                                             Collectively, as shown in table 2.1, for the nine companies we reviewed,
                                             we found that the expenses reasonably associated with the sale and
                                             service of buyup and catastrophic crop insurance combined were 27.5
                                             percent of total premiums for 1994 and 26.4 percent for 1995. These rates
                                             are considerably lower than the 31 percent and 31.4 percent of total
                                             premiums paid by FCIC to reimburse the companies for these sales in those
                                             years. In total for 1994 and 1995, FCIC reimbursements exceeded delivery
                                             expenses by $81 million. FCIC reviewed and agreed with our analysis and
                                             treatment of these expenses.

                                             Appendix III provides a complete listing of those expenses that do not
                                             appear to be reasonably associated with the sale and service of federal
                                             crop insurance and should not be considered in determining an
                                             appropriate future administrative expense reimbursement. Appendix III
                                             also includes our rationale for expense adjustments. Appendix IV shows



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                      the expenses for selling and servicing federal crop insurance as reported
                      by the nine companies in our review and our presentation of the expenses
                      reasonably associated with the sale and service of federal crop insurance.
                      In addition, for 1995, appendix IV shows adjusted expenses as they relate
                      to buyup and to catastrophic insurance. As shown in the appendix, for
                      1995, companies’ adjusted expenses related to buyup insurance were
                      27.1 percent of premiums and expenses related to catastrophic insurance
                      were 22.2 percent of premiums. In comparison, in 1995, companies
                      received an administrative expense reimbursement for buyup insurance of
                      32.6 percent of buyup premiums and compensation for catastrophic
                      insurance of 24 percent of premiums.


                      We also found a number of expenses reported by the nine companies that,
Other Reported        while in categories associated with the sale and service of crop insurance,
Expenses Represent    seemed to be excessive in nature for a taxpayer-supported program and
Opportunities to      offer opportunities for FCIC to reduce future reimbursement rates.
                      Collectively, controlling these expenses should reduce the average cost of
Lower                 selling and servicing crop insurance policies. These expenses included
Reimbursement Rates   above-average commissions to agents on buyup policies; travel expenses,
                      such as corporate aircraft and excessive automobile charges; and
                      entertainment expenses, such as country club memberships and stadium
                      sky box rentals. Each of these types of expenses is discussed below.


Agent Commissions     In the crop insurance business, participating companies compete with
                      each other for market share through the sales commissions paid to
                      independent insurance agents. To this end, companies offer higher
                      commissions to agents to attract them and their farmer clients from one
                      company to another. When an agent switches from one company to
                      another, the acquiring company increases market share, but there is no net
                      benefit to the crop insurance program. On average, the nine companies in
                      our review paid agents sales commissions of 16 percent of buyup
                      premiums they sold in 1994 and 16.2 percent in 1995. However, one
                      company paid more—about 18.1 percent of buyup premiums sold in 1994
                      and 17.5 percent in 1995. When this company, which accounted for about
                      15 percent of all sales in these 2 years, is not included in the companies’
                      average, commission expenses for the other eight companies averaged
                      15.6 percent of buyup premiums in 1994 and 15.8 percent in 1995. This
                      company paid its agents about $6 million more than the amount it would
                      have paid had it used the average commission rate paid by the other eight




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                          companies. According to FCIC officials, the agency plans to further study
                          the issue of appropriate agent commissions.


Travel-Related Expenses   Employee travel is an essential part of selling and servicing crop
                          insurance. Although FCIC has not provided specific guidance on
                          appropriate expenses for travel, government travel regulations provide
                          guidance as to what type of expenses might be appropriate when
                          conducting business on behalf of the government. In our review of
                          company-reported expenses, at eight of the nine companies we found
                          instances of expenses that seemed to be excessive for conducting a
                          taxpayer-supported program.

                          For example, we found that one company in our sample for 1994 reported
                          expenses of $8,391 to send six company managers (four accompanied by
                          their spouses) to a 3-day meeting at a resort location. The billing from the
                          resort included rooms at $323 per night, $405 in golf green fees, $139 in
                          charges at a golf pro shop, and numerous restaurant and bar charges. Our
                          sample for 1995 included a $31,483 billing from the same resort for lodging
                          and other costs associated with a company “retreat” costing a total of
                          $46,857. Furthermore, we found in one instance, as part of paying for
                          employees to attend industry meetings at resort locations, a company paid
                          for golf tournament entry fees, tickets to an amusement park, spouse
                          travel, child care, and pet care. The company reported these as delivery
                          expenses for crop insurance.

                          Moreover, our samples of travel expenditures revealed instances of
                          charges that appeared to involve the purchase of items not related to
                          business. For example, at one company, our sample included charges to
                          the company corporate charge card of $107 at a department store, $175 at
                          a clothing store, $165 at a country club gift shop, $364 at a book and
                          record shop, $41 at an airport gift shop, $209 at a resort gift shop, $208 at a
                          hotel gift shop, and $928 from a cruise line. We found similar examples at
                          five other companies.

                          Some companies incurred expenses associated with maintaining their own
                          travel fleet. For example, one company owned a corporate jet and another
                          leased an aircraft. Both employed full-time pilots. Subsequent to the years
                          involved in our review, both companies decided it would be more
                          cost-effective to rely more heavily on commercial flights instead of owned
                          or leased aircraft. The companies we reviewed varied widely with respect
                          to furnishing automobiles—from providing only a few pool automobiles,



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                         to providing automobiles for a few officials, to providing automobiles for
                         up to 45 percent of company employees. The types of vehicles also varied
                         from luxury and sport utility to standard and economy.

                         FCIC’s guidelines do not tell companies how they must spend their
                         administrative expense reimbursement. However, in our opinion, if the
                         current reimbursement provides companies with the opportunities to
                         travel as described above, FCIC may be able to reduce its reimbursement
                         rate and still reimburse companies for the reasonable expenses of selling
                         and servicing crop insurance to farmers.


Entertainment Expenses   Recruiting new employees and maintaining employee morale is a
                         reasonable business expense. However, our review of company expenses
                         showed that some companies’ entertainment expenditures appeared
                         excessive for selling and servicing crop insurance to farmers. For example,
                         one company spent about $44,000 in 1994 for Canadian fishing trips for a
                         group of company employees and agents. It also spent about $18,000 to
                         rent and furnish a sky box at a baseball stadium. Company officials said
                         the expenditures were necessary to attract agents to the company. These
                         expenditures were reported as travel expenses in 1994 and as advertising
                         expenses in 1995. Moreover, the company’s 1995 travel expenses included
                         $22,000 for a trip to Las Vegas for several company employees and agents.
                         Similarly, our sample of company expenditures disclosed payment for
                         season tickets to various professional sports events at two other
                         companies; and six companies paid for country club memberships and
                         related charges for various company officials and reported these as
                         expenses to sell and service crop insurance.

                         Companies also purchased promotional items as gifts for agents and
                         employees. For example, our 1994 sample of expenditures at one company
                         included $17,514 paid for 1,375 boxes of chocolates and $8,242 paid to
                         purchase 2,000 cookbooks as gifts to agents and employees.

                         While a number of the companies believe the type of expenses described
                         above are important to maintaining an effective sales force and supporting
                         their companies’ mission, we believe that most of these expenses appear
                         to be excessive for a taxpayer-supported program. These entertainment
                         expenses may be helpful in competing for agents, but it is not clear how
                         these types of expenses directly benefit either the farmer or the
                         government in the delivery of crop insurance to farmers. We did not
                         exclude the above items from our determination of necessary delivery



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                             expenses because they were in categories that appear to be associated
                             with crop insurance delivery. But FCIC agreed that these types of expenses
                             may be excessive for a government-sponsored program like federal crop
                             insurance.


                             Several emerging factors affecting the crop insurance program have
Emerging Factors             increased companies’ revenues or may decrease companies’ expenses.
Have Increased               These factors include the following:
Companies’ Revenues
                         •   higher crop prices and higher premium rates in 1996 and 1997 that resulted
                             in higher premium income;
                         •   expanded use of new types of revenue guarantee coverage (such as crop
                             revenue coverage) that, for a higher premium, protects farmers against
                             price drops between planting and harvest; and
                         •   continuing simplification of program administrative requirements,
                             potentially resulting in reduced company expenses.

                             Higher crop prices and higher premium rates could enable FCIC to reduce
                             the administrative expense reimbursement by about 3 percent of buyup
                             premiums below the adjusted expense level determined in our analysis of
                             companies’ 1994-95 expenses without diminishing service to farmers. New
                             types of revenue guarantee coverage as well as simplification actions
                             could serve to increase companies’ revenues or decrease companies’
                             expenses even further in the future. Each of these factors is discussed
                             below.


Higher Crop Prices and       Two factors affecting the premiums paid by farmers have improved the
Premium Rates                income potential of crop insurance companies over the levels achieved in
                             1994 and 1995. These two factors are the (1) FCIC-projected market price of
                             the commodity to be insured and (2) premium rate established by FCIC.
                             When projected market prices and premium rates increase, the premiums
                             that farmers pay increase. When the premiums that farmers pay increase,
                             reimbursements to companies—which are currently paid on the basis of a
                             percentage of premiums—increase proportionately without a
                             proportionate increase in workload for the companies.

                             As shown in table 2.2, the projected market price FCIC used in establishing
                             crop insurance premiums for six major crops increased 9.2 percent from
                             1995 to 1997, after the 1994-95 period we reviewed.




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Table 2.2: Increase in FCIC’s Projected
Market Prices Used in Determining                                                                                                    Percent
                                                                                       FCIC’s projected market prices          increase from
Crop Insurance Premiums
                                          Crop                                               1995          1996       1997       1995 to 1997
                                          Soybeans                                          $5.50          $6.75     $6.15                11.8
                                          (per bushel)
                                          Grain sorghum                                       2.10          2.50      2.30                   9.5
                                          (per bushel)
                                          Corn                                                2.25          2.65      2.45                   8.9
                                          (per bushel)
                                          Wheat                                               3.35          3.55      3.85                14.9
                                          (per bushel)
                                          Peanuts                                             0.34          0.34      0.34                   0.0
                                          (per pound)
                                          Cotton                                              0.68          0.67      0.69                   1.5
                                          (per pound)
                                          Weighted average percent                                                                           9.2
                                          increase from 1995 to 1997a
                                          a
                                              Weighted by 1995 crop insurance liabilities for each crop.

                                          Source: GAO’s analysis of FCIC’s data.



                                          Furthermore, to improve the actuarial soundness of the program, FCIC has
                                          increased the basic premium rates that are the other principal component
                                          of the crop insurance premiums.2 From 1995 to 1996, basic premium rates
                                          for buyup insurance increased 3.6 percent, on average.3 FCIC projects
                                          premium rates to further increase in 1997. The increase in premium rates
                                          combined with the increase in crop prices resulted in an overall increase
                                          in premiums of about 13 percent. This increase occurred after the period
                                          we studied.

                                          As a result of this increase in premiums, companies will receive a
                                          proportionate increase in their administrative expense reimbursement,
                                          about 3 percent of premiums, unless FCIC reduces the reimbursement rate.
                                          The additional 3 percent of premiums—the 13-percent increase in
                                          premiums multiplied by the 27.1 percent of premiums that we determined
                                          represents companies’ expenses reasonably associated with the sale and
                                          service of buyup crop insurance in 1995—is in effect an unanticipated
                                          bonus to the companies and does not represent additional work for them.

                                          2
                                           In 1995, we recommended that the Secretary of Agriculture raise crop insurance premium rates to
                                          improve actuarial soundness. See Crop Insurance: Additional Actions Could Further Improve
                                          Program’s Financial Condition (GAO/RCED-95-269, Sept. 28, 1995).
                                          3
                                           The increase is calculated from the earned premium rate—the ratio of total premiums to total
                                          liabilities—for buyup crop insurance.



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                          This means that FCIC, at current crop price and premium rates, could
                          reduce the administrative reimbursement for buyup insurance by about
                          3 percentage points and still reimburse companies for the reasonable
                          expenses associated with selling and servicing crop insurance. Conversely,
                          if premiums decline, the companies would receive a proportionate
                          decrease in their expense reimbursement.

                          The increase in the companies’ reimbursement resulting from the higher
                          premiums that have occurred since 1995 will not be accompanied by a
                          proportionate increase in the companies’ workload. Company
                          administrative work processes remain essentially the same regardless of
                          the premium charged. For example, the cost of data entry and
                          transmission is a function of the number of documents and data elements
                          processed and transmitted, not the premiums those documents represent.
                          Similarly, the cost of loss adjustment is a function of the frequency and
                          nature of crop loss, not the premiums charged on the damaged crops.
                          Thus, as premiums increase, the companies receive windfall increases in
                          their income unless the reimbursement percentage is reduced.


Expanded Use of Revenue   A second factor that may improve the companies’ income potential is the
Guarantee Coverage        introduction of a more expensive form of crop insurance. In 1996, FCIC
                          approved a privately developed revenue guarantee crop insurance policy
                          on a pilot basis in seven states. In January 1997, FCIC’s board of directors
                          authorized the expansion of this program to additional crops and states.
                          The revenue guarantee policy protects producers against a decline in the
                          value of the insured crop. The decline in value could occur because of
                          crop loss, as with traditional crop insurance policies, or it could result
                          from decline in commodity prices, or some combination of the two.
                          Because of the increased risk borne by the revenue guarantee program,
                          premiums are considerably higher than those charged for conventional
                          crop insurance. Thus, because the companies’ reimbursement is based on
                          a percentage of total premiums, they will receive higher reimbursements
                          without a commensurate increase in workload. A recent FCIC proposal
                          addresses the potentially high administrative reimbursement associated
                          with this product by limiting the administrative reimbursement for the
                          price-risk aspect of the program.


Program Simplification    A third emerging factor affecting the crop insurance program may aid the
Efforts                   companies in reducing their administrative expenses. As part of
                          implementing the 1994 crop insurance reform act, FCIC and the crop



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                  insurance industry jointly studied potential procedural changes that could
                  result in simplifying or streamlining program delivery processes. As of
                  January 1997, FCIC had completed action on 26 simplification projects
                  identified by the study group and was continuing to study 11 additional
                  potential changes. Simplification projects FCIC has implemented include

              •   restructuring actuarial documents, thereby reducing printed pages by
                  one-third;
              •   providing actuarial documents electronically;
              •   simplifying processing of small claims;
              •   authorizing companies to correct obvious and incidental errors directly;
              •   integrating various options and endorsements into crop insurance policies;
                  and
              •   implementing a single insurance policy format for most crops.

                  Neither FCIC nor the companies could precisely quantify the amount of
                  savings that can be expected from these changes, but they agreed that the
                  changes were necessary and collectively may reduce costs somewhat.
                  Industry representatives emphasized that FCIC should continue to
                  emphasize simplifying the delivery procedures. FCIC officials agreed but
                  noted that any changes must be carefully analyzed on the basis of their
                  impact on the actuarial soundness of the crop insurance program.
                  Appendix I provides a more detailed discussion of these changes and their
                  potential effects.


                  On the basis of our review of companies’ reported expenses and emerging
Conclusions       factors in the crop insurance industry, we believe that the current expense
                  reimbursement rate paid to participating companies exceeds the
                  reasonable expenses associated with selling and servicing crop insurance.
                  Our review showed that for 1994 and 1995, the actual expenses reasonably
                  associated with the sale and service of buyup crop insurance for the nine
                  companies in our review were about 27 percent of
                  premiums—4 percentage points below the 31-percent base reimbursement
                  rate paid to companies—and that FCIC could reduce rates another
                  3 percent of premiums because of higher crop prices and increased
                  premiums in 1996 and 1997 that provided companies with higher
                  reimbursements without any additional work. This would still provide
                  participating companies with adequate reimbursement for the reasonable
                  expenses associated with selling and servicing crop insurance. The 1994
                  reform act directs FCIC to reduce the overall reimbursement for buyup
                  insurance to no more than 27.5 percent of total premiums in 1999.



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                         However, we believe that the administrative reimbursement rate can be
                         reduced to a lower level at the current time—in the range of 24 percent.
                         Our analysis also showed that the compensation for catastrophic
                         insurance exceeded the companies’ expenses that can be reasonably
                         associated with selling and servicing catastrophic insurance, although to a
                         lesser extent.


                         We recommend that the Secretary of Agriculture direct the Administrator
Recommendations to       of the Risk Management Agency to
the Secretary of
Agriculture          •   determine the administrative expense reimbursement rate that reflects the
                         appropriate and reasonable costs of selling and servicing traditional buyup
                         insurance and include this rate in the new agreement currently being
                         developed with the companies;
                     •   determine the compensation that reflects the appropriate and reasonable
                         costs of selling and servicing catastrophic crop insurance and include it in
                         the new agreement currently being developed with the companies;
                     •   explicitly convey to participating insurance companies the type of
                         expenses that the administrative reimbursement is intended to cover; and
                     •   monitor companies’ expenses to ensure that the established rate is
                         reasonable for the services provided.


                         Overall, USDA’s Risk Management Agency agreed with the information
USDA and Crop            presented in the draft report and its conclusions and recommendations. In
Insurance Industry       its proposed 1998 standard reinsurance agreement with the private
Comments                 insurance companies, FCIC has included changes to the expense
                         reimbursement rate for delivering both buyup and catastrophic insurance.
                         Additionally, in this proposed agreement, FCIC has clarified the types of
                         expenses that the administrative reimbursement is intended to cover, and
                         it plans to monitor companies’ expenses in the future as a result of our
                         review. USDA’s Risk Management Agency also examined the methodology
                         used to conduct the review and found no fault in it.

                         In responding to our report, the industry raised questions about the
                         methodology we used in our analysis of companies’ reasonable delivery
                         expenses, including (1) the time period we examined; (2) the standards we
                         used to judge allowability of expenses; and (3) the applicability of
                         emerging factors, such as increased premiums and higher crop prices. In
                         addition, without being specific, the industry stated that a lower




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Administrative Expense Reimbursements
Paid by the Government Exceed Private
Companies’ Expenses




reimbursement rate—in the range of 24 percent—would “destabilize” the
industry.

With respect to the time period examined, we selected 1994 and 1995 to
provide a picture of expenses for delivering crop insurance before and
after the implementation of the 1994 reform act. Furthermore, these were
the first 2 years that the industry consistently provided the detailed data in
a format needed to fully analyze the expenses associated with the selling
and servicing of crop insurance. The industry stated that we understated
administrative expenses by using 2 years in which crop losses were
relatively low. We disagree. Crop losses for buyup coverage in 1995 were
equal to or higher than crop loss experiences throughout the 1990s, except
for 1993. Furthermore, we found that high crop losses did not significantly
increase companies’ loss-adjusting expenses—the delivery cost factor
most likely to be affected by high crop losses. For example, for buyup
insurance, while companies paid out $1.28 in loss claims for every dollar
of premium received in 1995 and $0.58 in loss claims for every dollar of
premium received in 1994, their related loss adjusting expenses as a
percent of premium for these 2 years were not substantially different.
Therefore, although losses were higher in 1995 than in 1994, the
companies’ loss adjusting expenses for processing these claims did not
increase commensurately. In addition, loss adjusting expenses are not a
significant portion of total administrative expenses (about 3.5 percent of
premiums on average for the nine companies we reviewed). Furthermore,
since the 1980s, the crop insurance companies have received additional
reimbursements in years of high crop losses.

Second, the standards we used to identify reasonable costs for delivering
crop insurance were developed on the basis of a number of different
widely recognized accounting, insurance, and acquisition standards. FCIC
agreed that the standards used were appropriate. We recognized all
expenses reasonably associated with selling and servicing crop insurance.
However, we continue to believe that the government should not be
expected to reimburse companies for such expenses as those related to
maximizing underwriting gains, acquiring other companies’ business,
payments to executives to refrain from joining or starting other
companies, payments to parent companies with no measurable benefits to
the program, profit-sharing bonuses, and payments to lobbyists. We
believe that these expenses should not be included in determining an
appropriate future reimbursement rate for administrative expenses.




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Administrative Expense Reimbursements
Paid by the Government Exceed Private
Companies’ Expenses




Third, two factors that have emerged since the 1994-95 time period that we
reviewed—higher premium rates and higher crop prices in 1996 and
1997—should be considered in evaluating the appropriate, future
reasonable reimbursement rate because these factors did increase
companies’ revenues without increasing expenses. Furthermore, USDA
projects that crop prices will generally increase through 2005. If crop
prices decline, FCIC could reevaluate the reimbursement rate.

Finally, we disagree that a lower reimbursement rate—in the range of 24
percent—would destabilize the industry. Such a rate represents the
companies’ current expenses that are reasonably associated with the sale
and service of crop insurance and as a result should not diminish service
to the farmer nor destabilize the program. Companies will still have the
opportunity to realize underwriting profits. In 1994 and 1995, for example,
the companies realized underwriting profits of $103 million and
$133 million, respectively.

(See apps. VIII and IX for the industry’s comments and our detailed
response.)




Page 46                                         GAO/RCED-97-70 Crop Insurance
Chapter 3

USDA Delivered 1995 Catastrophic
Insurance at Lower Cost to Government
Than Private Companies
                     In 1995, farmers without crop insurance were required to purchase
                     catastrophic risk protection insurance to participate in federal farm
                     programs—a requirement that was rescinded in 1996. Farmers could
                     purchase catastrophic insurance either from USDA’s FSA local offices or
                     from an authorized local insurance agent. In 1995, it was more costly for
                     the government to deliver catastrophic insurance through private
                     companies than through USDA. When basic delivery costs were offset by
                     income from farmer-paid processing fees, the costs to the government for
                     selling and servicing catastrophic insurance in 1995 were comparable for
                     both USDA and private companies. However, delivery through private
                     companies was more costly to the government because the companies
                     retained an estimated $45 million underwriting gain. In 1995, FCIC’s
                     long-term target for underwriting gain was 7 percent on the premiums for
                     which the companies retained risk. However, in 1995, the underwriting
                     gain paid by FCIC to the companies was about 37 percent. FCIC is currently
                     studying the issue of an appropriate long-term rate of return for companies
                     participating in the program. Legislation passed in 1996 requires USDA to
                     move delivery of catastrophic insurance solely to private companies,
                     where feasible.


                     In 1995, the total cost to the government to deliver catastrophic insurance
Cost to the          was less when provided through USDA than through private companies. The
Government in 1995   total cost to the government to deliver catastrophic insurance consists of
for USDA Delivery    three components: (1) basic sales and service delivery costs, (2) offsetting
                     income from processing fees paid by farmers, and (3) company-earned
Less Because of      underwriting gains. When only the first and second components were
Underwriting Gain    considered, the costs to the government for both delivery systems were
                     comparable. However, the payment of an underwriting gain to companies,
Paid to Companies    the third component, made the total cost of company delivery more
                     expensive to the government.

                     With respect to the first component—the costs of basic sales and service
                     delivery—the cost to the government was higher when provided through
                     USDA. The costs of basic sales and service for USDA’s delivery included
                     expenses associated with activities such as selling and processing policies,
                     developing computer software, training adjusters, and adjusting claims.
                     This cost also included indirect or overhead costs such as general
                     administration, rent, and utilities. Included in the 1995 direct and indirect
                     costs for USDA delivery was the Department’s one-time start-up costs for
                     establishing the USDA delivery system. Direct costs for basic delivery
                     through USDA amounted to about $91 per crop policy, and indirect costs



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Chapter 3
USDA Delivered 1995 Catastrophic
Insurance at Lower Cost to Government
Than Private Companies




amounted to about $42 per crop policy, for a total basic delivery cost to
the government of about $133 per crop policy. Appendix V provides more
detail on the components of total government costs to deliver catastrophic
insurance through USDA and insurance companies.

The basic delivery cost for company delivery consists of the administrative
expense reimbursement paid to companies by FCIC and the cost of
administrative support provided by USDA. The administrative expense
reimbursement amounted to about $73 per crop policy, and USDA’s support
costs amounted to about $10 per crop policy, for a total basic delivery cost
to the government for company delivery of about $83 per crop policy.

The second component—offsetting income from farmer-paid processing
fees—reduced the basic delivery cost to the government for both delivery
systems, but had a much larger impact in reducing the cost to the
government for the USDA delivery system. In 1995, farmers buying
catastrophic insurance were required to pay a $50 processing fee for each
crop they insured, up to certain limits. For USDA’s delivery, processing fees
paid by farmers reduced the government’s basic delivery cost of about
$133 by an average of $53 per crop policy.1 For company delivery, fees
paid by farmers and remitted to the government reduced the government’s
basic delivery cost of about $83 by $7 per crop policy. For company
delivery, the effect on the cost to the government was relatively small
because the 1994 reform act authorized the companies to retain the fees
they collected from farmers up to certain limits. Only those fees that
exceeded these limits were remitted back to the government. Combining
the basic sales and service delivery costs and the offsetting income from
farmer-paid processing fees, the government’s costs were comparable for
both delivery systems.

The third component—underwriting gains paid by FCIC only to the
companies—is the element that made delivery through USDA less
expensive. The insurance companies can earn underwriting gains in
exchange for taking responsibility for any claims resulting from those
policies for which the companies retain risk. In 1995, companies earned an
underwriting gain of an estimated $45 million, or about a 37-percent return
on the catastrophic premiums for which they retained risk. This
underwriting gain increased the government’s delivery cost for company
delivery by $127 per crop policy. Underwriting gains are, of course, not
guaranteed. In years with a high incidence of catastrophic losses,

1
 This $53 amount was calculated using data provided by FCIC on 803,438 crop policies sold by local
FSA offices and $42,822,950 in fees collected.



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                                       Chapter 3
                                       USDA Delivered 1995 Catastrophic
                                       Insurance at Lower Cost to Government
                                       Than Private Companies




                                       companies could experience net underwriting losses, meaning that they
                                       would have to pay out money from their reserves in excess of the
                                       premiums paid to them by the government, potentially reducing the
                                       government’s total cost of company delivery in such years.

                                       Table 3.1 summarizes the three components of the government’s cost to
                                       deliver catastrophic insurance through USDA and companies in dollars per
                                       crop policy for 1995.

Table 3.1: 1995 Cost Per Crop Policy
for Government’s Cost to Deliver       Components                                Government               Government
Catastrophic Insurance Through USDA    of cost                                        cost of                  cost of
and Private Companies                  to government                            USDA delivery         company delivery
                                       Basic delivery cost                            $132.72                    $83.37
                                       Less: fees remitted to                           53.30                       7.21
                                       government
                                       Subtotal cost to government                     $79.42                    $76.16
                                       Plus: underwriting gain                            n/a                    127.06
                                       paid to companies
                                       Total cost to government                        $79.42                   $203.22
                                       Source: GAO’s analysis of USDA’s data.



                                       The table shows that, overall, the government’s cost for delivering
                                       catastrophic insurance through USDA was about $124 less per crop policy
                                       than the delivery cost through companies in 1995.

                                       The 1995 catastrophic underwriting gain of about 37 percent was the
                                       critical component in the difference in comparative costs between USDA
                                       and company delivery. This gain was substantially higher than FCIC’s
                                       established long-term target of 7 percent for underwriting gains on the
                                       catastrophic premiums for which the companies retain risk. According to
                                       FCIC’s Senior Actuary, the large underwriting gain in 1995 may have been
                                       unusual. However, the program’s experience in 1996 suggests that the
                                       large underwriting gain in 1995 may not be that unusual; 1996 underwriting
                                       gains were even higher—about $58 million. FCIC is currently studying the
                                       issue of an appropriate long-term rate of return for companies
                                       participating in the program.




                                       Page 49                                             GAO/RCED-97-70 Crop Insurance
                       Chapter 3
                       USDA Delivered 1995 Catastrophic
                       Insurance at Lower Cost to Government
                       Than Private Companies




                       Beginning with crops harvested in 1997, the Federal Agriculture
1996 Legislation       Improvement and Reform Act of 1996 requires that USDA’s delivery of
Directs USDA to Move   catastrophic insurance be transferred to private companies in areas where
Toward More Private    there are sufficient private company providers. In July 1996, the Secretary
                       of Agriculture, after consultation with approved insurance providers,
Company Delivery of    identified 14 states in which USDA would no longer deliver catastrophic
Catastrophic           policies. Effective for the 1997 crop year, catastrophic policyholders in
                       these 14 states who purchased catastrophic coverage from USDA were
Insurance              either to select a local private company or be assigned by USDA to a local
                       private company. The 14 states are Arizona, Colorado, Illinois, Indiana,
                       Iowa, Kansas, Minnesota, Montana, Nebraska, North Carolina, North
                       Dakota, South Dakota, Washington, and Wyoming.

                       According to the American Association of Crop Insurers, crop insurance
                       industry executives unanimously support securing the remaining 36 states
                       for private delivery, beginning with crops harvested in 1998. According to
                       the Federal Agriculture Improvement and Reform Act of 1996, the
                       Secretary of Agriculture must make the announcement for any additional
                       states where USDA delivery is to be phased out by April 30 of the year
                       preceding the year in which the applicable crops will be harvested.


                       If only 1995 is considered, the delivery of catastrophic insurance through
Conclusions            USDA is less expensive to the government than through companies because
                       of the underwriting gains companies earned. These gains, 37 percent of
                       catastrophic premiums on which the companies retained risk, were far
                       higher than FCIC’s long-term target gain of 7 percent. Over time, gains and
                       losses may offset each other, and the target gain may be realized.
                       However, if underwriting gains do not become more commensurate with
                       FCIC’s target gain, the potential for high government costs and high
                       company profits will continue. FCIC is aware of this situation and is
                       currently studying the issue of an appropriate long-term rate of return for
                       companies participating in the program. Furthermore, this issue of
                       potentially high costs and high profits takes on added importance because
                       of the requirements of the Federal Agriculture Improvement and Reform
                       Act of 1996. This act requires USDA to transfer its delivery of catastrophic
                       insurance to private companies in areas where there are sufficient private
                       company providers.




                       Page 50                                          GAO/RCED-97-70 Crop Insurance
                     Chapter 3
                     USDA Delivered 1995 Catastrophic
                     Insurance at Lower Cost to Government
                     Than Private Companies




                     We recommend that the Secretary of Agriculture direct the Administrator
Recommendation to    of the Risk Management Agency to closely monitor the experience of the
the Secretary of     catastrophic insurance program to ensure that over time the underwriting
Agriculture          gains earned on catastrophic insurance by the companies do not routinely
                     exceed FCIC’s long-term target.


                     FCIC agreed with our conclusions and recommendation and has already
USDA and Crop        changed the proposed 1998 standard reinsurance agreement to ensure that
Insurance Industry   underwriting gains on catastrophic insurance will be more closely in line
Comments             with its long-term target.

                     The industry, however, questioned our methodology for comparing the
                     cost to the government of the USDA and company delivery systems.
                     Specifically, it stated that the processing fees paid by farmers and the
                     underwriting gains paid to companies should not be considered in
                     analyzing the costs to the government for catastrophic insurance delivery.
                     It also suggested that restricting our analysis to 1995 provided a distorted
                     picture of underwriting gains because it only represented 1 year’s
                     experience. It further stated that our analysis did not take into account
                     that, in its view, the quality of service provided to farmers by the
                     companies was much higher than that provided by USDA.

                     We disagree that an analysis of the comparative costs to the government of
                     company- and USDA-delivered catastrophic insurance should exclude the
                     processing fee and underwriting gains components. In computing the
                     overall costs to the government, all revenue and payment components
                     have to be considered. With respect to the industry’s concern about our
                     period of analysis, 1995 was the only year in which a comparative
                     assessment could be made at the time we conducted our review because it
                     was the only year in which both USDA and the companies were delivering
                     catastrophic insurance. Since then, however, we note that underwriting
                     gains paid to the companies in 1996 exceeded those paid in 1995. This
                     would serve to make the cost to the government for company-delivered
                     catastrophic insurance even higher. With respect to the issue of
                     comparative service quality, we did not make this a principal focus of our
                     review. However, during the course of our work, we found little to suggest
                     that the service provided by companies or USDA was less than satisfactory.

                     The industry’s comments also indicate that it believes our conclusions
                     might mislead public policymakers by implying that delivery of
                     catastrophic insurance by private industry should be reduced. We do not



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USDA Delivered 1995 Catastrophic
Insurance at Lower Cost to Government
Than Private Companies




believe that this is the case. We did not conclude or recommend that the
industry should have its role in catastrophic insurance delivery reduced.
We do hold the view, however, that the level of underwriting gain paid to
the companies should be managed so that it more closely follows FCIC’s
target.




Page 52                                         GAO/RCED-97-70 Crop Insurance
Chapter 4

Alternative Expense Reimbursement
Arrangements Offer Potential for Savings

                           The current method for reimbursing administrative expenses for buyup
                           insurance—whereby FCIC pays private companies a fixed percentage of
                           premiums—has certain advantages, including ease of administration.
                           However, expense reimbursement based on a percentage of premiums
                           does not necessarily reflect the amount of work or cost involved to sell
                           and service crop insurance policies. We identified four alternative
                           reimbursement arrangements that offer the potential to reduce FCIC’s
                           reimbursements and to more closely match reimbursements with
                           expenses. Each has advantages and disadvantages. Industry leaders prefer
                           FCIC’s current reimbursement method because it is relatively simple to
                           administer and because they believe that most alternatives could reduce
                           their reimbursements.


                           Through our discussions with FCIC and crop insurance industry officials,
Four Alternatives to       we identified the following four alternatives to the current expense
the Current                reimbursement method that offer potential cost savings to the government
Reimbursement              and may more closely match FCIC’s reimbursements with companies’
                           expenses:
Arrangement
                       •   place a cap on the amount reimbursed per policy;
                       •   reimburse companies a flat fee per policy, plus a reduced percentage of
                           premiums;
                       •   reimburse companies according to a schedule of allowable expenses; and
                       •   reduce reimbursement rates as companies’ total premium volume
                           increases.

                           Currently, FCIC calculates administrative expense reimbursements by
                           multiplying companies’ total written premiums by a set reimbursement
                           percentage, regardless of the expenses incurred by the company to sell
                           and service crop insurance. Table 4.1 shows the 1995 distribution of
                           premiums and reimbursements for certain buyup policies for all
                           participating companies.1




                           1
                            We limited our analysis to policies with “additional” coverage—the most frequently purchased type of
                           coverage. Additional coverage includes coverage equal to or greater than 65 percent of the yield
                           guarantee at 100 percent of the projected market price. These policies represented about 65 percent of
                           the crop insurance premiums written in 1995. Although farmers are permitted to select different
                           coverage levels for their operational units, they are also permitted to purchase one policy covering
                           their entire farming operations. Our analysis was limited to those policies with additional coverage for
                           the entire farming operation. See app. VI.



                           Page 53                                                            GAO/RCED-97-70 Crop Insurance
                                         Chapter 4
                                         Alternative Expense Reimbursement
                                         Arrangements Offer Potential for Savings




Table 4.1: 1995 Distribution of Premiums and Reimbursements, Total and Average Per Policy
                                   Premiums             Number of policies                        1995 reimbursement
  Premium range                           Average per                Percent by                           Percent by Average per
From             To      Total ($000)             policy          Count           range    Total ($000)       range       policy
$1             $499          $39,627               $213         186,156            43.6        $12,284          4.9          $66
500            1,499         101,957                 900        113,321            26.5         31,607         12.5          279
1,500          4,999         247,675               2,723          90,956           21.3         76,779         30.4          844
5,000          9,999         162,669               6,853          23,736            5.6         50,428         20.0        2,125
10,000        49,999         222,070             17,421           12,747            3.0         68,842         27.3        5,401
50,000        99,999          23,905             65,674              364            0.1          7,411          2.9       20,359
100,000     499,999           14,097            167,821               84            0.0a         4,370          1.7       52,024
500,000        & up            2,044          1,021,993                 2           0.0a           634          0.3      316,818
Total                      $814,045              $1,905         427,366           100.0      $252,354         100.0         $590
                                         Note: Totals may not add because of rounding.
                                         a
                                             Amount less than 0.1 percent.

                                         Source: GAO’s analysis of FCIC’s data.



                                         Each of the four alternatives, as discussed below, has the potential to
                                         more closely match FCIC’s expense reimbursements to the expenses
                                         actually incurred by the companies for the sale and service of crop
                                         insurance. In addition to having cost savings potential, the four
                                         alternatives offer specific advantages and disadvantages. To illustrate the
                                         four alternatives, we applied them to the 1995 experience data shown in
                                         table 4.1


Alternative 1—Place a Cap                Under the current reimbursement arrangement, as policy premiums
on Reimbursements Per                    increase, the companies’ reimbursement from FCIC for administering the
Policy                                   policies increases. However, the workload, or cost, associated with
                                         administering the policy generally does not increase proportionately.
                                         Therefore, for policies with the highest premiums, there may be a large
                                         differential between FCIC’s reimbursement and the costs incurred to
                                         administer those policies. For example, in 1995, the largest 3 percent of
                                         the policies received about one-third of the total reimbursement. In fact,
                                         the five largest policies in 1995 had reimbursements ranging from about
                                         $118,000 to $472,000. FCIC could reduce its total expense reimbursements
                                         to companies by capping, or placing a limit on, the amount it reimburses
                                         companies for the sale and service of crop insurance policies.




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                           Alternative Expense Reimbursement
                           Arrangements Offer Potential for Savings




Alternative 2—Pay a Flat   For each crop insurance policy written, an insurance company must
Amount Per Policy Plus a   perform some minimum level of work, regardless of the premium. The
Percentage of Premiums     company, usually through an agent, must obtain, record, and process
                           certain basic policy information. The company performs additional work
                           that varies, generally depending on the size of the farm and value of the
                           crops insured. A larger farm may require more time to measure and
                           inspect the component fields and more contacts with the farmer. This
                           alternative is designed to recognize both the fixed and variable aspects of
                           selling and servicing crop insurance policies. For example, FCIC could
                           reimburse companies a fixed amount (such as $100) for each policy
                           written to pay for the fixed expense associated with each policy. In
                           addition, FCIC could pay a percentage of premiums to compensate
                           companies for the variable expenses associated with the size and value of
                           a policy.


Alternative 3—Tie          Administrative expense reimbursements could be tied to the cost of
Reimbursements to          performing specific services that benefit the crop insurance program. For
Schedule of Allowable      example, most government contractors are paid on the basis of the
                           Federal Acquisition Regulation (FAR),2 which establishes a schedule of
Expenses                   allowable expenses. Using the FAR, a contractor providing goods and
                           services to the federal government submits a bill that is audited against a
                           schedule of allowable expenses, and subsequently, the government pays
                           an adjusted amount to the contractor, if appropriate. Using this approach,
                           the amount paid would include only reimbursement for allowed expenses.
                           FCIC could limit the overall reimbursement rate and limit the
                           reimbursement rate for specific components, such as commissions, data
                           processing, and travel. Companies could also be required to follow federal
                           guidelines to reimburse employees or contractors for any travel.


Alternative 4—Reduce       Assuming companies can realize some economies of scale for certain cost
Reimbursement Rates as     items, FCIC could reduce the reimbursement rates for individual companies
Premium Volumes Increase   as their written premium volumes increase. For example, some expenses,
                           such as underwriting and overhead, are based on fixed expenses, such as
                           investments in equipment and facilities, annual training, and state licenses
                           and fees. These types of fixed expenses decrease as a percent of total
                           premiums written as premium volume increases. Currently, FCIC pays the
                           same percent of written premiums to participating companies regardless
                           of the companies’ size of operation or premium amount written. Under this


                           2
                            48 C.F.R. chapter 31 et seq.



                           Page 55                                          GAO/RCED-97-70 Crop Insurance
                                            Chapter 4
                                            Alternative Expense Reimbursement
                                            Arrangements Offer Potential for Savings




                                            alternative, FCIC would reimburse companies on a sliding scale based on
                                            premium volume.


                                            We found that all four alternatives have the potential to reduce FCIC’s
Each Alternative Has                        reimbursement for administrative expenses. Each alternative, however,
Potential Advantages                        has advantages and disadvantages compared with the current
and Disadvantages                           reimbursement arrangement. For example, some alternatives have the
                                            advantage of possibly encouraging smaller companies to participate in the
                                            program. On the other hand, some alternatives have the potential
                                            disadvantage of increasing the administrative burden on FCIC or decreasing
                                            incentives for participating companies to deliver crop insurance. The
                                            potential advantages and disadvantages of each alternative are discussed
                                            below.


Place a Cap on                              Under this alternative, FCIC could realize the largest amount of
Reimbursements Per                          administrative reimbursement savings while only affecting a relatively
Policy                                      small percentage of policies. This alternative would eliminate high
                                            reimbursement payments for large or high-premium policies. To illustrate,
                                            to calculate potential cost savings using this alternative, we capped the
                                            administrative expense reimbursements on individual policies at three
                                            different levels—$1,550, $3,100, and $6,200—affecting about 9, 3, and
                                            1 percent, respectively, of policies in 1995. Potential savings generated
                                            from this alternative would depend at what level the cap was established,
                                            as shown in table 4.2.


Table 4.2: Potential Savings Depend on Reimbursement Cap Level
                                 Premiums                                                                 Percent              Average
Per policy                       per policy         Alternative Potential savings                      of policies   reimbursement as a
reimbursement                     related to    reimbursement          (dollars in                    affected by        percent of total
cap                      reimbursement cap (dollars in millions)         millions)                            cap              premium
$1,550                   $5,000 and above                     $177.9                  $74.4                   8.6                   21.9
3,100                    10,000 and above                      212.0                      40.3                3.1                   26.0
6,200                    20,000 and above                      234.1                      18.2                0.9                   28.8
                                            Note: Reimbursement is based on 31 percent of premiums.

                                            Source: GAO’s analysis of FCIC’s 1995 data.



                                            As shown in the table, a $3,100 cap would have created a $40.3 million
                                            savings while reimbursing companies at the 31-percent reimbursement




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                                           Alternative Expense Reimbursement
                                           Arrangements Offer Potential for Savings




                                           level for more than 95 percent of the policies written in 1995. Only about 3
                                           percent of all policies written would have been affected by using a $3,100
                                           cap on reimbursements. Decreasing the cap to $1,550 would have provided
                                           savings to the government of about $74 million while limiting
                                           reimbursements on less than 10 percent of the policies written in 1995.

                                           Although offering the potential for significant cost savings, this alternative
                                           has the disadvantage of possibly discouraging some companies from
                                           aggressively marketing larger crop insurance policies for FCIC.


Paying a Flat Amount Per                   This alternative offers a potential for cost savings that is somewhat less
Policy Plus a Percentage of                than capping reimbursements at $1,550 per policy, but it may encourage
Premiums                                   companies to sell small-premium policies. To illustrate the potential for
                                           cost savings, we selected three different reimbursement combinations. As
                                           shown in table 4.3, if FCIC reimbursed companies a fixed $100
                                           reimbursement per policy plus 17.5 percent of the premiums, the overall
                                           average reimbursement rate would be 22.8 percent. Compared with the
                                           1995 reimbursement method, this approach would produce a savings of 8.2
                                           percent of premiums, or about $67 million, from the 31 percent
                                           reimbursement rate. Table 4.3 also illustrates other reimbursement
                                           combinations.


Table 4.3: Savings Potential for Different Reimbursement Combinations
                                                            Alternative 1995 reimbursement
Alternative                            Alternative                                                  Average
reimbursement                reimbursement (dollars                                      reimbursement as a       Potential savings
arrangements                           in millions)         Average per policy           percent of premium     (dollars in millions)
20 percent plus $100 per                     $205.5                     $480.96                        25.3                    $46.8
policy
17.5 percent plus $100 per                    185.2                       433.34                       22.8                     67.2
policy
17.5 percent plus $150 per                    206.6                       483.34                       25.4                     45.8
policy
                                           Source: GAO’s analysis of FCIC’s 1995 data.



                                           Because one component of the reimbursement would be a flat fee
                                           regardless of premium size, reimbursements for small, or low-premium,
                                           policies under this alternative may exceed reimbursements for these kinds
                                           of policies under the current system. This may encourage sales and service
                                           to smaller farmers, a goal advanced by some crop insurance observers.




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                           Chapter 4
                           Alternative Expense Reimbursement
                           Arrangements Offer Potential for Savings




                           This alternative has the further advantage of more closely matching FCIC’s
                           reimbursement to the administrative workload of the companies and their
                           agents. Finally, unlike the previous alternative that capped
                           reimbursements, reimbursements under this alternative would still be
                           linked in part to premiums. Therefore, companies will continue to have an
                           incentive to sell higher coverage.

                           This alternative has the disadvantage of requiring FCIC to more closely
                           monitor companies to ensure they do not generate additional policies
                           solely to increase their revenue.


Tying Reimbursements to    This alternative would offer FCIC the opportunity to better control the
Schedule of Allowable      expenses to be reimbursed by paying participating companies according to
Expenses                   a schedule of allowable expenses for performing specific services, such as
                           selling and writing a policy, processing a policy, and adjusting claims.
                           Companies could be required to reimburse employees or contractors for
                           any travel according to federal reimbursement guidelines for travel. Using
                           the FAR, a contractor providing goods and services to the federal
                           government submits a bill that is audited against a schedule of allowable
                           expenses, and subsequently, the government pays an adjusted amount to
                           the contractor, if appropriate. Savings under this alternative would depend
                           upon the rates agreed to by FCIC and the companies. In addition, this
                           alternative could provide participating companies with additional
                           protection during years with high crop losses by reimbursing them for the
                           actual loss-adjusting expenses they incur.

                           A major disadvantage of this alternative is that FCIC would need to increase
                           its oversight of participating companies’ financial operations. FCIC would
                           need to draft and approve additional regulations, audit expense vouchers
                           against a schedule of allowable expenses, and require participating
                           companies to follow additional regulations.


Reducing Reimbursement     This alternative offers the advantage of potential cost savings and may
Rates as Premium Volumes   encourage smaller companies’ participation in the program. Some industry
Increase                   observers have expressed concern at the decline in the number of
                           participating companies—from 49 in 1985 to 19 in 1995. For this
                           reimbursement alternative, companies could be reimbursed at a higher
                           rate for their first level of business and at a reduced rate at higher
                           premium levels. To illustrate, we calculated results using declining
                           reimbursement rates for premium levels of $20 million and below; over $20



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                                          Chapter 4
                                          Alternative Expense Reimbursement
                                          Arrangements Offer Potential for Savings




                                          to $50 million; over $50 to $100 million; and over $100 million. Table 4.4
                                          shows the results of our analysis.


Table 4.4: Savings Potential for Declining Reimbursement Rates
Company premium                                                   Alternative reimbursement
volume range (dollars in   1995 premiums (dollars                                         Amount (dollars in       Potential savings
millions)                             in millions)                      Percent                    millions)     (dollars in millions)
$20 and below                               $279.3                          31.0                      $86.6                      $0.0
Over $20 to $50                              195.2                          29.0                        56.6                      3.9
Over $50 to $100                             196.1                          27.0                        52.9                      7.8
Over $100                                    143.5                          25.0                        35.9                      8.6
Total/average                               $814.1                          28.5                     $232.0                     $20.4
                                          Note: Totals may not add because of rounding.

                                          Source: GAO’s analysis of FCIC’s data.



                                          At the indicated premium levels, in 1995, this alternative had the potential
                                          to save the government about $20.4 million in administrative expense
                                          reimbursements while having minimal or no impact on participating
                                          companies. Of the 19 participating companies, 10 wrote total premiums of
                                          $20 million or less, and therefore this alternative would have had no effect
                                          on the amount of reimbursements paid to these 10 companies. Only 3 of
                                          the 19 companies wrote premiums in excess of $100 million.

                                          Compared with the current system, this alternative would have the effect
                                          of favoring smaller companies over larger companies. To the extent that
                                          smaller or nonparticipating companies perceive that larger companies do
                                          not have a competitive advantage based on the size of operations, they
                                          may see increased opportunities to stay in or enter the industry. This
                                          outcome would be viewed as an advantage by those who want to see an
                                          increase in the number of participating firms.

                                          A disadvantage of this alternative is that it could discourage some larger
                                          companies from aggressively delivering crop insurance for FCIC.
                                          Furthermore, to the extent that selling and servicing crop insurance
                                          policies are subject to economies of scale, such economies may not be
                                          achieved if companies do not expand their operations.




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                      Alternative Expense Reimbursement
                      Arrangements Offer Potential for Savings




                      According to crop insurance industry officials, participating companies
Participating         generally prefer the current reimbursement arrangement because they
Companies Generally   believe that most alternatives would reduce their reimbursements and
Prefer Current        increase their administrative workload. Officials at some participating
                      companies also said that alternative arrangements would reduce their
Reimbursement         incentives to deliver federal crop insurance if their overall revenues from
Arrangement           reimbursements were reduced. Several company officials also stated that
                      any reduced administrative reimbursements would increase the need for
                      FCIC to provide additional opportunities for underwriting gains. In addition
                      to continuing the current reimbursement arrangement, participating
                      companies want FCIC to simplify administrative requirements. They believe
                      some of the existing requirements are needlessly costly and unnecessary
                      to ensure the integrity of the program. Appendix I provides more
                      information about FCIC’s efforts to simplify crop insurance program
                      administration.


                      USDA’s Risk Management Agency concurred with our draft report’s
USDA and Crop         treatment of alternative reimbursement arrangements. In its 1998 standard
Insurance Industry    reinsurance agreement, FCIC has proposed using the second
Comments              alternative—having the government pay a flat amount per policy and a
                      percentage of premiums.

                      The crop insurance industry stated that we made recommendations to
                      make major changes to the reimbursement system and that these changes
                      would most likely, among other things, greatly undermine agents’
                      compensation. We did not recommend one alternative over another or
                      over the current system but instead described the arguments for and
                      against the major alternatives that we identified. In so doing, we were
                      complying with the 1994 mandate.

                      Furthermore, throughout our report and in this chapter, we focused on the
                      effects on companies, not on the agents. Companies may compensate their
                      agents in ways that they consider appropriate, regardless of the
                      companies’ arrangement with the government. (See apps. VIII and IX.)




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Page 61   GAO/RCED-97-70 Crop Insurance
Appendix I

Simplification and Paperwork Reduction


                         This appendix summarizes the Federal Crop Insurance Corporation’s
                         (FCIC) reported progress in simplifying administrative requirements placed
                         on companies delivering crop insurance for the federal government. The
                         Federal Crop Insurance Reform and Department of Agriculture
                         Reorganization Act of 1994 required FCIC to initiate efforts to simplify the
                         administrative burden placed on companies.

                         Since implementation of the reform act in October 1994, FCIC has worked
                         with an industry group to identify and implement simplification actions
                         without jeopardizing program soundness. The list below summarizes FCIC’s
                         reported progress as of January 1997. According to U.S. Department of
                         Agriculture (USDA) officials, in considering future simplification actions,
                         USDA will continue to measure the effect of these actions on farmers and
                         the program’s actuarial soundness.


Simplification Actions   1. FCIC restructured actuarial documents, such as premium rate and special
Completed                provision tables, to provide pertinent information on fewer pages. This
                         reduced the number of pages printed each year by one-third, or
                         approximately 2 million pages.

                         2. FCIC began providing all actuarial tables electronically to companies,
                         instead of in hard copy. This change reduced delivery time to participating
                         companies and saved the government from printing 4 million pages per
                         year.

                         3. FCIC established a limited-access computer server for reinsured
                         companies’ use. Now, companies can call in by modem and download
                         relevant program information, such as premium rates, policy information,
                         FCIC bulletins, and other company-specific information.


                         4. FCIC established a public-access computer server (i.e., an Internet web
                         site) and placed a large amount of relevant crop insurance data on the
                         server. This capability allows FCIC to provide more information to the
                         public more quickly and reduces the waiting time previously associated
                         with FCIC’s processing of special requests for computerized information.

                         5. FCIC analyzed its basic crop insurance computer system to ensure that it
                         contained no unnecessary or redundant data requirements. On the basis of
                         this analysis, FCIC implemented processes to minimize companies’
                         preparation and reporting time and reduce rejections of program data.




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Simplification and Paperwork Reduction




6. FCIC expanded the availability of the Group Risk Plan insurance. This
coverage option requires less analysis of farm programs to underwrite a
policy and reduces the amount of time required to settle a claim, relying
on general, published data rather than producer-specific data.

7. FCIC eliminated the Group Risk Plan’s preliminary payment feature,
saving the companies, agents, farmers, and FCIC additional follow-up and
reconciliation work.

8. FCIC made Group Risk Plan coverage for forage available at the
catastrophic level. Since forage insurance is a very complex product to
administer, expanding the pilot program to provide catastrophic coverage
provides simplification benefits to everyone involved.

9. FCIC introduced the Tropical Fruit Tree crop insurance plan in Florida.
The plan eliminates significant up-front administrative work by insuring
the tree rather than the fruit. Time-consuming paperwork is now only
required at loss adjustment time and only for those policies that have
losses.

10. FCIC approved an express claims pilot project for a variety of crops for
all locations. This simplified process for handling small claims allows
companies to settle smaller claims more quickly and at a lower
administrative cost. FCIC will monitor this pilot project to ensure that the
use of this process does not lead to increased underwriting losses.

11. FCIC eliminated the requirement that companies prorate prevented
planting acres. Prior to this change, companies were required to perform a
number of detailed measurements and calculations when there was more
than one insurance unit and crop on a policy. Eliminating this requirement
should save administrative effort and cost, but it could expose FCIC to
additional losses. FCIC will need to continue monitoring the results of this
change.

12. FCIC approved the use of combined forms, on a company-by-company
basis. For example, producers will be able to report actual production
history data and intended acres on one form and then update this form
with actual acreage data if different. According to FCIC, these combined
forms allow companies to reduce the number of times that they must
contact the farmer.




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Simplification and Paperwork Reduction




13. FCIC implemented a computerized system to track policyholders. This
system allows insurers to verify certain facts without making
time-consuming, in-person checks with local offices, other companies, or
FCIC. The data that can be verified include, for example, the producer’s
(1) insurance status the prior year and (2) compliance with conservation
compliance requirements.

14. To save time and reduce policyholder and company visits, FCIC has
combined a number of policy dates. For example, FCIC may have had
sales-closing dates for different crops in the same area for October 31,
November 1, and November 15. To the extent permitted by sound
underwriting principles, one closing date has been established for as many
crops as possible. FCIC’s crop insurance program has many different dates,
including sales-closing, acreage-reporting, production-reporting,
final-planting, late-planting, end-of-insurance period, cancellation and
termination. These dates vary across the almost 40,000 county crop
programs. Batching dates together whenever possible makes it easier for
farmers, agents, and others to remember to perform all required tasks in a
timely manner.

15. FCIC gave participating companies expanded authority to issue
individualized insurance endorsements for farmers with particular needs.
In the past, prior FCIC approval was required for most of these special
endorsements; now, companies may issue more types of agreements
without obtaining FCIC’s approval for each individual producer.

16. FCIC authorized companies to correct obvious and inadvertent errors,
such as digit reversals and misplaced data entries without obtaining FCIC’s
consent in each case.

17. FCIC integrated selected policy options and endorsements into the
standard crop insurance policy. Now, endorsements can be activated
automatically when farmers choose them during the normal application
process. Previously, each company was often required to process a
separate application and issue a separate document.

18. FCIC simplified the corn grain/silage loss provisions. Implementing this
change makes it easier for farmers to calculate and report harvested grain
as silage, when appropriate.

19. FCIC standardized and simplified the type and practice codes used to
distinguish between different types or varieties of a crop (i.e., early versus



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Appendix I
Simplification and Paperwork Reduction




late oranges) or management practices (i.e., irrigated versus nonirrigated).
The codes, which are used for processing the policies and are first applied
by the agents, were not standard and caused unnecessary confusion and
work for agents, companies, and FCIC.

20. As of December 1996, the transition to a common insurance policy is
either complete or in process for 39 of 42 crops. Use of a common policy
will simplify the companies’ paperwork burden by reducing the number of
different forms and will also reduce confusion by eliminating minor policy
differences between crops.

21. FCIC expanded the companies’ authority to approve master yields. This
somewhat complex part of the process for establishing the insurance
guarantee on certain crops was previously performed by the Risk
Management Agency’s Regional Service Offices and required considerable
time for communications between the companies and the regional service
offices.

22. FCIC changed the T-yield procedure to a simple average across acres
instead of the complex weighting system previously used. This change
simplified the analysis performed by agents and data processing by
companies.

23. FCIC extended the requirement to verify acreage on perennial crops
from annually to once every 5 years. Since planted acreage for trees and
vines does not vary greatly from year to year, the old requirement was
unnecessarily burdensome.

24. FCIC provided producers’ production history, crop and acreage data,
and other pertinent data on its limited access server to facilitate the
transfer of policyholder data to assuming companies during the transition
of catastrophic insurance to single delivery in the 14 states where single
delivery was authorized.

25. FCIC made it easier for participating companies to check producers’
status in the Non-standard Classification System by making this
information available electronically. FCIC uses the Non-standard
Classification System to adjust the rate or guarantee of individual farmers
whose historical experience is significantly worse than other farmers in
the same area. Current Non-standard Classification System data are
important to companies in accurately underwriting and assigning risk to
some farmers.



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                            Appendix I
                            Simplification and Paperwork Reduction




                            26. FCIC implemented an option whereby farmers could opt out, or exclude,
                            hail and fire coverage for multiple years with a single application.
                            Previously, farmers had to apply annually for this exclusion and submit
                            data about the replacement coverage that they purchased from a private
                            insurer.


Simplification Actions in   1. FCIC is working to automate the issuance and reporting of written
Progress                    individualized endorsement agreements. This change could reduce the
                            time required for processing these agreements—about 4,000 a year—by 2
                            to 4 weeks.

                            2. FCIC is automating the funding of reinsurance escrow accounts for the
                            1997 reinsurance year, which will provide funds to companies sooner. This
                            funding allows reinsured companies to be reimbursed for paid losses
                            either on the same day that claims data are submitted or the next day.

                            3. FCIC is automating the list of farmers who have been declared ineligible
                            for crop insurance and to whom the participating companies are
                            prohibited from selling policies. Easier access to these data will reduce
                            errors and time.

                            4. FCIC is in the process of reviewing the quality-control requirements
                            imposed in FCIC’s Manual 14 to identify and eliminate redundant or
                            unnecessary requirements, such as overlapping and duplicative reviews or
                            inspections and outdated procedures and policies.

                            5. Using data from USDA’s National Agricultural Statistics Service, FCIC is
                            developing proxy-yield substitutes for the current T-yield system. This
                            change will address program complaints from companies, provide greater
                            flexibility, and fill the gap in the crop insurance program when actual
                            records are not submitted.

                            6. Simplified actual production history and added-land procedures are
                            being developed to reduce the number of individual unit databases
                            maintained by companies.

                            7. FCIC is currently developing a system to quote provisional prices to
                            farmers. With this type of system, FCIC can issue actuarial tables earlier so
                            that farmers can purchase coverage for at least a minimum price, knowing
                            that the market price, which is announced later, may be higher. This




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Appendix I
Simplification and Paperwork Reduction




change will enable companies to begin using actuarial data much sooner
and to spread work out over a greater period.

8. FCIC is reviewing the timing of reports on fees collected from farmers to
determine the feasibility of less frequent reporting. The current
administrative effort required to collect and account for the $50 and $10
fees seems to be excessive for the companies and for FCIC.

9. FCIC is reviewing the timing of the reconciliation of minor accounting
errors on the companies’ reports to determine the feasibility of less
frequent reporting. The current, monthly requirement may impose too
great a burden for the sums involved.

10. FCIC is reviewing the feasibility of an automatic all-county insurance
option. This change, if implemented, would benefit farmers by
automatically providing coverage in cases where farmers decide after the
sales closing date to plant an insured crop in a county in which they had
not intended to plant and for which they had not purchased insurance.

11. FCIC is adjusting the insurance period for the Texas Citrus Tree
program to make the crop year and the reinsurance year coincide. This
will eliminate the need for manual accounting and data processing
adjustments that are required to move the business from one year to
another.




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Appendix II

Companies Included in Expense Review


                                          FCIC had standard reinsurance agreements with 22 companies in 1994 and
                                          19 companies in 1995 to sell and service federal crop insurance. In
                                          performing our review, we reviewed nine managing general agencies that
                                          each managed the business for one or more standard reinsurance
                                          agreement holders—those insurance companies responsible for the
                                          standard reinsurance agreement—representing about 85 percent of the
                                          total federal crop insurance premiums written by private companies in
                                          1994 and 1995 combined. We made our selection of companies considering
                                          factors such as premium volume, location, and type of ownership. As a
                                          result of business acquisitions and changing business relationships in 1994
                                          and 1995, our review included 12 standard reinsurance agreement holders
                                          for 1994 and 12 for 1995. Tables II.1 and II.2 list the companies included in
                                          our review for 1994 and 1995, respectively, showing the name of the
                                          managing general agency, the location of the managing general agency,
                                          and the standard reinsurance agreement holder.


Table II.1: Companies Included in 1994 Review
Managing general agency                     Location                               Standard reinsurance agreement holder
American Agrisurance                       Council Bluffs, Iowa                    Redland Insurance Company, Insurance
                                                                                   Company of the Prairie States
Blakely Crop Hail, Inc.                    Topeka, Kansas                          Farmers Alliance Mutual Insurance
                                                                                   Company
Cotton States Mutual Insurance Company     Atlanta, Georgia                        Cotton States Mutual Insurance Company
Country Mutual Insurance Company           Bloomington, Illinois                   Country Mutual Insurance Company
Crop Growers Corporation                   Great Falls, Montana                    Cimarron Insurance Company, Continental
                                                                                   Insurance Company
IGF Insurance Company                      Des Moines, Iowa                        IGF Insurance Company
National Ag Underwriters, Inc.             Anoka, Minnesota                        NAU Insurance Company
Producers Lloyds Insurance Company         Amarillo, Texas                         Producers Lloyds Insurance Company
Rain and Hail Insurance Services, Inc.     West Des Moines, Iowa                   CIGNA Property and Casualty Insurance
                                                                                   Company, Columbia Mutual Insurance
                                                                                   Company
                                          Source: GAO’s analysis of FCIC’s data.




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                                          Appendix II
                                          Companies Included in Expense Review




Table II.2: Companies Included in 1995 Review
Managing general agency                     Location                               Standard reinsurance agreement holder
American Agrisurance                       Council Bluffs, Iowa                    Redland Insurance Company
Blakely Crop Hail, Inc.                    Topeka, Kansas                          Farmers Alliance Mutual Insurance
                                                                                   Company
Cotton States Mutual Insurance Company     Atlanta, Georgia                        Cotton States Mutual Insurance Company
Country Mutual Insurance Company           Bloomington, Illinois                   Country Mutual Insurance Company
Crop Growers Corporation                   Great Falls, Montana                    Continental Insurance Company, Dawson
                                                                                   Hail Insurance Company, Plains Insurance
                                                                                   Company
IGF Insurance Company                      Des Moines, Iowa                        IGF Insurance Company, PAFCO General
                                                                                   Insurance Company
Producers Lloyds Insurance Company         Amarillo, Texas                         Producers Lloyds Insurance Company
Rain and Hail Insurance Services, Inc.     West Des Moines, Iowa                   CIGNA Property and Casualty Insurance
                                                                                   Company
Rural Community Insurance Services         Anoka, Minnesota                        Rural Community Insurance Company
                                          Source: GAO’s analysis of FCIC’s data.




                                          Page 69                                            GAO/RCED-97-70 Crop Insurance
Appendix III

Summary of Adjustments Made to Reported
Expenses of Nine Companies, 1994-95

               For the nine companies included in our review, we evaluated their
               reported expenses to determine whether the reported expenses seemed
               reasonable for the sale and service of federal crop insurance. Generally,
               we considered as reasonable those expenses associated with
               (1) interacting with farmers, (2) reviewing insured property, (3) processing
               policy and claims paperwork, and (4) related overhead and indirect costs,
               including the training and travel of staff. In order to develop a consistent
               measure of delivery expenses across the industry, we deducted reported
               expenses that appeared unreasonable for the delivery of crop insurance.

               We categorized adjustments to the companies’ reported crop insurance
               expenses into 19 areas, as shown in table III.1. Amounts in parenthesis
               represent deductions from the companies’ reported expenses; other
               amounts are additions to the companies’ reported expenses. For 1994, the
               nine companies reported expenses of $236.8 million for selling and
               servicing buyup insurance. Our review identified adjustments of
               $27.2 million for expenses that did not appear to be reasonably associated
               with the sale and service of crop insurance. For 1995, the nine companies
               reported expenses of $305.5 million related to buyup and catastrophic
               insurance. Our review of these reported expenses identified adjustments
               of $15.9 million. The percent of premium calculations in table III.1 are
               based on 1994 premiums of $763.4 million and 1995 catastrophic and
               buyup combined premiums of $1.1 billion for the nine companies.
               Following table III.1 is a brief explanation of each adjustment category.




               Page 70                                         GAO/RCED-97-70 Crop Insurance
                                              Appendix III
                                              Summary of Adjustments Made to Reported
                                              Expenses of Nine Companies, 1994-95




Table III.1: Summary of Adjustments Made to Reported Expenses of Nine Companies, 1994-95
                                                                      1994                                                1995
                                                                                             Percent of                          Percent of
Type of adjustment                                                          Amount            premium              Amount         premium
1. Extraordinary write-offs                                             ($4,218,984)               (0.55)         ($51,532)           (0.00)
2. Payments for purchased intangible assets                              (3,329,976)               (0.44)        (2,879,096)          (0.26)
3. Payments for non-compete contracts                                      (806,932)               (0.11)         (730,632)           (0.07)
4. Premiums paid for commercial reinsurance                              (5,415,638)               (0.71)        (5,321,977)          (0.49)
5. Bonuses tied to company profitability                                 (4,363,099)               (0.57)        (6,750,674)          (0.62)
6. State income taxes and tax penalties                                    (483,929)               (0.06)        (1,297,906)          (0.12)
7. Expenses not capitalized                                                         0               0.00         (2,400,000)          (0.22)
8. Fronting fees with no measurable benefit                              (1,162,314)               (0.15)        (1,533,513)          (0.14)
9. Loss-adjusting expenses not tied to correct year                        (114,724)               (0.02)          495,100             0.05
10. Crop-hail expenses                                                     (111,157)               (0.01)            (59,443)         (0.01)
11. Miscalculated and omitted expenses                                   (4,870,931)               (0.64)        6,949,340             0.63
12. Offsetting related income against reported expense items             (1,208,465)               (0.16)        (1,188,036)          (0.11)
13. Parent company management fees with no measurable                      (618,217)               (0.08)         (486,600)           (0.04)
benefit
14. Prior year expenses                                                      (20,000)              (0.00)                  0           0.00
15. Lobbying and related expenses                                          (113,585)               (0.01)         (304,809)           (0.03)
16. Interest paid on late paid premiums to FCIC                            (611,260)               (0.08)            (38,996)         (0.00)
17. Claim overpayments/adjustments due to company error                     258,789                 0.03          (298,891)           (0.03)
18. Personal and/or family expenses                                             (701)              (0.00)             (1,846)         (0.00)
19. Undocumented expenses                                                    (31,467)              (0.00)                  0           0.00
Total adjustments                                                      ($27,222,590)               (3.57)     ($15,899,511)           (1.45)
                                              Note: Amounts in parenthesis were subtracted from reported expenses.

                                              Source: GAO’s analysis of nine participating companies’ data.



                                              The following is a brief explanation of each numbered adjustment
                                              category.

                                              1. Extraordinary write-offs are one-time expenses relating to the
                                              purchase of another company’s business. These charges included
                                              liabilities unforeseen at the time of purchase.

                                              2. Payments for purchased intangible assets are payments for the
                                              purchase of another company’s business above its book value, commonly
                                              called goodwill.




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Appendix III
Summary of Adjustments Made to Reported
Expenses of Nine Companies, 1994-95




3. Payments for non-compete contracts are payments to individuals as
compensation for not competing in the crop insurance industry for a
specified period of time. Typically, such payments are in conjunction with
the purchase of one company by another company.

4. Premiums paid for commercial reinsurance are premiums paid by
an insurance company to another company to (1) reduce its risk of
underwriting loss and (2) increase its capacity to write more insurance
than otherwise allowed by its own surplus. This type of expense should be
paid from the company’s underwriting results and is not associated with
the direct sale and service of federal crop insurance to farmers.

5. Bonuses tied to company profitability are company earnings from
selling and servicing crop insurance distributed as bonuses and reported
as a necessary delivery expense. The administrative expense
reimbursement is intended to reimburse participating companies only for
expenses that can be reasonably associated with selling and servicing crop
insurance, not provide a profit. Underwriting is intended to provide
companies with the potential to earn profits.

6. State income taxes and tax penalties are state taxes paid on profits
resulting from the delivery and the underwriting of crop insurance and
expenses related to tax penalties. These expenses should be paid from
underwriting results.

7. Expenses not capitalized are expenses of capital assets charged-off in
the period acquired. Generally accepted accounting principles require that
such costs be amortized over the useful life of the asset. We applied an
appropriate depreciation method for the type of asset in question and
recognized as an expense a portion of the asset’s cost for the period of our
review.

8. Fronting fees with no measurable benefit are fees paid to another
company, explicitly for service or support of crop insurance, but at a rate
that is above the industry average and for which no measurable benefit
from this higher rate could be identified. While this may be a necessary
expense of selling and servicing crop insurance in some circumstances, we
deducted seemingly high charges for which there was no identifiable
benefit to the purchasing company or the government.




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Appendix III
Summary of Adjustments Made to Reported
Expenses of Nine Companies, 1994-95




9. Loss-adjusting expenses not tied to correct year are both additions
and subtractions to a company’s loss-adjusting expenses to adjust some
expenses reported on a calendar year basis to a reinsurance year basis.

10. Crop-hail expenses are expenses directly and indirectly related to the
sale and service of private crop-hail insurance but reported as expenses
related to the sale and service of federal crop insurance.

11. Miscalculated and omitted expenses are various amounts that were
either calculated in error or, although associated with the sale and service
of crop insurance, not reported.

12. Offsetting related income against reported expense items are
reductions to expense accounts in an amount equal to related income
accounts. For example, we reduced reported interest expenses by
offsetting, unreported interest income; we reduced automobile expenses
by offsetting personal mileage reimbursements paid to the company; and
we reduced legal expenses by the amount of related legal expense
reimbursements received from FCIC. Generally accepted accounting
principles require a matching of income and expense items.

13. Parent company management fees with no measurable benefit
are various fees assessed by parent companies to subsidiary crop
insurance companies and reported as crop insurance delivery expenses,
but for which no measurable benefit to the federal crop insurance program
could be identified.

14. Prior year expenses are payments for 1993 premium taxes and other
prior year commission expenses that should not be included in 1994 and
1995 expenses.

15. Lobbying and related expenses are payments to industry trade
associations for lobbying activities precluded by FCIC’s standard
reinsurance agreement.

16. Interest paid for late paid premiums to FCIC are interest payments
made to FCIC or others to borrow money to pay FCIC for premiums due.
While these were reported by some companies as an expense of selling
and servicing crop insurance, they were not a necessary expense but
reflect companies’ operating decisions, including decisions about working
capital levels.




Page 73                                          GAO/RCED-97-70 Crop Insurance
Appendix III
Summary of Adjustments Made to Reported
Expenses of Nine Companies, 1994-95




17. Claim overpayments/adjustments due to company error are claim
overpayments made as a result of company oversight but charged as a
crop insurance delivery expense.

18. Personal and/or family expenses are personal and family expenses,
such as clothing and airline tickets, erroneously reported as crop
insurance delivery expenses.

19. Undocumented expenses are expenses reported as crop insurance
expenses for which no supporting documentation could be found.




Page 74                                     GAO/RCED-97-70 Crop Insurance
Appendix IV

Crop Insurance Companies’ Expenses for
Selling and Servicing Crop Insurance

                                           The tables in this appendix show the expenses for selling and servicing
                                           federal crop insurance as reported by the nine companies in our review
                                           and as adjusted to reflect the expenses reasonably associated with the sale
                                           and service of federal crop insurance. Table IV.1 shows the
                                           company-reported and GAO-adjusted expenses for 1994. Table IV.2 shows
                                           the percent of premium, dollars per policy, and dollars per unit with
                                           premium for the GAO-adjusted expenses for 1994. Table IV.3 shows
                                           company-reported and GAO-adjusted expenses for 1995. Since the
                                           companies reported combined expenses and did not separate expenses for
                                           catastrophic and buyup insurance, table IV.4 shows GAO-adjusted expenses
                                           for catastrophic insurance for 1995, based on a proration of total adjusted
                                           expenses using units with a claim payment, policies with premium, and
                                           premium volume ratios. Table IV.5 shows GAO-adjusted expenses for buyup
                                           insurance for 1995, based on similar prorations. The difference between
                                           reported and adjusted expense figures in these tables are the adjustments
                                           we made, as explained in appendix III. Premiums, policies with premium,
                                           units with premium, and units with a claim payment for the nine
                                           companies in our review for 1994 and 1995 are shown in table IV.6.


Table IV.1: Company-Reported and GAO-Adjusted Expenses for Selling and Servicing Federal Crop Insurance, 1994
                                                                      Company-reported total          GAO-adjusted total
Operating expense classifications                                                   expenses                  expenses
1. Claim adjustment services
Direct                                                                            $24,460,403                $24,463,848
Reinsurance assumed                                                                      (180)                        0
Less: reinsurance ceded                                                                     0                         0
Net claim adjustment services                                                     $24,460,223                $24,463,848
2. Commission and brokerage
Direct excluding contingent                                                      $129,226,151              $121,200,911
Reinsurance assumed excluding contingent                                            1,166,759                   193,759
Less: reinsurance ceded excluding contingent                                                0                         0
Contingent — direct                                                                   935,080                   788,637
Contingent — reinsurance assumed                                                            0                         0
Less: contingent — reinsurance ceded                                                        0                         0
Policy and membership fees                                                                  0                         0
Net commission and brokerage                                                     $131,327,990              $122,183,307
Lines 3-17. General operating expenses
3. Allowances to managers and agents                                                 $184,274                 $5,006,101
4. Advertising                                                                        848,569                   873,918
5. Boards, bureaus and associations                                                 1,882,252                  1,871,932
                                                                                                             (continued)



                                           Page 75                                         GAO/RCED-97-70 Crop Insurance
                                            Appendix IV
                                            Crop Insurance Companies’ Expenses for
                                            Selling and Servicing Crop Insurance




                                                                                 Company-reported total           GAO-adjusted total
Operating expense classifications                                                            expenses                     expenses
6. Surveys and underwriting reports                                                                69,390                     90,255
7. Audit of assureds’ records                                                                      18,033                     18,030
8. Salary-related items:
Salaries                                                                                        28,035,230                25,749,033
Payroll taxes                                                                                    1,973,329                 1,710,273
9. Employee relations and welfare                                                                3,248,618                 3,745,063
10. Insurance                                                                                     729,616                    830,871
11. Director’s fees                                                                                26,200                     34,724
12. Travel and travel items                                                                      4,220,388                 4,160,899
13. Rent and rent items                                                                          2,918,090                 3,159,992
14. Equipment                                                                                    3,078,328                 3,170,820
15. Printing and stationery                                                                      2,585,875                 2,816,230
16. Postage, telephone and telegraph, exchange                                                   3,813,519                 3,962,573
and express
17. Legal and auditing                                                                           2,107,965                 2,014,607
Subtotal of lines 3-17                                                                         $55,739,676               $59,215,321
18.Taxes, licenses and fees
State and local insurance taxes deducting                                                         $23,134                     $3,134
guaranty association credits of $
Insurance department licenses and fees                                                            316,266                    315,534
Gross guaranty association assessments                                                                  0                          0
All other (excluding federal & foreign                                                            528,252                    116,771
income and real estate)
Total taxes, licenses and fees                                                                   $867,652                   $435,439
19. Real estate expenses                                                                          $67,369                         $0
20. Real estate taxes                                                                             $62,481                         $0
21. Aggregate write-ins for miscellaneous                                                      $24,296,372                $3,301,257
operating expenses
22. Total expenses                                                                            $236,821,763              $209,599,172

                                            Source: GAO’s analysis of nine companies’ data.




                                            Page 76                                                     GAO/RCED-97-70 Crop Insurance
                                           Appendix IV
                                           Crop Insurance Companies’ Expenses for
                                           Selling and Servicing Crop Insurance




Table IV.2: GAO-Adjusted Expenses for Selling and Servicing Federal Crop Insurance, 1994, as a Percent of Premium and
in Terms of Dollars Per Policy and Dollars Per Unit
                                                                                                                 Dollars per
                                                             GAO-adjusted        Percent of      Dollars per       unit with
Operating expense classifications                                expenses         premium             policy       premium
1. Claim adjustment services
Direct                                                           $24,463,848            3.2          $58.63          $15.64
Reinsurance assumed                                                         0             0            0.00             0.00
Less: reinsurance ceded                                                     0           0.0            0.00             0.00
                                a
Net claim adjustment services                                    $24,463,848            3.2          $58.63          $15.64
2. Commission and brokerage
Direct excluding contingent                                     $121,200,911           15.9         $290.48          $77.49
Reinsurance assumed excluding contingent                             193,759            0.0            0.46             0.12
Less: reinsurance ceded excluding contingent                                0           0.0            0.00             0.00
Contingent — direct                                                  788,637            0.1            1.89             0.50
Contingent — reinsurance assumed                                            0             0            0.00             0.00
Less: contingent — reinsurance ceded                                        0           0.0            0.00             0.00
Policy and membership fees                                                  0             0            0.00             0.00
Net commission and brokerage                                    $122,183,307           16.0         $292.84          $78.12
Lines 3-17. General operating expenses
3. Allowances to managers and agents                              $5,006,101            0.7          $12.00           $3.20
4. Advertising                                                       873,918            0.1            2.09             0.56
5. Boards, bureaus and associations                                1,871,932            0.2            4.49             1.20
6. Surveys and underwriting reports                                   90,255            0.0            0.22             0.06
7. Audit of assureds’ records                                         18,030            0.0            0.04             0.01
8. Salary-related items:
Salaries                                                          25,749,033            3.4           61.71           16.46
Payroll taxes                                                      1,710,273            0.2            4.10             1.09
9. Employee relations and welfare                                  3,745,063            0.5            8.98             2.39
10. Insurance                                                        830,871            0.1            1.99             0.53
11. Director’s fees                                                   34,724            0.0            0.08             0.02
12. Travel and travel items                                        4,160,899            0.5            9.97             2.66
13. Rent and rent items                                            3,159,992            0.4            7.57             2.02
14. Equipment                                                      3,170,820            0.4            7.60             2.03
15. Printing and stationery                                        2,816,230            0.4            6.75             1.80
16. Postage, telephone and telegraph, exchange                     3,962,573            0.5            9.50             2.53
and express
17. Legal and auditing                                             2,014,607            0.3            4.83             1.29
Subtotal of lines 3-17                                           $59,215,321            7.8         $141.92          $37.86
18. Taxes, licenses and fees
                                                                                                                 (continued)


                                           Page 77                                            GAO/RCED-97-70 Crop Insurance
                                            Appendix IV
                                            Crop Insurance Companies’ Expenses for
                                            Selling and Servicing Crop Insurance




                                                                                                                                Dollars per
                                                                     GAO-adjusted             Percent of        Dollars per       unit with
Operating expense classifications                                       expenses               premium               policy      premium
State and local insurance taxes deducting                                     $3,134                  0.0              $0.01         $0.00
guaranty association credits of $
Insurance department licenses and fees                                       315,534                  0.0               0.76           0.20
Gross guaranty association assessments                                               0                0.0               0.00           0.00
All other (excluding federal & foreign                                       116,771                  0.0               0.28           0.07
income and real estate)
Total taxes, licenses and fees                                              $435,439                  0.1              $1.04         $0.28
19. Real estate expenses                                                           $0                 0.0              $0.00         $0.00
20. Real estate taxes                                                              $0                 0.0              $0.00         $0.00
21. Aggregate write-ins for miscellaneous                                 $3,301,257                  0.4              $7.91         $2.11
operating expenses
22. Total expenses                                                     $209,599,172                  27.5           $502.35        $134.01

                                            a
                                                Net claim adjustment services were $141.13 per unit with a claim payment.

                                            Source: GAO’s analysis of FCIC’s and nine companies’ data.




                                            Page 78                                                           GAO/RCED-97-70 Crop Insurance
                                            Appendix IV
                                            Crop Insurance Companies’ Expenses for
                                            Selling and Servicing Crop Insurance




Table IV.3: Company-Reported and GAO-Adjusted Expenses for Selling and Servicing Federal Crop Insurance, 1995a
                                                                      Company-reported total          GAO-adjusted total
Operating expense classifications                                                   expenses                   expenses
1. Claim adjustment services
Direct                                                                                $33,298,853               $36,880,112
Reinsurance assumed                                                                            0                          0
Less: reinsurance ceded                                                                        0                          0
Net claim adjustment services                                                         $33,298,853               $36,880,112
2. Commission and brokerage
Direct excluding contingent                                                          $160,218,937              $155,817,956
Reinsurance assumed excluding contingent                                                 597,277                    155,857
Less: reinsurance ceded excluding contingent                                            2,636,000                         0
Contingent — direct                                                                     1,070,325                 1,568,212
Contingent — reinsurance assumed                                                               0                          0
Less: contingent — reinsurance ceded                                                           0                          0
Policy and membership fees                                                                     0                          0
Net commission and brokerage                                                         $159,250,539              $157,542,025
Lines 3-17. General operating expenses
3. Allowances to managers and agents                                                   $2,911,220                $6,126,462
4. Advertising                                                                          1,194,318                 1,232,376
5. Boards, bureaus and associations                                                     2,844,774                 2,945,358
6. Surveys and underwriting reports                                                      110,993                    168,270
7. Audit of assureds’ records                                                             20,344                     20,344
8. Salary-related items:
Salaries                                                                               41,837,055                37,633,413
Payroll taxes                                                                           3,718,427                 3,808,615
9. Employee relations and welfare                                                       4,032,784                 5,524,937
10. Insurance                                                                            938,831                    967,129
11. Director’s fees                                                                       37,169                     56,251
12. Travel and travel items                                                             6,344,078                 6,585,353
13. Rent and rent items                                                                 3,798,264                 4,192,367
14. Equipment                                                                           4,037,347                 4,453,554
15. Printing and stationery                                                             4,943,435                 5,409,392
16. Postage, telephone and telegraph, exchange                                          5,720,936                 6,243,747
and express
17. Legal and auditing                                                                  2,823,371                 2,896,073
Subtotal of lines 3-17                                                                $85,313,346               $88,263,642
18. Taxes, licenses and fees
State and local insurance taxes deducting                                               $259,637                   $205,137
guaranty association credits of $
                                                                                                                 (continued)


                                            Page 79                                            GAO/RCED-97-70 Crop Insurance
                                            Appendix IV
                                            Crop Insurance Companies’ Expenses for
                                            Selling and Servicing Crop Insurance




                                                                                   Company-reported total            GAO-adjusted total
Operating expense classifications                                                              expenses                      expenses
Insurance department licenses and fees                                                               576,373                    576,373
Gross guaranty association assessments                                                                      0                         0
All other (excluding federal & foreign                                                             1,304,293                     60,955
income and real estate)
Total taxes, licenses and fees                                                                   $2,140,303                    $842,465
19. Real estate expenses                                                                           $611,554                    $496,081
20. Real estate taxes                                                                                $65,884                    $50,000
21. Aggregate write-ins for miscellaneous                                                       $24,787,168                  $5,493,812
operating expenses
22. Total expenses                                                                             $305,467,647                $289,568,136

                                            a
                                                These numbers are for catastrophic and buyup insurance combined.

                                            Source: GAO’s analysis of nine companies’ data.




                                            Page 80                                                        GAO/RCED-97-70 Crop Insurance
                                           Appendix IV
                                           Crop Insurance Companies’ Expenses for
                                           Selling and Servicing Crop Insurance




Table IV.4: GAO-Adjusted Expenses for Catastrophic Insurance, 1995, as a Percent of Premium and in Terms of Dollars Per
Policy and Dollars Per Unit
                                                            GAO-adjusted                                         Dollars per
                                                              catastrophic       Percent of     Dollars per        unit with
Operating expense classifications                               expensesa          premium           policy        premium
1. Claim adjustment services
Direct                                                            $3,357,617            2.1          $16.84           $7.50
Reinsurance assumed                                                         0           0.0            0.00             0.00
Less: reinsurance ceded                                                     0           0.0            0.00             0.00
                                b
Net claim adjustment services                                     $3,357,617            2.1          $16.84           $7.50
2. Commission and brokerage
Direct excluding contingent                                       $6,053,764            3.8          $30.37          $13.52
Reinsurance assumed excluding contingent                                    0           0.0            0.00             0.00
Less: reinsurance ceded excluding contingent                                0           0.0            0.00             0.00
Contingent — direct                                                         0           0.0            0.00             0.00
Contingent — reinsurance assumed                                            0           0.0            0.00             0.00
Less: contingent — reinsurance ceded                                        0           0.0            0.00             0.00
Policy and membership fees                                                  0           0.0            0.00             0.00
Net commission and brokerage                                      $6,053,764            3.8          $30.37          $13.52
Lines 3-17. General operating expenses
3. Allowances to managers and agents                                $599,412            0.4           $3.01           $1.34
4. Advertising                                                       346,600            0.2            1.74             0.77
5. Boards, bureaus and associations                                  853,669            0.5            4.28             1.91
6. Surveys and underwriting reports                                   35,309            0.0            0.18             0.08
7. Audit of assureds’ records                                          6,156            0.0            0.03             0.01
8. Salary-related items:
Salaries                                                          10,980,358            7.0           55.09           24.53
Payroll taxes                                                      1,203,287            0.8            6.04             2.69
9. Employee relations and welfare                                  1,491,037            0.9            7.48             3.33
10. Insurance                                                        325,858            0.2            1.63             0.73
11. Director’s fees                                                   11,912            0.0            0.06             0.03
12. Travel and travel items                                        2,054,867            1.3           10.31             4.59
13. Rent and rent items                                            1,161,849            0.7            5.83             2.60
14. Equipment                                                      1,165,806            0.7            5.85             2.60
15. Printing and stationery                                        1,699,309            1.1            8.52             3.80
16. Postage, telephone and telegraph, exchange                     1,861,310            1.2            9.34             4.16
and express
17. Legal and auditing                                               816,076            0.5            4.09             1.82
Subtotal of lines 3-17                                           $24,612,816           15.6         $123.48          $54.98
18. Taxes, licenses and fees
                                                                                                                 (continued)


                                           Page 81                                            GAO/RCED-97-70 Crop Insurance
                                            Appendix IV
                                            Crop Insurance Companies’ Expenses for
                                            Selling and Servicing Crop Insurance




                                                                  GAO-adjusted                                                  Dollars per
                                                                   catastrophic           Percent of         Dollars per          unit with
Operating expense classifications                                    expensesa             premium                policy         premium
State and local insurance taxes deducting                                 $76,683                  0.0             $0.38               $0.17
guaranty association credits of $
Insurance department licenses and fees                                    174,781                  0.1                 0.88             0.39
Gross guaranty association assessments                                           0                 0.0                 0.00             0.00
All other (excluding federal & foreign                                     21,922                  0.0                 0.11             0.05
income and real estate)
Total taxes, licenses and fees                                          $273,386                   0.2             $1.37               $0.61
19. Real estate expenses                                                $184,262                   0.1             $0.92               $0.41
20. Real estate taxes                                                     $18,572                  0.0             $0.09               $0.04
21. Aggregate write-ins for miscellaneous                               $520,179                   0.3             $2.61               $1.16
operating expenses
22. Total expenses                                                   $35,020,595                 22.2            $175.69             $78.23

                                            a
                                              These numbers are based on a proration of the adjusted combined total amounts shown in table
                                            IV.3. Loss adjusting expenses are prorated between catastrophic and buyup insurance based on
                                            units indemnified—units with a claim payment. Most commission expenses are prorated directly
                                            between catastrophic and buyup insurance; some are prorated based on premiums. Line 3
                                            expenses are prorated between catastrophic and buyup insurance based on premiums. All other
                                            expenses are prorated between catastrophic and buyup insurance based on the number of
                                            policies with premiums. See table IV.6 for unit, policy, and premium data used.
                                            b
                                            Net claim adjustment services were $91.37 per unit with a claim payment.

                                            Source: GAO’s analysis of FCIC’s and nine companies’ data.




                                            Page 82                                                       GAO/RCED-97-70 Crop Insurance
                                           Appendix IV
                                           Crop Insurance Companies’ Expenses for
                                           Selling and Servicing Crop Insurance




Table IV.5: GAO-Adjusted Expenses for Buyup Insurance, 1995, as a Percent of Premium and in Terms of Dollars Per Policy
and Dollars Per Unit
                                                                                                                Dollars per
                                                           GAO-adjusted         Percent of     Dollars per        unit with
Operating expense classifications                       buyup expensesa          premium            policy        premium
1. Claim adjustment services
Direct                                                           $33,522,495           3.6          $73.07          $20.23
Reinsurance assumed                                                         0          0.0            0.00             0.00
Less: reinsurance ceded                                                     0          0.0            0.00             0.00
                                b
Net claim adjustment services                                    $33,522,495           3.6          $73.07          $20.23
2. Commission and brokerage
Direct excluding contingent                                     $149,764,192          16.0         $326.45          $90.40
Reinsurance assumed excluding contingent                             155,857           0.0            0.34             0.09
Less: reinsurance ceded excluding contingent                                0          0.0            0.00             0.00
Contingent — direct                                                1,568,212           0.2            3.42             0.95
Contingent — reinsurance assumed                                            0          0.0            0.00             0.00
Less: contingent — reinsurance ceded                                        0          0.0            0.00             0.00
Policy and membership fees                                                  0          0.0            0.00             0.00
Net commission and brokerage                                    $151,488,261          16.2         $330.21          $91.44
Lines 3-17. General operating expenses
3. Allowances to managers and agents                              $5,527,050           0.6          $12.05           $3.34
4. Advertising                                                       885,776           0.1            1.93             0.53
5. Boards, bureaus and associations                                2,091,689           0.2            4.56             1.26
6. Surveys and underwriting reports                                  132,961           0.0            0.29             0.08
7. Audit of assureds’ records                                         14,188           0.0            0.03             0.01
8. Salary-related items:
Salaries                                                          26,653,055           2.8           58.10           16.09
Payroll taxes                                                      2,605,328           0.3            5.68             1.57
9. Employee relations and welfare                                  4,033,900           0.4            8.79             2.43
10. Insurance                                                        641,271           0.1            1.40             0.39
11. Director’s fees                                                   44,339           0.0            0.10             0.03
12. Travel and travel items                                        4,530,486           0.5            9.88             2.73
13. Rent and rent items                                            3,030,518           0.3            6.61             1.83
14. Equipment                                                      3,287,748           0.4            7.17             1.98
15. Printing and stationery                                        3,710,083           0.4            8.09             2.24
16. Postage, telephone and telegraph, exchange                     4,382,437           0.5            9.55             2.65
and express
17. Legal and auditing                                             2,079,997           0.2            4.53             1.26
Subtotal of lines 3-17                                           $63,650,826           6.8         $138.75          $38.42
18. Taxes, licenses and fees
                                                                                                                (continued)


                                           Page 83                                           GAO/RCED-97-70 Crop Insurance
                                            Appendix IV
                                            Crop Insurance Companies’ Expenses for
                                            Selling and Servicing Crop Insurance




                                                                                                                                Dollars per
                                                                 GAO-adjusted             Percent of         Dollars per          unit with
Operating expense classifications                              buyup expensesa             premium                policy         premium
State and local insurance taxes deducting                               $128,454                   0.0             $0.28               $0.08
guaranty association credits of $
Insurance department licenses and fees                                    401,592                  0.0                 0.88             0.24
Gross guaranty association assessments                                           0                 0.0                 0.00             0.00
All other (excluding federal & foreign                                     39,033                  0.0                 0.09             0.02
income and real estate)
Total taxes, licenses and fees                                          $569,079                   0.1             $1.24                0.34
19. Real estate expenses                                                $311,819                   0.0             $0.68                0.19
20. Real estate taxes                                                     $31,428                  0.0             $0.07               $0.02
21. Aggregate write-ins for miscellaneous                             $4,973,633                   0.5            $10.84               $3.00
operating expenses
22. Total expenses                                                  $254,547,541                 27.1            $554.86            $153.65

                                            a
                                              These numbers are based on a proration of the adjusted combined total amounts shown in table
                                            IV.3. Loss adjusting expenses are prorated between catastrophic and buyup insurance based on
                                            units indemnified—units with a claim payment. Most commission expenses are prorated directly
                                            between catastrophic and buyup insurance; some are prorated based on premiums. Line 3
                                            expenses are prorated between catastrophic and buyup insurance based on premiums. All other
                                            expenses are prorated between catastrophic and buyup insurance based on the number of
                                            policies with premiums. See table IV.6 for unit, policy, and premium data used.
                                            b
                                            Net claim adjustment services were $87.08 per unit with a claim payment.

                                            Source: GAO’s analysis of FCIC’s and nine companies’ data.



Table IV.6: Summary of Federal Crop
Insurance Activity for the Nine                                                                1995
Companies in Our Expense Review             Data for nine                                Combined                 1995
                                            companies                                  catastrophic       Catastrophic         1995 Buyup
                                            combined                         1994        and buyup                only                only
                                            Premiums                $763,400,148     $1,095,309,588       $157,580,729        $937,728,859
                                            Policies with                 417,239            658,094             199,333            458,761
                                            premium
                                            Units with                  1,564,071          2,104,302             447,634          1,656,668
                                            premium
                                            Units with a claim            173,339            421,698              36,746            384,952
                                            payment
                                            Source: GAO’s analysis of FCIC’s data.




                                            Page 84                                                       GAO/RCED-97-70 Crop Insurance
Appendix V

Methodology for Comparing 1995 Cost to
Government to Deliver Catastrophic
Insurance Through USDA and Private
Companies
                            The government sells and services catastrophic crop insurance through
                            USDA as well as through private companies. Table V.1 provides an analysis
                            of the government’s costs to deliver catastrophic insurance through USDA
                            in 1995. Table V.2 provides an analysis of the government’s costs to deliver
                            catastrophic insurance through private companies in 1995. Unlike our
                            evaluation of companies’ expenses to sell and service crop insurance, this
                            analysis is a comparison of costs to the government to deliver catastrophic
                            insurance through two different delivery systems. This analysis compares
                            the total costs to the government to deliver catastrophic insurance through
                            USDA and private companies, including all private companies, not only the
                            ones in our review. Below is an explanation of our methodology for
                            determining the government’s costs for each delivery system.


Methodology for             To determine the cost to the government for USDA’s delivery of
Determining the Cost to     catastrophic crop insurance, we identified and summed all applicable
the Government to Deliver   expenses paid with government funds. We then reduced these expenses by
                            the amount of processing fees paid by farmers and collected by USDA’s
Catastrophic Insurance      local Farm Service Agency (FSA) offices. The government’s basic costs to
Through USDA in 1995        deliver catastrophic insurance through USDA in 1995 were the costs that
                            USDA incurred to sell and service catastrophic crop insurance policies. The
                            majority of these costs consisted of direct and indirect expenses incurred
                            by FSA’s local offices. USDA also incurred other direct and indirect costs for
                            software development, central staff support, and FCIC support. Offsetting
                            these expenses were the amount of catastrophic insurance processing fees
                            collected from farmers by FSA’s offices and remitted to USDA, thereby
                            reducing USDA’s overall delivery expenses and the costs to the government.
                            See table V.1.

                            We identified the costs incurred by FSA’s local offices to deliver
                            catastrophic insurance using USDA’s County Office Work Measurement and
                            Fund Allocation System for 1995. This system is used to track the amount
                            of time in staff work days required to perform identified elements of work
                            performed in local county offices which is then multiplied by an average
                            cost per staff work day that includes salaries and benefits. With assistance
                            from USDA, we selected all work items that related directly or indirectly to
                            the delivery of catastrophic insurance. Those work items that were
                            directly related to catastrophic insurance delivery are listed in table V.1
                            with their respective work item codes, for example, “225 Signup for
                            catastrophic program” and “9092 Photocopies.” We computed direct costs
                            for FSA’s local offices to be $45,965,217.




                            Page 85                                           GAO/RCED-97-70 Crop Insurance
Appendix V
Methodology for Comparing 1995 Cost to
Government to Deliver Catastrophic
Insurance Through USDA and Private
Companies




For those work items that were indirectly related, such as general
administration of USDA’s County Office Work Measurement and Fund
Allocation System, rent, and utilities, we included a prorated amount
based on the relationship between the total cost of the direct catastrophic
insurance delivery work items of $45,965,217 to the total cost of all direct
work items in the system of $281,621,066, or about 16.3 percent. We
applied this percentage to the total for overhead work items of
$202,393,699 to determine the overhead costs of FSA’s local offices of
$33,034,000.

Other costs incurred by the government to deliver catastrophic insurance
through USDA included direct and indirect costs for FSA’s software
development and support staff, and FCIC’s support. According to FSA, it
expended about 10,163 work hours for software development between
June 1, 1994, and December 31, 1995. FSA estimated an average software
development cost, including salaries and benefits, of $32 per hour for a
total of $325,208. In addition, FSA incurred costs for central staff support1
in its Washington, D.C., state, and area offices of $8,007,249. This total
included direct salary, travel, printing, and other costs amounting to
$7,129,169; and estimated indirect support costs of $878,080. FCIC’s support
costs for salaries, computer resources, training, travel, public awareness,
loss adjusting, and other miscellaneous costs amounted to $19,303,489.
The total we computed for direct and indirect costs of $78,999,217 for FSA’s
local offices plus the total direct and indirect costs for FSA’s software
development, FSA’s support staff, and FCIC’s support of $27,635,946 equals
the total basic cost to the government to deliver catastrophic insurance
through USDA in 1995 of $106,635,163, or $132.72 per crop policy.

FSA’slocal offices collected $42,822,950 in processing fees from farmers.
This directly reduced the cost to the government to deliver catastrophic
insurance through USDA because these dollars were remitted to USDA.
Accordingly, the total cost to the government of USDA’s delivery was
$63,812,213, or $79.42 per crop policy.




1
 In 1995, these staff were part of USDA’s Agricultural Stabilization and Conservation Service.



Page 86                                                            GAO/RCED-97-70 Crop Insurance
                            Appendix V
                            Methodology for Comparing 1995 Cost to
                            Government to Deliver Catastrophic
                            Insurance Through USDA and Private
                            Companies




Methodology for             To determine the cost to the government for private companies’ delivery
Determining the Cost to     of catastrophic insurance, we identified and totaled (1) all government
the Government to Deliver   payments to private companies to deliver catastrophic crop insurance and
                            (2) all expenses incurred by FSA’s local offices to support private delivery
Catastrophic Insurance      of catastrophic insurance. We also reduced the government’s cost for
Through Companies in        private company delivery by the amount of excess processing fees
1995                        collected by companies and remitted to USDA. The basic costs to the
                            government to deliver catastrophic insurance through private companies
                            in 1995 consisted of a percentage of premiums reimbursed to companies
                            and various support costs incurred by FSA. Offsetting these expenses were
                            the amount of excess catastrophic insurance processing fees companies
                            collected from farmers and remitted to USDA, thereby slightly reducing the
                            government’s cost for company delivery. In addition, USDA paid the
                            companies an underwriting gain in 1995 that was based on the amount of
                            underwriting risk the companies retained. See table V.2.

                            In 1995, the government paid the companies $25,882,567 in expense
                            reimbursements for catastrophic policies. This is about 14.8 percent of
                            their written catastrophic insurance premiums of about $174.9 million.

                            FSA’s local offices provided various support services to private companies
                            in 1995. Costs incurred for this support are tracked using various work
                            item codes in USDA’s County Office Work Measurement and Fund
                            Allocation System. With assistance from FSA, we selected each work item
                            relating directly to support services provided to private companies, such
                            as “0210 Information for reinsured companies.” We computed total
                            support costs provided by FSA’s local offices to be $3,499,061. Combined
                            with the expense reimbursement of $25,882,567, the total basic cost to the
                            government to deliver catastrophic insurance through private companies
                            in 1995 was $29,381,628, or $83.37 per crop policy.

                            The Federal Crop Insurance Reform and Department of Agriculture
                            Reorganization Act of 1994 authorized companies to retain processing fees
                            collected from farmers up to specified limits per farmer per county.2 Fees
                            collected that exceeded these limits had to be remitted to the government.
                            This reduced the basic cost to the government for company delivery by the
                            amount of fees that the companies remitted to the government, or by
                            $2,543,000. In 1995, USDA also paid companies additional reimbursements
                            totaling $2,950 for excess loss adjusting. After including excess loss
                            adjusting reimbursements and offsetting income from fees, the

                            2
                             Participating companies retained $17,356,400 in catastrophic insurance processing fees collected from
                            farmers.



                            Page 87                                                          GAO/RCED-97-70 Crop Insurance
                                              Appendix V
                                              Methodology for Comparing 1995 Cost to
                                              Government to Deliver Catastrophic
                                              Insurance Through USDA and Private
                                              Companies




                                              government’s cost to deliver catastrophic insurance through private
                                              companies was $26,841,578 or $76.16 per crop policy.

                                              Also, under the 1995 standard reinsurance agreement, companies could
                                              share in any underwriting gains or losses resulting from the catastrophic
                                              insurance they sold. Since premiums for catastrophic insurance coverage
                                              are paid entirely by the government, any underwriting gains—premiums in
                                              excess of claims paid out—are premium dollars funded by the
                                              government. In 1995, the companies earned an estimated underwriting
                                              gain of $44,777,673. Therefore, in 1995, the cost to the government to
                                              deliver catastrophic insurance through companies was increased by this
                                              amount of underwriting gain, for a total cost to deliver catastrophic
                                              insurance through companies of $71,619,251, or $203.22 per crop policy.

                                              To determine costs per crop policy, we obtained from FCIC’s Experience
                                              database 1995 crop policy counts for catastrophic insurance for each
                                              delivery system. According to FCIC’s Experience database for 1995, USDA
                                              sold 803,438 catastrophic crop policies and the companies sold 352,422
                                              catastrophic crop policies. We then divided the amounts derived for each
                                              cost category by these crop policy counts. Although we did not
                                              independently assess the accuracy and reliability of USDA’s computerized
                                              databases, we used the same files USDA uses to manage the crop insurance
                                              program and its local county offices.


Table V.1: Cost to the Government to Deliver Catastrophic Insurance Through USDA, 1995
                                                                                                                 Percent of $283
                                                                                                Cost per crop          million in
Cost category                                                                           Cost           policy         premiums
FSA local office direct costs—work codes and titles
225 Signup for catastrophic program                                            $19,020,924            $23.67                 6.7
226 Actual production history for insured crops                                 11,427,774              14.22                4.0
227 Refund of catastrophic processing fees                                         367,096               0.46                0.1
228 Claim for indemnity                                                           1,501,256              1.87                0.5
229 Acreage report                                                                6,757,722              8.41                2.4
230 Indemnity payment assignment                                                       17,540            0.02                0.0a
231 Critical loss appraisals                                                      1,812,832              2.26                0.6
9092 Photocopies                                                                   963,255               1.20                0.3
9093 Aerial photocopies                                                            409,583               0.51                0.1
9115 Reform training travel costs                                                 2,679,690              3.34                0.9
9116 Reform postage costsb                                                        1,007,545              1.25                0.4
Subtotal of FSA local office direct costs                                      $45,965,217            $57.21                16.2
                                                                                                                     (continued)


                                              Page 88                                              GAO/RCED-97-70 Crop Insurance
                                            Appendix V
                                            Methodology for Comparing 1995 Cost to
                                            Government to Deliver Catastrophic
                                            Insurance Through USDA and Private
                                            Companies




                                                                                                                                Percent of $283
                                                                                                          Cost per crop               million in
Cost category                                                                                 Cost               policy              premiums
FSA local office indirect costs
Allocation of various overhead work items                                             $33,034,000                  $41.12                     11.7
Total FSA local office costsc                                                         $78,999,217                  $98.33                     27.9
Other direct and indirect USDA costs:
FSA direct central software development                                                  $325,208                   $0.40                         0.1
FSA central staff support—direct costs                                                  7,129,169                     8.87                        2.5
FSA central staff support—indirect costs                                                  878,080                     1.09                        0.3
Subtotal FSA central staff support costs                                               $8,007,249                   $9.97                         2.8
USDA/FCIC direct costs
Salaries                                                                                1,541,635                     1.92                        0.5
Computer resources                                                                      1,899,550                     2.36                        0.7
Training                                                                                    20,566                    0.03                        0.0a
Travel                                                                                    628,451                     0.78                        0.2
Public awareness                                                                        1,462,610                     1.82                        0.5
Loss adjustment contractors                                                             7,819,110                     9.73                        2.8
Miscellaneous                                                                           5,931,567                     7.38                        2.1
Subtotal of USDA/FCIC direct costs                                                    $19,303,489                  $24.03                         6.8
Total of other USDA costs                                                             $27,635,946                  $34.40                         9.8
Total basic delivery cost to government                                             $106,635,163                  $132.72                     37.7
Less catastrophic fees collected                                                      $42,822,950                  $53.30                     15.1
Subtotal cost to government                                                           $63,812,213                  $79.42                     22.6
Plus underwriting gain                                                                           $0                 $0.00                         0.0
Total cost to governmentd                                                             $63,812,213                  $79.42                     22.6

                                            Note: Totals may not add because of rounding.
                                            a
                                                Less than 0.1 percent.
                                            b
                                             This work code benefitted both the USDA and the company delivery systems; thus, we prorated
                                            the total amount for this work code for both delivery systems based on total federal crop
                                            insurance crop policies.
                                            c
                                              Local office expenses shown do not reflect indemnity activity that may have occurred in the first
                                            quarter of fiscal year 1996. USDA was unable to provide such data.
                                            d
                                                Costs include USDA’s one-time start up costs for establishing the USDA delivery system.

                                            Source: GAO’s analysis of USDA’s data.




                                            Page 89                                                           GAO/RCED-97-70 Crop Insurance
                                             Appendix V
                                             Methodology for Comparing 1995 Cost to
                                             Government to Deliver Catastrophic
                                             Insurance Through USDA and Private
                                             Companies




Table V.2: Cost to the Government to Deliver Catastrophic Insurance Through Companies, 1995
                                                                                                                             Percent of $174.9
                                                                                                         Cost per crop               million in
Cost category                                                                                Cost               policy             premiums
Expense reimbursement                                                               $25,882,567                   $73.44                    14.8
Support services provided by FSA’s local offices—work codes and
titles
0210 Information for reinsured companiesa                                             $2,698,827                   $7.66                       1.5
                      a                                                                                                  b
9086 Aerial compliance                                                                       1,700                  0.00                       0.0c
                                      a
9094 Photocopies provided companies                                                      165,973                    0.47                       0.1
                                             a
9095 Aerial photocopies provided companies                                               147,535                    0.42                       0.1
9102 Postage costs for companiesa                                                         43,073                    0.12                       0.0c
9116 Reform postage costsd                                                               441,952                    1.25                       0.3
Total cost of support services provided by FSA                                        $3,499,061                   $9.93                       2.0
Total basic delivery cost to government                                             $29,381,628                   $83.37                    16.8
Less catastrophic fees remitted to the government in excess of                        $2,543,000                   $7.22                       1.5
limits established by 1994 reform act
Plus excess loss adjusting reimbursement                                                  $2,950                   $0.01                       0.0c
Subtotal of fees and excess loss adjusting reimbursement                              ($2,540,050)                ($7.21)                   (1.5)
Subtotal cost to government                                                         $26,841,578                   $76.16                    15.4
Plus underwriting gain                                                              $44,777,673                 $127.06                     25.6
Total cost to government                                                            $71,619,251                 $203.22                     41.0
                                             Note: Totals may not add because of rounding.
                                             a
                                               These work codes benefitted both catastrophic and buyup policies sold by the companies; thus,
                                             we prorated the total amount for this work code to include only the amount related to the
                                             companies’ catastrophic crop policies.
                                             b
                                                 Less than $0.01.
                                             c
                                                 Less than 0.1 percent.
                                             d
                                              This work code benefitted both delivery systems; thus, we first prorated the work code amount to
                                             both delivery systems based on total federal crop insurance crop policies and then prorated the
                                             companies’ amount to include only the amount related to the companies’ catastrophic crop
                                             policies.

                                             Source: GAO’s analysis of USDA’s data.




                                             Page 90                                                         GAO/RCED-97-70 Crop Insurance
Appendix VI

Explanation of Policy and Premium Data
Used to Illustrate Alternative Expense
Reimbursement Arrangements
                                         Crop insurance policies typically consist of more than one unit being
                                         insured per policy, many with different types of coverage on those units.
                                         Table VI.1 shows policy counts and premium amounts for the various
                                         coverage mixes selected by farmers. Policies with additional coverage
                                         represent the largest percentage of both policies and premiums sold by
                                         companies, 60.1 and 64.6 percent, respectively.


Table VI.1: 1995 Premiums and Policies by Type of Coverage
Dollars in thousands
Coverage mix                   Percent of                    Percent of
on a given        Number of         total        Total            total          Premiums by type of coverage
policy              policies     policies    premiums        premiums Catastrophic     Limited    Additional              Other
Policies sold by companies
Catastrophic        186,031          26.2      $141,648             11.2          $141,648        $0            $0           $0
only
Limited               33,352          4.7          65,872             5.2                0     65,872            0            0
additional only
Catastrophic           4,910          0.7          19,811             1.6            6,212     13,599            0            0
and limited
additional
Additional only     427,366          60.1       814,045             64.6                 0         0       814,045            0
Catastrophic          41,319          5.8       137,795             10.9            25,037         0       112,759            0
and additional
Limited               14,704          2.1          61,075             4.8                0     23,473       37,602            0
additional and
additional
Catastrophic           2,145          0.3          15,127             1.2            1,946      5,466        7,715            0
and limited
additional and
additional
Other                  1,331          0.2           5,235             0.4                7         4            21        5,202
Total federal       711,158         100.0    $1,260,609            100.0          $174,850   $108,415     $972,141       $5,202
crop insurance
sold by
companies
Total USDA          457,607         100.0      $282,997            100.0          $282,979        n/a          n/a           18
catastrophic
Total federal      1,168,765        100.0    $1,543,606            100.0          $457,830   $108,415     $972,141       $5,220
crop insurance
sold
                                         Note: Totals may not add because of rounding.

                                         Source: GAO’s analysis of FCIC’s data.




                                         Page 91                                                   GAO/RCED-97-70 Crop Insurance
Appendix VII

GAO-Adjusted Delivery Expenses for Buyup
Insurance in Relation to Published Data on
Commercial Lines of Insurance
                                         As mandated by the 1994 crop insurance reform act, table VII.1 presents
                                         GAO-adjusted delivery expenses for buyup insurance as a percent of
                                         premium for 1994 and 1995 as well as the published 10-year average
                                         delivery expenses as a percent of premium for various commercial
                                         property and casualty lines of insurance. The buyup delivery expenses
                                         compared are our adjusted, nine-company total expenses as a percent of
                                         buyup premium as shown in appendix IV, table IV.2 for 1994 and table IV.5
                                         for 1995. Property and casualty delivery expenses as a percent of premium
                                         are from Best’s Aggregates & Averages: Property-Casualty, 1996 Edition.
                                         We did not, however, use this information to arrive at our conclusion of an
                                         appropriate reimbursement rate.

                                         As we note in our table, a comparison of companies’ percentage of
                                         premium data for various insurance lines may be misleading because the
                                         amount of premium dollars involved per policy is not shown. In particular,
                                         premiums for some commercial insurance lines are significantly lower
                                         than government crop insurance premiums. Consequently, although
                                         expenses as a percent of premium may appear to be much higher for
                                         several commercial lines, the amount of expense dollars involved per
                                         policy is actually less than for government crop insurance.

                                         In addition, the expense ratios for commercial lines are based on
                                         premiums that include both risk and expense factors, while the expense
                                         ratios for multiple-peril buyup crop insurance are based on the premiums
                                         that include only a risk factor. Furthermore, we did not analyze the
                                         numbers associated with any commercial lines of insurance, including the
                                         factors that determine delivery expenses.


Table VII.1: Delivery Expenses as a Percent of Premium for 1994 and 1995 Adjusted Government Buyup Crop Insurance
and Published 10-Year Averages for Commercial Insurance Lines
                                                      Delivery expenses as a percent of premiuma
                                  Loss-adjusting
Line of insurance                      expenses     Commission expenses        All other expenses         Total expenses
Group accident and health                     4.9                     8.1                     9.3                    22.3
1995 Buyup (adjusted 9-co.                    3.6                    16.2                     7.4                    27.1
total)
1994 Buyup (adjusted 9-co.                    3.2                    16.0                     8.2                    27.5
total)
Private passenger auto                        8.4                     8.6                    13.9                    31.0
physical damage
Workers’ compensation                        11.7                     5.4                    13.9                    31.0
           b
Other lines                                   4.2                     6.9                    20.4                    31.4
                                                                                                              (continued)


                                         Page 92                                            GAO/RCED-97-70 Crop Insurance
                                      Appendix VII
                                      GAO-Adjusted Delivery Expenses for Buyup
                                      Insurance in Relation to Published Data on
                                      Commercial Lines of Insurance




                                                  Delivery expenses as a percent of premiuma
                                Loss-adjusting
Line of insurance                    expenses    Commission expenses               All other expenses           Total expenses
Reinsurance                                6.2                       20.1                         6.1                        32.4
                            c
Other accident and health                  5.4                       13.0                        16.5                        34.9
Personal linesd                           11.2                       10.0                        14.2                        35.4
Private passenger auto                    13.0                        8.5                        14.1                        35.6
liability
Aircraft                                   8.1                       14.4                        14.1                        36.6
Commercial auto physical                   6.7                       15.1                        14.9                        36.7
damage
Total (average) all lines                 12.6                       11.2                        14.8                        38.6
Fidelity                                   7.3                       13.0                        19.3                        39.6
Allied lines                               7.4                       15.1                        17.6                        40.1
Farmowners multiple peril                  8.8                       16.6                        15.1                        40.5
Commercial linesa                         13.8                       12.3                        15.2                        41.3
Commercial auto liability                 13.0                       13.3                        15.2                        41.5
Ocean marine                               8.0                       19.1                        14.4                        41.5
Homeowners multiple peril                 11.2                       16.1                        14.9                        42.1
Burglary and theft                         5.2                       14.6                        22.7                        42.5
Fire                                       5.2                       17.3                        20.0                        42.5
Inland marine                              5.7                       17.5                        19.5                        42.7
Earthquake                                14.3                       13.8                        16.2                        44.3
Medical malpractice                       30.7                        3.9                        11.3                        45.9
Commercial multiple peril                 15.9                       17.4                        18.3                        51.6
Boiler and machinery                       5.0                       11.5                        35.8                        52.3
Other liability                           27.7                       11.0                        14.5                        53.2
Surety                                     9.6                       19.1                        28.9                        57.6

                                                                                                        (Table notes on next page)




                                      Page 93                                                   GAO/RCED-97-70 Crop Insurance
Appendix VII
GAO-Adjusted Delivery Expenses for Buyup
Insurance in Relation to Published Data on
Commercial Lines of Insurance




Notes: Totals may not add because of rounding.
a
  Percentage of premium data may be misleading because the amount of premium dollars
involved per policy is not shown. In particular, premiums for some commercial insurance lines are
significantly lower than for government crop insurance. Consequently, although expenses as a
percent of premium may appear to be much higher for several commercial lines, the amount of
expense dollars involved per policy is actually less than for government crop insurance. See
comment 9 in app. VIII or comment 7 in app. IX for an explanation of how percentage of premium
information should be interpreted.
b
    Other lines includes glass, credit, mortgage guaranty, international, and miscellaneous.
c
    Other accident and health includes credit accident & health.
d
 Personal lines include private passenger auto and homeowners multiple peril; commercial lines
include all other lines, including earthquake.

Source: GAO’s analysis of nine participating companies’ data and data from Best’s Aggregates &
Averages: Property-Casualty, 1996 Edition (Oldwick, New Jersey: A.M. Best Company, Inc.,
1996), pp. 174-178.




Page 94                                                             GAO/RCED-97-70 Crop Insurance
Appendix VIII

Comments From National Crop Insurance
Services, Inc.

Note: GAO comments
supplementing those in the
report text appear at the
end of this appendix.




                             Page 95   GAO/RCED-97-70 Crop Insurance
                 Appendix VIII
                 Comments From National Crop Insurance
                 Services, Inc.




See comment 1.




                 Page 96                                 GAO/RCED-97-70 Crop Insurance
                 Appendix VIII
                 Comments From National Crop Insurance
                 Services, Inc.




See comment 2.




                 Page 97                                 GAO/RCED-97-70 Crop Insurance
                 Appendix VIII
                 Comments From National Crop Insurance
                 Services, Inc.




See comment 3.




                 Page 98                                 GAO/RCED-97-70 Crop Insurance
                          Appendix VIII
                          Comments From National Crop Insurance
                          Services, Inc.




See comment 4.




See comment 5.




See comment 2, app. IX.




See comment 6.




                          Page 99                                 GAO/RCED-97-70 Crop Insurance
                            Appendix VIII
                            Comments From National Crop Insurance
                            Services, Inc.




See comment 7.




See comment 8.



See comment 9.




Now on pp. 31, 83 and 84.

Now on pp. 92 and 93.




                            Page 100                                GAO/RCED-97-70 Crop Insurance
                  Appendix VIII
                  Comments From National Crop Insurance
                  Services, Inc.




See comment 10.




                  Page 101                                GAO/RCED-97-70 Crop Insurance
                  Appendix VIII
                  Comments From National Crop Insurance
                  Services, Inc.




See comment 11.




See comment 12.




                  Page 102                                GAO/RCED-97-70 Crop Insurance
                  Appendix VIII
                  Comments From National Crop Insurance
                  Services, Inc.




See comment 13.




Now on p. 53.




                  Page 103                                GAO/RCED-97-70 Crop Insurance
                  Appendix VIII
                  Comments From National Crop Insurance
                  Services, Inc.




See comment 14.




See comment 15.




See comment 16.




See comment 17.




                  Page 104                                GAO/RCED-97-70 Crop Insurance
                  Appendix VIII
                  Comments From National Crop Insurance
                  Services, Inc.




Now on p. 56.




See comment 18.




See comment 19.




                  Page 105                                GAO/RCED-97-70 Crop Insurance
                  Appendix VIII
                  Comments From National Crop Insurance
                  Services, Inc.




See comment 20.




See comment 21.




                  Page 106                                GAO/RCED-97-70 Crop Insurance
                  Appendix VIII
                  Comments From National Crop Insurance
                  Services, Inc.




See comment 22.




See comment 23.




See comment 24.




                  Page 107                                GAO/RCED-97-70 Crop Insurance
Appendix VIII
Comments From National Crop Insurance
Services, Inc.




Page 108                                GAO/RCED-97-70 Crop Insurance
                 Appendix VIII
                 Comments From National Crop Insurance
                 Services, Inc.




                 1. Because of publishing constraints, we did not reproduce the comments
GAO’s Comments   of individual members that the association provided in an appendix.
                 However, copies of these comments are available from GAO’s Director of
                 Food and Agriculture Issues.

                 2. As we note early in the report, the insurance companies play an
                 important role in delivering federal crop insurance. However, much of the
                 program’s success resulted from changes made by the 1994 reform act and
                 the Federal Agriculture Improvement and Reform Act of 1996.

                 3. Over the last 15 years, the purchase of crop insurance has become more
                 important to farmers. The 1994 reform act restricted disaster assistance
                 payments, and the Federal Agriculture Improvement and Reform Act of
                 1996 made farmers more responsible for managing risk. As a result,
                 farmers are more likely to purchase crop insurance. Therefore, while
                 agents have to sell the product, farmers now have more incentives to
                 purchase it. While we agree that incentives are important for attracting,
                 motivating, and retaining a workforce, we question whether a
                 taxpayer-supported program should be asked to reimburse certain
                 expenses.

                 4. Our report was intended to respond to the mandate contained in the
                 1994 reform act. In planning our response, we developed an approach that
                 addressed all of the questions in the law. For reporting purposes, we
                 focused on the issue that the legislative history of the mandate indicated
                 was of most concern to congressional decisionmakers—the cost of
                 administering the program.

                 5. We used 1994 and 1995 data for our analysis because these 2 years
                 provide a picture of expenses for delivering crop insurance before and
                 after the implementation of the reform act. Because of industry concerns
                 expressed early in our review about the use of this 2-year period, we
                 considered the extent to which loss-adjusting expenses may change with
                 varying loss experience as well as the extent to which loss-adjusting
                 expenses may affect total administrative expenses. We found that high
                 crop losses did not significantly increase companies’ loss-adjusting
                 expenses—the delivery cost factor most likely to be affected by high crop
                 losses. For example, for buyup insurance, while companies paid out $1.28
                 in loss claims for every dollar of premium received in 1995 and $0.58 in
                 loss claims for every dollar of premium received in 1994, their related
                 loss-adjusting expenses as a percent of premium for these 2 years were not
                 substantially different. Therefore, although losses were higher in 1995 than



                 Page 109                                        GAO/RCED-97-70 Crop Insurance
Appendix VIII
Comments From National Crop Insurance
Services, Inc.




in 1994, the companies’ loss-adjusting expenses for processing these
claims did not increase commensurately. In addition, loss-adjusting
expenses are not a significant portion of total administrative expenses
(about 3.5 percent of premiums on average for the nine companies we
reviewed). Furthermore, since the 1980s, the crop insurance companies
have received additional reimbursements in years of high crop losses.

6. The years we examined—1994 and 1995—were the first 2 years that the
industry provided USDA with the detailed data needed to analyze the
expenses associated with the selling and servicing of crop insurance. Data
from earlier years were not available in a consistent, detailed format for
analysis. In 1989, the companies were required to submit summary
expense data and ratios, but according to FCIC, many companies did not
submit these data and the data that were provided were not consistent
between companies. Furthermore, in 1991, FCIC rescinded this
requirement. In the 1995 standard reinsurance agreement, FCIC began to
require companies to submit a detailed expense report in the National
Association of Insurance Commissioners’ (NAIC) format using NAIC
guidelines for the prior calendar year—calendar year 1993. However, not
all companies complied with the requirement until 1994.

7. We contacted National Crop Insurance Services, Inc. (NCIS) early in our
review to discuss our review objectives and obtain the association’s views.
We spoke with NCIS officials during the course of our review and obtained
data on company membership in NCIS. However, NCIS officials did not offer
to provide any company expense data. Furthermore, because we had
access to FCIC’s and the nine companies’ original data, we did not request
company expense data from NCIS.

8. As discussed above, we believe that 1994 and 1995 were the 2 most
appropriate years to analyze. Prior to 1994, companies did not report their
expense data in a manner that is amenable to detailed analysis. As a result,
we are not at all certain that the industry’s assertion is accurate.

9. In appendix VII of our draft report, we inadvertently omitted the
loss-adjusting expenses associated with commercial insurance lines in our
presentation of commercial lines of insurance expenses in relation to the
expenses of government-sponsored multiple-peril crop insurance. In
response to the industry’s observation on this omission, we revised the
appendix to include reported loss-adjusting expenses. Contrary to the
industry’s assertion, however, we did not use this information to arrive at
our conclusion of an appropriate reimbursement rate for delivering federal



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crop insurance; we presented this information only because it was
required by the 1994 reform act.

We did not use this information for our analysis because the percentages
presented do not provide an appropriate comparison between commercial
lines of insurance and government-sponsored multiple-peril crop
insurance for several reasons. First, the expense ratios for commercial
lines are based on premiums that include both risk and expense factors,
while the expense ratios for multiple-peril crop insurance are based on
premiums that include only a risk factor. Second, we did not verify the
ratios for the commercial lines of insurance, and hence we cannot speak
to the accuracy of the cost elements that have been included in the
computations of those ratios. Finally, premium rates for commercial
insurance lines are significantly lower than average rates for multiple-peril
crop insurance. As a result, if a comparison to other lines of insurance is
to be made, the only appropriate comparison is on a dollars-per-policy
basis, not on a percentage-of-premium basis. Although expenses as a
percent of premium may appear to be much higher for several commercial
lines, the amount of expense dollars involved per policy is actually less
than for government crop insurance.

If we examine the dollars paid per policy instead of the percentage of
premium per policy, the reimbursement for multiple-peril crop insurance
per dollar of premium substantially exceeds the reimbursement for other
lines. For example, in 1995, according to NAIC, the average consumer
payment for private passenger automobile insurance was $666 per vehicle,
and the reported delivery expense rate was as much as 35.6 percent, or
$237. In comparison, for 1995 buyup crop insurance, the average premium
was $1,905 per policy, and the 31-percent reimbursement rate resulted in
an average payment to crop insurance companies of $591—or about 2.5
times more than the dollar value of delivery expenses for private
passenger automobile insurance. If the reimbursement rate had been
27.1 percent in 1995, as we believe would have been appropriate for that
year, the crop insurance companies would have received an average
reimbursement payment per policy—$516—an amount that is still more
than double the dollar value of delivery expenses for this private
passenger automobile insurance. A comparison of the reimbursement for
multiple-peril crop insurance on a dollars-per-policy basis to other
insurance lines yields similar results.

10. We welcome any additional perspectives. However, while NCIS asserts
that the industry’s consultants will bring an “unbiased perspective” to the



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issue, we question how consultants hired by the industry can be truly
objective. In any event, we cannot assess the contribution of these
consultants to the issue without seeing their product.

11. At the time of our review, the industry and the government had only 1
year of experience with the catastrophic insurance program. Furthermore,
in 1996, the underwriting gains on catastrophic insurance were higher than
in 1995.

12. As we state in chapter 3, the government’s costs for delivering
catastrophic insurance are higher through private insurance companies
because these companies earn underwriting gains, and USDA does not.

13. We recognize that government policy is to move the sale of
catastrophic insurance to the private sector. Our report simply analyzes
the differences in costs for the two delivery systems. As we state in
chapter 3, our only recommendation is that FCIC closely monitor the
underwriting gains associated with private-sector delivery of this
insurance in the context of FCIC’s long-term target.

14. While the industry’s comment focuses on agents’ compensation, our
report focuses on the government’s reimbursement arrangements with
companies, not agents. We recognize that companies can compensate their
agents in ways that they consider appropriate, regardless of the
companies’ arrangement with the federal government.

15. As required by the 1994 act, we examined the advantages and
disadvantages of alternative reimbursements to private companies—not
agents—and did not recommend one alternative over another.
Furthermore, we noted that the insurance companies prefer the current
system.

16. As we recognize in chapter 4, this capping alternative has the
disadvantage of possibly discouraging some companies from aggressively
marketing larger crop insurance policies for FCIC. However, our review
showed that a capping alternative that achieved an overall 24-percent
reimbursement rate for administrative expenses would affect only the
largest 5 percent of policies.

17. We agree that this alternative may require additional oversight by FCIC,
as we state in chapter 4. While the industry appears to believe that this
alternative provides no incentive for delivering crop insurance, we believe



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that one component of the alternative—the percentage of
premiums—would continue to serve as an incentive.

18. While we agree that this alternative is likely to increase FCIC’s
administrative workload, we discuss it simply to present a widely
considered alternative for delivery of government services. Moreover, at
least one company within the industry believes that the Federal
Acquisition Regulation (FAR) is an appropriate alternative. In 1993, one
company testified before the Subcommittee on Agriculture, Rural
Development, FDA, and Related Agencies, House Committee on
Appropriations, that it endorsed the FAR as an appropriate reimbursement
arrangement.

19. As we note in chapter 4, this alternative may discourage some larger
companies from aggressively delivering crop insurance.

20. In any competitive business, companies must shoulder certain
expenses for the opportunity to earn profits. However, in the case of the
federal crop insurance program, companies are paid for these expenses
through the administrative expense reimbursement. In addition, the
companies have the opportunity to earn profits through underwriting
gains.

21. We examined the two 1989 reports as part of our review, and to the
extent that they provided information applicable to the current crop
insurance program, we considered it. However, in so doing, we noted that
the program’s size and nature has changed significantly since the 1980s.

22. We do not challenge the industry’s characterization of the
administrative expense reimbursement as a form of subsidy, but it is not
clear what the significance of this alternative terminology is. Regardless of
the terms used to describe this payment to insurance companies, it is clear
that the reimbursement to companies is intended to compensate them for
the reasonable expenses associated with selling and servicing crop
insurance, not to provide them with an additional source of profits. To
believe otherwise, would negate the rationale for the mandated joint
GAO/FCIC study of the adequacy of the administrative expense
reimbursement.

23. As we note in the introduction to our report, the crop insurance
companies play an important role in the delivery of federal crop insurance.
Nothing in our report suggests that their role should be reduced or



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eliminated. However, continuing emphasis on reducing the federal budget
requires FCIC to ensure that it is not paying more than is necessary to
implement the crop insurance program.

24. We do not believe that lowering the reimbursement rate will destabilize
the crop insurance industry. A lower reimbursement rate—in the range of
24 percent—will adequately compensate companies for their reasonable
administrative expenses to deliver crop insurance and should not diminish
service to farmers and still allow profits from underwriting.




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Note: GAO comments
supplementing those in the
report text appear at the
end of this appendix.




See comment 1.




See comment 2.




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See comment 3.




See comment 4.




See comment 5.




See comment 6.




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See comment 7.




See comment 8.




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See comment 1.




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See comment 2.
See comment 3.
See comment 9.




See comment 10.




See comment 2.


See comment 3.




See comment 4.




See comment 7.




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See comment 1.




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See comment 5.




See comment 4.




See comments 2 and 5.




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See comment 5.




See comment 6.




See comment 11.




See comment 12.




See comment 13.




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See comment 14.




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See comment 15.




See comment 16.




See comment 17.




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See comment 18.




See comments 3 and 9.




See comment 19.




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See comment 20.




See comment 21.




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See comment 22.




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See comment 23.




See comment 24.




See comment 25.




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See comment 26.




See comment 7.




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See comment 22.




See comment 27.



See comment 28.




See comment 29.


Now on pp. 4 and 22.



See comment 30.




See comment 31.




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See comment 32.




See comment 33.




See comment 34.




See comment 35.




See comment 36.




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See comment 37.




See comment 38.




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                 1. The 1994 reform act mandated that GAO and FCIC jointly evaluate the
GAO’s Comments   current financial arrangement between FCIC and approved insurance
                 providers for delivering multiple-peril crop insurance to farmers. In
                 researching the legislative history of this provision, we found that the
                 paramount congressional interest was in controlling the costs of
                 reimbursing crop insurers in the context of funding this and other
                 agricultural programs in a deficit reduction environment. Moreover, we
                 confirmed our interpretation of the mandate in a commitment letter to the
                 Chairmen and Ranking Minority Members of the Senate Committee on
                 Agriculture, Nutrition, and Forestry, and the House Committee on
                 Agriculture at the outset of our review. This letter set forth our approach
                 for meeting this mandate, including our scope and methodology. We
                 believe that the report fulfills the mandate.

                 2. We used 1994 and 1995 data for our analysis because these 2 years
                 provide a picture of expenses for delivering crop insurance before and
                 after the implementation of the reform act. Because of industry concerns
                 expressed early in our review about the use of this 2-year period, we
                 considered the extent to which loss-adjusting expenses may change with
                 varying loss experience as well as the extent to which loss-adjusting
                 expenses may affect total administrative expenses. We found that high
                 crop losses did not significantly increase companies’ loss-adjusting
                 expenses—the delivery cost factor most likely to be affected by high crop
                 losses. For example, for buyup insurance, while companies paid out $1.28
                 in loss claims for every dollar of premium received in 1995 and $0.58 in
                 loss claims for every dollar of premium received in 1994, their related
                 loss-adjusting expenses as a percent of premium for these 2 years were not
                 substantially different. Therefore, although losses were higher in 1995 than
                 in 1994, the companies’ loss-adjusting expenses for processing these
                 claims did not increase commensurately. In addition, loss-adjusting
                 expenses are not a significant portion of total administrative expenses
                 (about 3.5 percent of premiums on average for the nine companies we
                 reviewed). Furthermore, since the 1980s, the crop insurance companies
                 have received additional reimbursements in years of high crop losses.

                 The draft report’s reference to 1995 as a year of relatively low crop losses
                 was intended to reflect a low level of catastrophic loss claims. Because
                 this reference was apparently confusing, we have deleted it from the final
                 report. In actuality, the loss ratio on buyup coverage in 1995 exceeded the
                 loss ratio in 1990 and 1992 and was about the same as the loss ratio in
                 1991. Only in 1993, the year of a one-in-100-year flood event, was the loss
                 ratio substantially higher.



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3. Our analysis is based on actual company expenditures in 1994 and 1995
and actual crop price information for 1996 and 1997. We did not
specifically address future crop prices. However, USDA’s World Agricultural
Outlook Board projects generally increasing prices through 2005. If crop
prices decline, FCIC could reevaluate the reimbursement rate for
administrative expenses.

4. This assertion is not correct. As we noted in our report, the FAR was just
one of several sources we used to develop criteria for identifying expenses
reasonably associated with selling and servicing crop insurance. We
recognized all expenses reasonably associated with selling and servicing
crop insurance. However, we continue to believe that the taxpayer should
not be expected to reimburse companies for such expenses as those
related to maximizing underwriting gains, acquiring other companies’
business, paying executives to refrain from joining or starting other
companies, paying parent companies management fees without receiving
any measurable benefits for the program, providing profit-sharing
bonuses, and paying lobbying expenses. We believe that these expenses
should not be included in determining an appropriate future
reimbursement rate for administrative expenses.

5. Contrary to the industry’s assertion, we believe that the reimbursement
for administrative expenses is just that. It is intended to reimburse
companies for the costs of selling and servicing crop insurance, not to
provide an additional source of profit to the industry. While FCIC
encourages the companies to provide competitive service within the
reimbursement rate provided, FCIC expects, as evidenced by the standard
reinsurance agreement, that the profits companies seek should come from
underwriting gains, not from the administrative reimbursement. In fact,
since 1990, companies have earned over $0.5 billion in net underwriting
gains.

6. While an evaluation of the quality of service provided by the companies
and USDA was not a principal focus of our review, we found little to suggest
that the quality of service by companies and USDA to farmers was
unsatisfactory.

7. Contrary to the industry’s assertion, we did not use the information in
appendix VII to arrive at our conclusion of an appropriate reimbursement
rate for delivering federal crop insurance; we presented this information
only because it was required by the 1994 reform act. In this appendix of
our draft report, we inadvertently omitted the loss-adjusting expenses



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associated with commercial insurance lines in our presentation of
commercial lines of insurance expenses in relation to the expenses of
government-sponsored multiple-peril crop insurance. In response to the
industry’s observation on this omission, we revised the appendix to
include reported loss-adjusting expenses.

We did not use this information for our analysis because the percentages
presented do not provide an appropriate comparison between commercial
lines of insurance and government-sponsored multiple-peril crop
insurance for several reasons. First, the expense ratios for commercial
lines are based on premiums that include both risk and expense factors,
while the expense ratios for multiple-peril crop insurance are based on
premiums that include only a risk factor. Second, we did not verify the
ratios for the commercial lines of insurance and hence we cannot speak to
the accuracy of the cost elements that have been included in the
computations of those ratios. Finally, premium rates for commercial
insurance lines are significantly lower than average rates for multiple-peril
crop insurance. As a result, if a comparison to other lines of insurance is
to be made, the only appropriate comparison is on a dollars-per-policy
basis, not on a percentage-of-premium basis. Although expenses as a
percent of premium may appear to be much higher for several commercial
lines, the amount of expense dollars involved per policy is actually less
than for government crop insurance.

If we examine the dollars paid per policy instead of the percentage of
premium per policy, the reimbursement for multiple-peril crop insurance
per dollar of premium substantially exceeds the reimbursement for other
lines. For example, in 1995, according to NAIC, the average consumer
payment for private passenger automobile insurance was $666 per vehicle,
and the reported delivery expense rate was as much as 35.6 percent, or
$237. In comparison, for 1995 buyup crop insurance, the average premium
was $1,905 per policy, and the 31-percent reimbursement rate resulted in
an average payment to crop insurance companies of $591—or about 2.5
times more than the dollar value of delivery expenses for private
passenger automobile insurance. If the reimbursement rate had been
27.1 percent in 1995, as we believe would have been appropriate for that
year, the crop insurance companies would have received an average
reimbursement payment per policy—$516—an amount that is still more
than double the dollar value of delivery expenses for this private
passenger automobile insurance. A comparison of the reimbursement for
multiple-peril crop insurance on a dollars-per-policy basis to other
insurance lines yields similar results.



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8. We have carefully reviewed the industry’s comments on our report and
our methodology, findings, conclusions, and recommendations. We are
confident that our work was performed with due professional care using a
sound methodology and that our findings are well supported, our
conclusions flow logically from the facts, and our recommendations offer
reasonable suggestions for reducing the costs of the crop insurance
program. Accordingly, we have published this report to make it available
for timely decisionmaking by FCIC and the Congress.

9. Regarding the industry’s assertion concerning premium rates, as we
noted in Crop Insurance: Additional Actions Could Further Improve the
Program’s Financial Condition (GAO/RCED-95-269, Sept. 28, 1995), FCIC
increased premium rates annually from 1991 through 1995. As noted in our
current report, FCIC also increased premium rates 3.6 percent from 1995 to
1996. Because of the congressionally mandated goal of a 1.075 loss ratio
for the program, it is likely that premium rates will remain at their current
level or increase slightly. Accordingly, we continue to hold the view that
the assumptions we made with regard to premium levels are reasonable.

10. Data available from earlier years were not in an appropriate format for
analysis. In 1989, the companies were required to submit summary
expense data and ratios, but according to FCIC, many companies did not
submit these data, and the data that were provided were not consistent
between companies. Furthermore, in 1991, FCIC rescinded this
requirement. In the 1995 standard reinsurance agreement, FCIC began to
require companies to submit a detailed expense report in the NAIC format
using NAIC guidelines for the prior calendar year—calendar year 1993.
However, not all companies complied with the requirement until 1994.

11. Over the last 15 years, the purchase of crop insurance has become
more important to farmers. The 1994 reform act restricted disaster
assistance payments, and the 1996 farm bill made farmers more
responsible for managing risk. As a result, farmers are more likely to
purchase crop insurance. Therefore, while agents have to sell the product,
farmers now have more incentives to purchase it.

12. We recognize that private companies do not get fully reimbursed for
their administrative expenses until the end of the insurance cycle.
However, as the companies complete different administrative tasks, such
as reporting to FCIC the type of crop and amount of acreage a policyholder
has planted, they are reimbursed for their effort. Moreover, we believe that




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this arrangement ensures proper internal controls in the program by
withholding payments until the work is complete.

13. In examining the 1995 expenses during the course of our review, we
found instances of temporary employees being hired as well as overtime
being paid. Quite naturally, as business grows, staffing may increase.
However, the increases in the number of policies that led to the increase in
workload also resulted in increased premium revenues and thus increased
reimbursement for administrative expenses.

14. We agree that commercial reinsurance is an important tool for
increasing companies’ financial capacity and managing their underwriting
risk and that reinsurance costs can be legitimate business expenses.
However, the cost of reinsurance relates to companies’ decisions to
manage risk rather than to the sale and service of crop insurance.
Therefore, we believe, and FCIC agrees, that this expense should be paid
from companies’ underwriting revenues and not be considered in
determining a future reimbursement rate for administrative expenses.

15. We recognize that acquisition expenses are a legitimate cost of doing
business. To the extent that acquisitions could be attributed to physical
assets related to the sale and service of crop insurance, we considered
them as a reasonable crop insurance expense. However, we do not believe
that all acquisition expenses, such as the $3 million non-compete payment
one company reported paying the acquired companies’ executives, should
be included in the calculation for determining a long-term expense
reimbursement rate. FCIC agreed that this is not an expense reasonably
associated with the sale and service of crop insurance.

16. Contrary to the industry’s assertion, we recognized management fees
as a reasonable program expense to the extent that companies could
identify tangible benefits received from parent companies. Management
fees paid without tangible benefits, however, represent a method of
sharing income with the parent company, not an administrative expense
reasonably associated with the sale and service of crop insurance.

17. We recognized all bonuses related to employee performance as well as
all bonuses paid to agents as reasonable expenses associated with the sale
and service of crop insurance. However, we continue to believe that
bonuses associated with company profit sharing should not be included in
determining an appropriate future reimbursement rate for administrative
expenses. For example, at one privately-held company, profits from the



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sales of crop insurance—taken after all delivery expenses were met—were
paid to executives and employees in the form of bonuses. For the 2-year
period, 1994 and 1995, the company paid its executives and employees
$9 million in profit-sharing bonuses, representing about 49 percent of basic
salaries in 1994 and 63 percent in 1995. When these profit-sharing bonuses
were added to salaries, overall employee salaries at this company were
35-percent higher than the nine-company average.

18. We did not recommend reducing the expense reimbursement rate on
the basis of companies’ use of corporate aircraft. However, on the basis of
our review of the companies’ expense documentation, we believe that
these and other similar expenses provide opportunities for FCIC to lower
its future reimbursement rate for administrative expenses while still
adequately reimbursing companies for the reasonable expenses of selling
and servicing crop insurance policies. These other expenses included
excessive automobile charges; entertainment expenses, including country
club memberships and stadium sky box rentals; trips to resort locations;
and personal expenses, such as child care and pet care. It is not
reasonable to expect taxpayers to fund these types of expenses.

19. We presented a status report on FCIC’s simplification efforts in
appendix I and did not evaluate the cost savings to the industry that might
result. Our report did not use potential reductions in administrative
requirements as the basis for concluding that FCIC could lower its
reimbursement rate. Any cost reductions resulting from simplification
would only serve to further reduce the companies’ expenses of selling and
servicing crop insurance.

20. Regardless of the terms used, FCIC’s reimbursement to companies for
administrative expenses is intended to compensate them for the
reasonable expenses associated with selling and servicing crop insurance.

21. We stated in our report that the companies have no obligation to spend
their FCIC reimbursement for administrative expenses on crop
insurance-related expenses because we wanted to point out that
companies had no legal requirement to refund federal money spent for
activities that are not reasonably associated with the sale and service of
government crop insurance.

22. The industry’s assertion that the government’s cost to use the Farm
Service Agency (FSA) to sell catastrophic insurance is 60-percent higher
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government. The industry excludes (1) the $50 farmer-paid processing fee,
which FSA remits to the Treasury and which the companies generally
retain; and (2) the companies’ underwriting gains. As noted in chapter 3,
these two factors resulted in a total cost to the government in 1995 for
companies’ delivery that was significantly higher than FSA’s delivery cost.

23. We recognize that the private insurance companies perform an
important service in informing farmers about risk management. We
considered the expenses associated with this effort in determining an
appropriate future reimbursement rate for administrative expenses.
Therefore, we do not believe that the adjustments in the reimbursement
rate that we recommended would reduce the industry’s incentives to
educate farmers about their risk management needs.

24. The industry’s comment reflects some misunderstanding of our
(1) accounting for the cost to the government for catastrophic insurance
delivery and (2) analysis of the companies’ compensation for delivering
this insurance. Regarding the government’s cost, the $50 processing fee
farmers pay offsets to some extent the government’s delivery costs
through FSA because this fee is returned to the Treasury. In contrast, the
$50 fee paid to the companies generally has no impact on the cost to the
government because the companies retain the fee as income. In analyzing
the companies’ compensation for delivering catastrophic insurance, we
included the $50 fee in their total compensation for catastrophic insurance
because they retain it.

25. While the private sector and FSA have played an important role in
implementing the new program, several factors influenced participation in
the crop insurance program in 1995 and 1996, including congressionally
mandated participation and requirements that disaster assistance be on
budget.

26. FCIC pays the companies a percentage of premiums—explicitly for
loss-adjusting expenses—that can be used to offset any expenses,
including administrative and operating expenses. In fact, the companies’
loss-adjusting expenses in 1995 were about 2 percent of catastrophic
premiums, while their direct reimbursement from FCIC was about
14 percent of premiums. Additionally, in exchange for delivering
catastrophic insurance, private companies receive and retain a $50
processing fee from farmers, up to a maximum of $100 per farmer per
county.




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27. The 1989 Arthur Andersen study of crop insurance delivery expenses
may not be an appropriate basis of comparison because it looked at two
different private-sector delivery systems—not FCIC and private-sector
delivery—and found that one system was less expensive than the other.

28. It is not clear which studies the industry is referencing. However, since
the 1994 reform act increased the program’s size dramatically, the
relevance of these pilot studies may be questionable.

29. Our report clearly notes that the reimbursement rate will decline
through 1999, as required by the 1994 act.

30. As required by the 1994 act, we examined the advantages and
disadvantages of alternative means of reimbursing companies for their
administrative expenses and did not recommend one alternative over
another. Furthermore, we noted that the insurance companies prefer the
current system.

31. We did not imply any criticisms of the current reimbursement system’s
service to small farmers. Rather, we discussed the potential effects of the
alternatives on service to small farmers. In this context, table 4.1 is
intended to show how premiums and reimbursements were distributed in
1995.

32. We do not believe that a cap on the administrative expense
reimbursement would substantially destabilize the industry. Assuming a
capping alternative that achieves an overall 24-percent reimbursement
rate, only the largest 5 percent of policies would be affected.

33. This alternative provides incentives for selling both small and large
policies—a minimum payment for small policies and a
percentage-of-premium component for larger policies.

34. While we agree that this alternative is likely to increase FCIC’s
administrative workload, we discuss it simply to present a widely
considered alternative for delivery of government services. Moreover, at
least one company within the industry believes that the FAR is an
appropriate alternative. In 1993, this company testified before the
Subcommittee on Agriculture, Rural Development, FDA, and Related
Agencies, House Committee on Appropriations, that it endorsed the FAR as
an appropriate reimbursement arrangement.




Page 150                                         GAO/RCED-97-70 Crop Insurance
Appendix IX
Comments From the American Association
of Crop Insurers and the Crop Insurance
Research Bureau, Inc.




35. As we noted in chapter 4, this alternative may discourage some larger
companies from aggressively delivering crop insurance.

36. We acknowledged in our report that other alternatives exist, and we
did not intend to provide an all-inclusive analysis of the alternatives
available. Instead, we focused on the major alternatives identified by
discussions with industry and agency officials.

37. We disagree. We are recommending that FCIC implement an
administrative reimbursement rate that pays companies for the expenses
reasonably associated with selling and servicing crop insurance.

38. We agree that the program has been generally successful. Furthermore,
as we note in the introduction to the report, the private insurance
companies are important players in the delivery of federal crop insurance.
Nevertheless, the continuing emphasis on reducing the federal budget
requires FCIC to ensure that it is not paying more than is necessary to
implement the crop insurance program. A lower reimbursement rate—in
the range of 24 percent—will adequately compensate companies’ for their
expenses to deliver crop insurance, and a lower reimbursement rate
should not diminish service to the farmer.




Page 151                                        GAO/RCED-97-70 Crop Insurance
Appendix X

Major Contributors to This Report


               Ronald E. Maxon, Jr., Assistant Director
               Thomas M. Cook, Evaluator-in-Charge
               Ruth Anne Decker
               Robert R. Seely, Jr.
               Carol Herrnstadt Shulman
               Sheldon H. Wood, Jr.




(150119)       Page 152                                   GAO/RCED-97-70 Crop Insurance
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