Analysis of Crop Insurance Proposals H.R. 4360 and H.R. 4592

Published by the Government Accountability Office on 1990-05-01.

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

                   United   States General Accounting        Office

For Release        Analysis        of   Crop     Insurance    Proposals
on delivery         H.R.    4360    and   H.R.     4592
Expected    at
10:00 a.m. EDT
May 1, 1990

                    Statement   of
                    John W. Harman,      Director
                    Food and Agriculture          Issues
                    Resources,    Community,        and Economic                Development

                    Before    the
                    Subcommittee       on Conservation,               Credit,       and
                       Rural    Development
                    Committee     on Agriculture
                    House of Representatives

                                                                                   GA0Foi-m   180(12;~~)
Mr.     Chairman            and Members of the                      Subcommittee:

           We are pleased                 to testify               before        this      Subcommittee                  on ways to
reform       the      federal            crop      insurance            program.             As you requested,                        our
testimony          addresses              how well          two legislative                   proposals                 for
replacing          the       current            crop     insurance             program--H.R.                   4360,          introduced
by Representative                   English,             and H.R.             4592,       introduced               by
Representative                Grandy-- meet eight                       criteria           for         assessing              the
federal        role         in providing                disaster         assistance                to farmers.                  These
criteria         were        initially             identified            in a September                    1989 GAO report-l
Our analysis                focuses         only        on the         two proposals                   you are most
interested            in.       Other           alternatives             could          meet more criteria                          than
these       proposals.

           In summary,            both          proposals           would        generally              meet four              of the
eight       criteria.             However,              these       proposals             differ         in the          degree         to
which       they      meet these                criteria.              Like      current           programs,             both
proposals          strongly              rely      on federal            resources               for     premium              subsidies
and the        payment          of excess               losses         but     rely       on private               companies               to
deliver        services.                 We believe             that     any proposal                   that       uses        a mixed
private/public                 system           requires           a strong           federal           regulatory,
oversight,            and audit             function            to ensure             program           integrity              and to
protect        the      government's                   financial             interests.                In particular,                  we
believe        H.R.         4592 requires                 stronger            federal        oversight.

lDisaster          Assistance:                   CrOR Insurance Can Provide                                Assistance                More
Effectivelv          Than Other                  Proqrams (GAO/RCED-89-211,                                Sept.         20,        1989).

        Let me now briefly                 discuss         our criteria              for     assessing           federal
disaster       assistance            programs        to    farmers.

        In developing             these        criteria,        we determined                that      the      policy
principles           of equity        and efficiency              are essential                elements          of any
desirable        disaster         assistance            program.         These principles                     suggest
that    an equitable           disaster           assistance          policy         ensures          that      aid      is
provided       consistently            to victims           suffering           from        similar          losses       over
time.        An efficient            disaster         assistance         policy            ensures       that
benefits       are provided             at the        lowest      possible           cost      to government                  and
to society           as a whole.              In our opinion,            an equitable                 and efficient
disaster        assistance           policy       should       exhibit         the     following             eight

        --    (1) determine             compensation            by the         amount        of a farmer's
              loss,     not    by the          severity        of the     disaster,

        --     (2) provide           similar         amounts      of assistance                to     farmers
              suffering          similar        amounts        of losses,

        --     (3)    not   provide           farmers      more assistance                  than      the     amount          of
              their       disaster         losses,

      --     (4)     not         create       incentives               to encourage             farming         practices
            that       increase             the      likelihood               and extent           of losses,

       --    (5) make the programs                          consistently                 available         over     time         to
             allow         for      long-range            planning,

       --    (6) help             farmers          withstand             and recover            from the         effects          of
             natural             disasters,

       --    (7)     provide          predictable                  annual        costs,       and

       --    (8) meet their                   objectives                at the      lowest         possible        cost.


       Both proposals                  meet our            first         criterion,           which       is that          the
amount      of disaster              assistance             provided             should       be determined                by the
amount      of a farmer's                  loss,         not by the             severity        of the         disaster.
Both meet this              criterion              because          the        conditions          for    compensation
are agreed         to before               the growing              season.             No legislative             or
administrative              action--             such as a presidential                       disaster
declaration--          is needed                 after     the         fact     to determine             the    level       of

       Both proposals                     also      meet our second                   criterion,          which      is that
disaster        assistance                programs         should             provide       similar       amounts          of

assistance          to      farmers        suffering           from      similar        amounts            of 10ss.~               In
a broad      sense,          they      meet this         criterion            because         all         crop       insurance
purchasers          would       be treated             equally         according          to the           terms        of their

         Neither           proposal        meets       our third          criterion,            which            is that
disaster       assistance              programs         should         not provide             farmers              more
assistance          than       the     amount      of their            disaster          losses.               In
determining           the      amount       of    insurance            policy       coverage,              both
proposals          permit       producers          to substitute                 ASCS county               yield        data       for
actual      production              histories.            A producer             would       be expected                to use
the   ASCS yield             when it        is higher.               Therefore,            producers                under    both
proposals          can be compensated                   for      more than          they       would           have been
entitled       to     if     they      had used their                actual        production              histories           to
determine          their       yields.

         Neither           proposal        meets       criterion          four,        which        is that            disaster
assistance          programs           should      not        create      incentives            to encourage
farming      practices              that    increase           the     likelihood            and extent                of
losses.        Subsidized              disaster         assistance              programs        discourage
farmers       from         taking      risk-reducing               measures         because,              with
subsidies,          farmers           may be able             to obtain          disaster           assistance              that
provides       protection              at a cost          lower        than      prevention.                   Generally,
the more a program                    is   subsidized,             the    less      likely          it     is that

2For the purpose of this analysis,                                   we are ignoring                     the     tax    system's
effect  on meeting this criterion.

farmers        will      try        to reduce               risks.               H.R.      4360 does not meet this
criterion         because             it     makes substantial                           use of subsidies,
particularly             in     its         provision             of a free                disaster       assistance              plan        to
producers.              H.R.        4592 also               includes              direct       and indirect               federal
subsidies.              Because             the    proposal             is different                  from and less
specific         than         the     current          system,              it     is difficult                to determine              the
extent       of program               subsidy          that          would         be involved.

         H.R.         4592 also             does not meet this                           fourth       criterion           because           it
has features             that         increase              the      risk         of excessive             loss.          This
proposal         emphasizes                 a more privatized                           insurance        program,
characterized                 by (1)         a commissioner                       who will          have apparently                   fewer
resources             than     the         current          FCIC manager,                    (2) a separate               office         of
crop      insurance            operations,                  (3)      an advisory               committee           with      few
members representing                         the      federal           government's                  interests,           and
(4)    a mixed          federal/state                   regulatory                 structure            that      may not
provide        the      federal             government               with         sufficient            authority          to
regulate         the         program         effectively.                        Our experience                in reviewing              loss
adjustment             practices--which                      have shown significant                             amounts          of
overpayments--                indicates              that      strong             federal         oversight         and control
is necessary                 to protect              the     government's                   financial           interests.3

         Generally,             both         proposals               meet criterion                   five,       which      is that
disaster         assistance                 programs           should             be consistently                 available            over

3Croo Insurance:                      Private           Company Loss Adiustment  Imnrovina,                                           but
Overuavments   Still                   Hiqh            (GAO/RCED-90-32,  Nov. 7, 1989).

time      to allow         for      long-range              planning.                Actual       implementation

experience,            however,           might       reveal         significant                 differences         between
them.        H.R.        4360 lessens              the      likelihood               of an ad hoc disaster
assistance           program            by providing            most producers                    with     a limited
amount       of disaster                assistance            protection               at no cost.             Furthermore,
the     effect       of H.R.            4592 on participation                          and the       comprehensiveness
of coverage              (both      in terms          of numbers                  of crops        and locations)               is
not     clear       to us.          The failure               of either              proposal,           however,        to
attract          sufficient             participation               or provide               sufficient          protection
could       lead     to periodic                 pressures          for      ad hoc disaster                 legislation,
creating           uncertainty             for     producers.

          Both proposals                 meet criterion                   six,       which       is that       disaster
assistance           programs            should          help    farmers             withstand           and recover           from
the     effects          of natural              disasters.               These proposals                 meet this
criterion           because         they         provide        cash assistance                   to producers            to
enable       them to continue                     farming.

          For several             reasons,           neither         proposal             meets      criterion           seven,
which       is that        disaster              assistance          programs               should       have predictable
annual       costs.            First,       both         proposals           subsidize            the     purchase        of crop
insurance           and,       thus,       program          costs         will       vary     with       participation
rates.           And second,              neither         proposal               significantly            addresses           how to
make crop           insurance             actuarially            sound,             a situation           in which
premium          costs        reflect        the     risk       underlying               insurance          coverage.               The
federal          government             would       absorb       excess             losses       under      each proposal.

Therefore,          federal           expenditures                could        increase         to the      extent         that
premiums        do not        fully          reflect           insurance         risks.          In particular,                 H.R.
4592 requires             the     Crop Insurance                   Commissioner                to establish           an
actuarially          sound premium                 for         a catastrophic              reinsurance           fund,          yet
some insurance              officials            have told               us that        this     cannot       be done.

         Neither         proposal            meets       our last          criterion,            which       is that
disaster        assistance             programs               should      meet their            objectives          at the
lowest      possible          cost.           Both proposals                   are heavily            subsidized,           which
increases          the    likelihood              and extent              of losses.             The federal
government          would        ultimately              have to compensate                     insurance        companies
for     some of these             excess          losses.              In addition,             the    H.R.    4592
regulatory          structure            raises              questions         about      how effectively
program        abuse      can be controlled,                       which        can also         lead     to extra
government          expenditures.                  This          proposal        also      includes          a federally
funded        hardship          allowance              for     premium         increases         above 35 percent.
Although        rates       are subject                 to     federal         approval,         there       appears        to be
minimal        incentive          to keep premium                      costs     down once this               level        is
reached.           As we understand                     the      proposal,         the     policyholder             pays
nothing        additional             out      of pocket,              and funds          do not        have to be
appropriated             before        the      fact          to cover         these      expenditures.

         Mr.    Chairman,             this      concludes              my prepared             statement.           My
colleagues          and I will               be happy            to answer         any questions              you may