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                       Testimony
                          Before the Committee on Agriculture,
                          Nutrition, and Forestry
                          United States Senate


For Release on Delivery
Expected at
9:00 a.m. EDT
                          CROP INSURANCE
Thursday
April 17, 1997

                          Opportunities Exist to
                          Reduce Government Costs
                          for Private-Sector Delivery
                          Statement of Robert A. Robinson, Director,
                          Food and Agriculture Issues
                          Resources, Community, and Economic
                          Development Division




GAO/T-RCED-97-139
Mr. Chairman and Members of the Committee:

We are pleased to have this opportunity to discuss the adequacy of the
administrative expense reimbursement paid by the U.S. Department of
Agriculture’s (USDA) Federal Crop Insurance Corporation (FCIC) to
participating insurance companies for selling and servicing crop insurance
and the comparative cost to the government of delivering catastrophic
crop insurance through USDA and the private sector. We also will address
alternative means to reimburse companies’ administrative expenses for
delivering crop insurance. Our testimony today is based on our report,
which was mandated by the 1994 crop insurance reform act. This report is
being issued today.1

In summary, for the 1994 and 1995 period we reviewed, we found that the
administrative expense reimbursement rate of 31 percent of premiums
paid to insurance companies resulted in reimbursements that were
$81 million more than the companies’ expenses for selling and servicing
crop insurance. The reimbursement is calculated as a percentage of the
premiums paid to the companies, regardless of the expenses incurred by
the companies. For the 2-year period, companies reported expenses that
were less than the reimbursements paid to them by FCIC. Furthermore, we
found that some of these reported expenses did not appear to be
reasonably associated with the sale and service of federal 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, we found other expenses
that appeared excessive for reimbursement through a taxpayer-supported
program. These expenses suggest 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, a variety of factors that have emerged since the period covered by
our review have increased companies’ revenues or may decrease
companies’ expenses. Crop prices and premium rates increased in 1996
and 1997, generating higher premiums. This had the effect of increasing
FCIC’s expense reimbursement to companies. 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

1
 Crop Insurance: Opportunities Exist to Reduce Government Costs for Private-Sector Delivery
(GAO/RCED-97-70, Apr. 17, 1997).



Page 1                                                                       GAO/T-RCED-97-139
             must comply. Combined, all these factors indicate that FCIC could lower
             the reimbursement to a rate in the range of 24 percent of premiums and
             still amply cover reasonable company expenses for selling and servicing
             federal crop insurance policies.

             Regarding the cost of catastrophic insurance delivery, we found that, in
             1995, the government’s total costs to deliver catastrophic insurance were
             less through USDA than private companies. Although the basic costs
             associated with selling and servicing catastrophic crop insurance through
             USDA and private companies were comparable, total delivery costs were
             less through USDA because USDA’s delivery avoids the need to pay an
             underwriting gain to companies. In 1995, the underwriting gains paid to
             participating companies for catastrophic insurance totaled about
             $45 million. In 1996, the underwriting gains paid for catastrophic insurance
             were about $58 million.

             Finally, we 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 when compared with
             the existing reimbursement arrangement. Companies generally prefer the
             existing reimbursement method because of its relative administrative
             simplicity.


             Federal crop insurance protects participating farmers against the financial
Background   losses caused by events such as droughts, floods, hurricanes, and other
             natural disasters. In 1995, crop insurance premiums were about
             $1.5 billion. USDA’s Risk Management Agency administers the federal crop
             insurance program through FCIC. Federal crop insurance offers farmers
             two primary types of insurance coverage. The first—called catastrophic
             insurance—provides protection against extreme crop losses for the
             payment of a $50 processing fee, whereas the second—called buyup
             insurance—provides protection against more typical smaller crop losses 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 also offers
             catastrophic insurance through the local offices of USDA’s Farm Service
             Agency.

             FCIC pays the companies a fee, called an administrative expense
             reimbursement, that is intended to reimburse the companies for the



             Page 2                                                     GAO/T-RCED-97-139
                  expenses reasonably associated with selling and servicing crop insurance
                  to farmers. The reimbursement is calculated as a percentage of the
                  premiums received, regardless of the expenses incurred by the companies.
                  Beginning in 1994, companies were required to report expenses in a
                  consistent format following standard industry guidelines to provide FCIC
                  with a basis for establishing future reimbursement rates. For buyup crop
                  insurance, FCIC reduced the administrative expense reimbursement from a
                  base rate of 34 percent of the premiums on policies sold from 1988
                  through 1991 to 31 percent of the premiums from 1994 through 1996. 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. In addition, the companies earn profits
                  when insurance premiums exceed losses on policies for which they retain
                  risk. These profits are called underwriting gains. Since 1990, companies
                  selling crop insurance have earned underwriting gains totaling more than
                  $500 million.

                  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 our review,
                  we examined expenses at nine companies representing about 85 percent
                  of the total federal crop insurance premiums written by private companies
                  in 1994 and 1995. We chose the companies considering factors such as
                  premium volume, location, and type of ownership.


                  In 1994 and 1995, FCIC’s administrative expense reimbursements to
Current           participating companies selling buyup insurance—31 percent of
Reimbursements    premiums—were higher than the expenses that can be reasonably
Exceed Delivery   associated with the sale and service of federal crop insurance. For the
                  2-year period, FCIC reimbursed the nine companies we reviewed about
Expenses          $580 million. For this period, the companies reported expenses of about
                  $542 million to sell and service crop insurance—a difference of about
                  $38 million. However, our review showed that about $43 million of the
                  companies’ reported expenses could not be reasonably associated with the
                  sale and service of federal crop insurance. Therefore, we believe that these
                  expenses should not be considered by FCIC in determining an appropriate
                  future reimbursement rate for administrative expenses. Furthermore, we
                  found that a number of the reported expenses appeared excessive for
                  reimbursement through a taxpayer-supported program and suggest an



                  Page 3                                                     GAO/T-RCED-97-139
                            opportunity to further reduce future reimbursement rates for
                            administrative expenses. Finally, a variety of factors have emerged since
                            the period covered by our review that have increased companies’ revenues
                            or may decrease their expenses, such as higher crop prices and premium
                            rates and reduced administrative requirements. These factors should be
                            considered in determining future reimbursement rates.


Some Reported Expenses      Our review showed that about $43 million of the companies’ reported
Not Reasonably Associated   expenses could not be reasonably associated with the sale and service of
With Crop Insurance         federal crop insurance. These expenses, which we believe should not be
                            considered in determining an appropriate future reimbursement rate for
Delivery                    administrative expenses, included expenses for acquiring competitors’
                            businesses, protecting companies from underwriting losses, sharing
                            company profits through bonuses or management fees, and lobbying
                            expenses.

                            Among the costs reported by the crop insurance companies that did not
                            appear to be reasonably associated with the sale and service of crop
                            insurance to farmers were those related 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 benefit to
                            the crop insurance program, and according to FCIC, was not an expense
                            that FCIC expected its reimbursement to cover. 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 that 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 no net value to
                            the crop insurance 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. In total, we identified
                            costs in this general category totaling about $12 million for the 2-year
                            period.




                            Page 4                                                   GAO/T-RCED-97-139
We also found that two companies included payments to commercial
reinsurers among their reported crop insurance delivery expenses. 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
company decisions to manage underwriting risks rather than to the sale
and service of crop insurance to farmers. We discussed this type of
expense with FCIC, and it agreed that this expense should be paid from
companies’ underwriting revenues 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.

Furthermore, we found that some companies included as administrative
expenses for selling and servicing crop insurance, expenses that resulted
from decisions to distribute profits to (1) company executives and
employees through bonuses or (2) parent companies through management
fees. We found that profit-sharing bonuses were a significant component
of total salary expenses at one company, equaling 49 percent of basic
salaries in 1994 and 63 percent in 1995. These bonuses totaled $9 million
for the 2 years. While company profit sharing may benefit a company in
competing with another company for employees, the bonuses do not
contribute to the overall sale and service of crop insurance or serve to
enhance program objectives. Furthermore, while we recognize that
performance-based employee bonuses and bonuses paid to agents
represent reasonable expenses, the profit-sharing bonuses in this example
did not appear to be reasonable program expenses because they were paid
out of profits after all necessary program expenses were paid.
Additionally, we identified profit-sharing bonuses totaling $2.1 million
reported as expenses at three other companies for 1994 and 1995. In total,
we found expenditures in this general category amounting to $12.2 million
over the 2 years.

Similarly, we noted that two companies reported expenditures for
management fees paid to parent companies as crop insurance
administrative expenses. 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



Page 5                                                   GAO/T-RCED-97-139
                             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 a dividend. These expenses totaled $1.1 million for the 2 years.

                             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 that the companies included
                             a total of $418,400 for lobbying in their expenses reported for 1994 and
                             1995. The vast majority of these expenses involved the portion of
                             companies’ membership dues attributable to lobbying by crop insurance
                             trade associations.

                             Adjusting for these and other expenses reported in error, we determined,
                             and FCIC concurred, that the expense rate for companies’ expenses
                             reasonably associated with the sale and service of buyup crop insurance in
                             1994-95 was about 27 percent of premiums. This is about 4 percentage
                             points, or $81 million, less than the reimbursement FCIC provided. Of these
                             4 percentage points, 2 points reflect companies’ reported expenses that
                             were less than their reimbursement; the remainder reflect adjustments to
                             their reported expenses that did not appear to be reasonably associated
                             with the sale and service of crop insurance.


Other Reported Expenses      In addition, we found a number of expenses reported by the companies
Represent Opportunities to   that, although associated with the sale and service of crop insurance,
Lower Reimbursement          seemed to be excessive for a taxpayer-supported program. While difficult
                             to fully quantify, these types of expenditures suggest that opportunities
Rates                        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.

                             For example, 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—an average of about 18.1 percent of buyup premiums
                             sold in 1994 and 17.5 percent in 1995. When this company, which



                             Page 6                                                     GAO/T-RCED-97-139
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 companies.

Furthermore, 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 $46,857 in total. In
another instance, as part of paying for employees to attend industry
meetings at resort locations, we found that one company paid for golf
tournament entry fees, tickets to an amusement park, spouse travel, child
care, and pet care, and reported these as crop insurance delivery
expenses.

Our review of companies’ expenses also 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 a Canadian fishing trip 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 that 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 companies’ expenditures disclosed payments 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. While a number of the companies believe that the
type of expenses described above are important to maintaining an
effective sales force and supporting their companies’ mission, we, along
with FCIC, believe that most of these expenses appear to be excessive for a
program supported by the American taxpayers.



Page 7                                                      GAO/T-RCED-97-139
Emerging Factors Have   Since the period covered by our review, a variety of factors have emerged
Increased Companies’    that have increased companies’ revenues or may decrease companies’
Revenues                expenses. Crop prices and premium rates increased in 1996 and 1997,
                        thereby generating higher premiums. This had the effect of increasing the
                        reimbursements paid to companies for administrative expenses by about
                        3 percent of premiums without a proportionate increase in workload for
                        the companies.

                        Moreover, FCIC and the industry’s efforts to simplify the program’s
                        administrative requirements may reduce companies’ workload, thereby
                        reducing their administrative expenses. As of January 1997, FCIC had
                        completed 26 simplification actions and was continuing to study 11
                        additional potential actions. Neither FCIC nor the companies could
                        precisely quantify the amount of savings that companies can expect from
                        these changes, but they agreed that the changes were necessary and
                        collectively may reduce costs.


                        In 1995, the government’s total cost to deliver catastrophic insurance
Government’s 1995       policies was less through USDA than through private companies. The total
Total Cost to Deliver   cost to the government to deliver catastrophic insurance consists of three
Catastrophic            components: (1) the basic sales and service delivery costs, (2) offsetting
                        income from processing fees paid by farmers, and (3) company-earned
Insurance Through       underwriting gains. When only the first and second components were
USDA Was Less Than      considered, the costs to the government for both delivery systems were
                        comparable. However, the payment of an underwriting gain to companies,
Through Private         the third component, made the total 1995 cost of delivery through private
Companies               companies more expensive to the government.

                        With respect to the first component—basic sales and service delivery
                        costs—the cost to the government was higher in 1995 when provided
                        through USDA. The government’s costs for basic sales and service delivery
                        through USDA included expenses associated with activities such as selling
                        and processing policies; developing computer software; training adjusters
                        and adjusting claims. These costs also included indirect or overhead costs,
                        such as general administration, rent, and utilities. Also included in the
                        1995 direct and indirect costs for USDA’s delivery were the Department’s
                        one-time start-up costs for establishing its delivery system. Direct costs for
                        basic delivery through USDA amounted to about $91 per crop policy, and
                        indirect costs amounted to about $42 per crop policy, for a total basic
                        delivery cost to the government of about $133 per crop policy. The basic
                        delivery cost to the government for company delivery consisted of the



                        Page 8                                                      GAO/T-RCED-97-139
administrative expense reimbursement paid to the companies by FCIC and
the cost of administrative support provided by USDA’s Farm Service
Agency. The administrative expense reimbursement paid to the companies
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 costs to the government for both delivery
systems. For USDA’s delivery, processing fees paid by farmers and remitted
to the Treasury reduced the government’s basic delivery cost of about
$133 by an average of $53 per crop policy. 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 the companies
more expensive in 1995. 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, companies could experience net underwriting losses, meaning that
they would have to pay out money from their reserves in excess of the
premium paid to them by the government, potentially reducing the
government’s total cost of company delivery in such years.

The 37-percent underwriting gain received by the companies on
catastrophic policies in 1995 substantially exceeded FCIC’s long-term
target. According to FCIC, the large underwriting gains in 1995 may have
been unusual in that there were relatively few catastrophic loss claims and
many farmers did not provide sufficient data on their production



Page 9                                                    GAO/T-RCED-97-139
                        capabilities. In 1996, however, the underwriting gains on catastrophic
                        policies were even higher—$58 million.


                        The current arrangement for reimbursing companies for their
Alternative             administrative expenses—under which FCIC pays private companies a
Reimbursement           fixed percentage of premiums—has certain advantages, including ease of
Arrangements Offer      administration. However, expense reimbursement based on a percentage
                        of premiums does not necessarily reflect the amount of work involved to
Potential for Savings   sell and service crop insurance policies. Alternative reimbursement
                        arrangements, including, among others, those that would (1) cap the
                        reimbursement per policy or (2) pay a flat dollar amount per policy plus a
                        reduced fixed percentage of premiums, offer the potential to better match
                        FCIC’s reimbursements with companies’ administrative expenses. Each
                        alternative has advantages and disadvantages, and we make no
                        recommendation concerning which alternative, if any, should be pursued.

                        With respect to the first alternative, 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. Savings would vary depending on where the cap is set. Capping
                        the expense reimbursement at around $1,500 per policy, for example,
                        would result in a potential savings of about $74 million while affecting less
                        than 10 percent of the individual policies written in 1995. Under the
                        current reimbursement arrangement, as policy premiums increase, the
                        companies’ reimbursement from FCIC for administering the policies
                        increases. However, the workload, or cost, associated with administering
                        the policy does not increase proportionately. Therefore, for policies with
                        the highest premiums, there is a large differential between FCIC’s
                        reimbursement and the costs incurred to administer those particular
                        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 generated administrative expense reimbursements
                        ranging from about $118,000 to $472,000.

                        Alternatively, FCIC could reduce its total expense reimbursements to
                        companies by paying a flat dollar amount per policy plus a reduced fixed
                        percentage of premiums. FCIC could reimburse companies a fixed amount
                        for each policy written to pay for the fixed expenses associated with each
                        policy as well as a percentage of premium to compensate companies for
                        the variable expenses associated with the size and value of a policy. For
                        example, paying a flat $100 per policy plus 17.5 percent of premium could



                        Page 10                                                     GAO/T-RCED-97-139
           result in a potential savings of about $67 million. FCIC has included this
           alternative in its proposed 1998 standard reinsurance agreement with the
           industry.

           As we discuss in more detail in our report, while these and other
           alternative reimbursement methods could result in lower cost
           reimbursements to insurance companies, some methods may increase
           FCIC’s own administrative expenses for reporting and compliance. Some
           alternatives may also assist smaller companies to compete more
           effectively with larger companies and/or encourage more service to
           smaller farmers than does the current system. Companies generally prefer
           FCIC’s current reimbursement method because of its administrative
           simplicity.

           In conclusion, we recommended that the Administrator of the Risk
           Management Agency determine an appropriate reimbursement rate for
           selling and servicing crop insurance and include this rate in the new
           reinsurance agreement currently being developed between FCIC and the
           companies. Furthermore, we recommended that the Administrator
           explicitly convey the type of expenses that the administrative
           reimbursement is intended to cover. USDA’s Risk Management Agency
           agreed with our recommendations and has included these changes in the
           proposed 1998 agreement now being developed.

           The crop insurance industry disagreed with the methodology, findings,
           conclusions, and recommendations presented in our report. It expressed
           concern that we were not responsive to the mandate in the 1994 act and
           did not appropriately analyze company data. It also expressed concern
           that implementing GAO’s recommendations could destabilize the industry.
           We carefully reviewed the industry’s comments and continue to believe
           that our report fulfills the intent of the mandate, our methodology is
           sound, our report’s findings and conclusions are well supported, and our
           recommendations offer reasonable suggestions for reducing the costs of
           the crop insurance program.


           This completes my prepared statement. I will be happy to respond to any
           questions you may have.




(150120)   Page 11                                                    GAO/T-RCED-97-139
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