July 26 (Bloomberg) -- This year’s once-in-a-generation drought may leave many crop farmers largely unscathed as they are protected by taxpayer-subsidized insurance, a program Congress is moving to make more generous.
With prices for corn, soy and wheat escalating along with estimates of the drought’s severity, government-backed revenue- insurance policies offered through units of companies such as ACE Ltd. and Wells Fargo & Co. probably will be paying out billions of dollars in claims. And the program is designed so that the larger the losses for insurers, the greater the share of the payouts the government will pick up.
Farmers “are laughing all the way to the bank,” Bruce Babcock, an Iowa State University economist and critic of the insurance program, said at a presentation in Washington July 19. “If the price goes up, you could end up better off than anticipated if you have a crop loss.”
“I’m not saying this is anything illegal, or immoral,” he added. “It’s just the way it is.”
In 2011, with a drought in Texas and other weather woes, government-run crop-insurance programs paid out a record $10.8 billion. Of premiums paid in 2011, farmers chipped in $4.5 billion, while the government paid $7.4 billion, according to data published by the department.
Because of the program’s reinsurance rules, insurers made a $1.7 billion profit even with those record payouts, while the government took an underwriting loss of about $500 million, Pat Engel, a spokeswoman for the USDA Risk Management Agency, said in an e-mail.
Jeff Scates, who farms corn and soybeans on 15,000 acres in Shawneetown, Illinois, said this year demonstrates the need for an effective insurance program. He said he may lose as much as 80 percent of his crop because of the dry conditions. With insurance, he said he can recoup 75 percent of his potentially lost revenues.
Because of vagaries in how the system is administered by the government and the costs of seeds and fertilizer, “you’re never whole,” he said in an interview. “I’m definitely in favor of the crop-insurance program. It gives us skin in the game. If everyone buys it, everyone is in the game.”
Like auto, fire, and other forms of insurance, farmers pay into the program each year, collecting only when they suffer losses. In each of the previous 10 years insurance companies made more in premiums than they paid out to farmers.
Federal crop insurance dates to the Dust Bowl droughts of the 1930s. The program and subsidies were boosted in 2000 as lawmakers sought to use it as a way to avoid what by the 1980s had become near-annual disaster payouts. Those payments cost taxpayers $68.7 billion from 1989 to 2009, according to the Congressional Research Service.
The program reflects a long-standing desire in Congress to protect farmers, who are considered essential to the economy and at unusual risk of losses because of weather, said Keith Collins, a former chief economist for the U.S. Department of Agriculture who is currently a consultant for the crop-insurance industry.
The share of government support for crop insurance could rise by the time the next disaster hits, as lawmakers are working on a new agriculture-policy law that would expand support both for farmers and the insurers. The Senate has passed a bill with a provision that reduces premium costs for new farmers, expands insurance for cotton growers and allows farmers to buy a supplemental policy.
The Senate changes would cost the government an additional $5 billion over the next decade, according to the nonpartisan Congressional Budget Office. The House Agriculture Committee has approved a similar measure.
That expansion partly compensates for the proposed elimination of another form of subsidy, direct payments, which growers can receive regardless of crop prices. House Agriculture Committee Chairman Frank Lucas, an Oklahoma Republican, called the insurance plan a “sound risk-management program that serves as a good example of a public-private partnership where producers pay for coverage.”
Lawmakers have moved “substantially in the direction of having risk management be the farmers’ safety net,” David Graves, manager of the American Association of Crop Insurers in Washington, said in an interview. The droughts last year and this year show the program is working, he said. Farmers will “have a loss, but they’ll be able next year to ante up and go at it again.”
The threat to crops is high.
The U.S. Drought Monitor today said moderate to severe drought expanded to 64 percent of the lower 48 states in the week ended yesterday, up slightly from the previous week. Yesterday, the Department of Agriculture designated 76 more counties as natural-disaster areas, bringing the total to 1,369 in 31 states -- 44 percent of those in the entire country. The USDA last week said 88 percent of the nation’s corn crop and 87 percent of soybeans were in drought-stricken areas, making the conditions the worst for farmers since 1988.
Higher commodity prices mean higher insurance payments to farmers, who are able to buy policies that are linked to the price of their crops at harvest time. Theoretically, that means growers, who often insure 70 percent to 75 percent of their crop, can end up with a bigger payday if their crop fails and prices rise than if they harvest their full expected crop while prices are stagnant.
The price of corn, the biggest U.S. crop, closed yesterday at $7.88 a bushel on the Chicago Board of Trade, up 20 percent from March 1, as the planting season was getting under way. Soybeans gained 22 percent in that period and wheat 36 percent.
And the higher the indemnities, the greater the share that the government chips in, protecting the companies such as ACE and Wells Fargo from overwhelming losses. The government also takes a share of underwriting profits.
Insurers aren’t protected from all losses.
“Drought conditions in the U.S. are impacting our crop- insurance business and will affect our earnings in the second half of the year,” Evan Greenberg, chairman and chief executive of ACE, said in a statement July 24.
Gabriel Boehmer, a spokesman for Wells Fargo, said “it’s ‘‘premature to speculate on the effects the drought will have’’ on the company” He said Wells Fargo recognizes “the vital role crop insurance plays in helping our country sustain an agricultural industry that delivers a stable, affordable food supply.”
Farmer groups say criticisms of the program are misplaced, because crop insurance has achieved its goal of reducing risk and lessening dependence on emergency bailouts that also cost billions.
After last year’s drought in Texas and flooding in the Midwest, “for the first time in my memory, we did not have any serious legislative effort at an ad hoc disaster bill,” Bob Young, the chief economist of the American Farm Bureau Federation in Washington, said in an e-mail.