Why Crop Insurance Costs Too Much
Vincent H. Smith
This paper examines the federally subsidized crop insurance program. Under this program, the federal government subsidizes about 60 percent of the premiums farmers pay for private insurance to protect them against financial losses due to drops in the value of their crops. The federal government also subsidizes the private insurance companies that sell the policies, paying them between 12 and 19.6 percent of the premiums farmers pay to cover the companies’ costs of marketing the policies. The paper’s main findings are:
1) Taxpayers spend billions of dollars annually to subsidize crop insurance, and this amount is rapidly growing: Since the 2008 Farm Bill, government subsidies for crop insurance have averaged $5.6 billion annually, a steep rise from the roughly $2 billion annual average spent between 2003 and 2007. The program is now over twenty-eight times larger than it was in 1994, when subsidized crop insurance cost roughly $200 million per year.
2) Crop insurance subsidies are now the single largest farm subsidy program: The $5.6 billion crop insurance program is nearly one-third of the total expenditures on programs directly targeted to farmers. It is rivaled in size only by the $5 billion farmers collect annually in direct payments. Farmers today rarely collect subsidies from the traditional farm subsidy programs because of historically high commodity prices.
3) Insurance companies are the real winners from crop insurance subsidies: The crop insurance program subsidizes the insurance companies’ overhead while letting them keep the bulk of any underwriting gains. This system of socialized losses and privatized gains is a windfall for companies and their agents; about 58 percent of crop insurance subsidies ultimately flow to them. Since 2005, the agricultural insurance industry has received $1.44 for every $1.00 received by farmers.
4) This program could be repealed without much harm to farmers: Farmers have repeatedly shown they will not buy crop insurance without massive government subsidies—that is, they do not think the benefits are worth the costs. Farmers could protect themselves against financial losses by making greater use of modern financial techniques, such as forward selling, puts, options, and derivatives.
5) If the program must remain, it should be dramatically reformed: Three simple reforms would significantly reduce crop insurance costs and increase its efficiency:
a. Replace the complex and confusing array of policies currently available with a single weather-based product that can be delivered online at extremely low delivery costs;
b. If this cannot be done for all crops now, reduce the subsidies for insurance companies to market the products so they bear some downside risks; and
c. Cap the amount any one farm entity can receive in crop insurance subsidies so that wealthy farmers do not receive government support.