Policy Documents

Why Crop Insurance Costs Too Much

Vincent H. Smith –
July 12, 2011

Agricultural insurance has become an increasingly important component of the farm program over the past decade. Since 2007, government subsidies for crop insurance have averaged about $5.6 billion per year, representing over one-third of total expenditures on income transfers and other government payments for programs targeted directly to farmers. However, about 58 percent of those expenditures have ended up in the hands of agricultural insurance companies and agricultural insurance agents. In fact, since 2005, on average, the agricultural insurance industry has received $1.44 for every dollar farmers have received in crop insurance subsidies.

Thus, the US federal crop insurance program has become one of the most expensive ways of transferring income to farmers while, at the same time, supplying products that most farmers would never buy absent subsidies. Further, the program involves many products that generate moralhazard behavior by farmers and waste resources. Nevertheless, the program is likely to continue for the foreseeable future, and to expand even further as livestock operations seek to benefit from a subsidy pool that until recently has been the domain of crop producers. Aside from substantial support for the program from agricultural organizations and insurance industry lobbies, it has broader political appeal as a Good Samaritan program that helps people when they appear to be in trouble.

In this context, this paper begins by examining the origins and evolution of the US crop insurance program and provides an overview of its complexity and diversity with respect to individual insurance products. The program’s growth in terms of subsidies and overall actuarial performance is then described. Next, the economic issues surrounding the program are examined, including concerns about delivery costs and the supply side. The paper ends with conclusions and recommendations for policy change. The major recommendations are as follows. Ideally, the entire crop insurance program should be abandoned. However, given that subsidized crop insurance is here to stay—at least for a while—first, the subsidized insurance products should be designed to minimize incentives for moral-hazard behavior, which almost always results in wasted resources. Second, the program should be structured to minimize delivery costs. Third, insurance subsidies should be capped on a per-farmer basis to minimize adverse income redistribution (taking from the relatively poor to disproportionately benefit the relatively rich).