Crop Insurance Increases Risk

Published October 13, 2015

A recent report from economist Helen Fessenden of the Federal Reserve Bank of Richmond shows federally subsidized crop insurance encourages farmers to undertake risky practices, increasing the cost of the program.

When the most recent farm bill passed in 2014, lawmakers abolished the controversial system of direct payments to farmers, but they expanded the crop insurance program. The government today pays 60 percent of farmers’ insurance premiums and 100 percent of the administrative and operating costs for insurers. Fessenden reports the program will likely cost $41 billion over a five-year period, 20 percent more than was paid out under the previous farm bill over five years.

Farmers Get Full Coverage

Proponents of the program argue it provides much-needed protection to farmers, but critics say it’s nothing more than a taxpayer handout.

“In the farm bill there are two new programs: agricultural risk coverage and price loss coverage,” said Vincent Smith, a visiting scholar at the American Enterprise Institute and professor at Montana State University. “Those programs have been characterized as if they’re insurance programs. They are not. They are subsidy programs.”

Agricultural risk coverage provides support when farmers’ estimated revenues fall below historical averages. Price loss coverage pays farmers when the price of their commodity falls below a reference price.

A February 2015 report from The Heritage Foundation concluded the programs “go far beyond providing farmers with a safety net.” According to the report, “The ARC program removes virtually all risk associated with producing and marketing the crops that the program covers. Farmers selecting this option receive taxpayer-funded subsidies for even minor losses—losses that often can simply be attributed to normal business risk.”

The harvest price option subsidy indemnifies farmers for lost production at either the planting or the harvest price, whichever is higher. When corn yields fell in 2012 due to drought, the price of corn rose significantly, and farmers with the harvest price option were indemnified at the high harvest price.

“So the upshot was that the actual revenue per acre that the average farmer received was above what they expected to get when they planted the crop,” Smith said.

Subsidizes Wealthy Risk-Takers

Crop insurance subsidies largely go to large, profitable farmers, those in the top 10 or 15 percent of farms, according to Smith.

“These are multimillionaires operating financially very successful operations who don’t need any government help,” Smith said.

Critics say the highly subsidized crop insurance program leads to excessive risk-taking, such as planting on poor land and using less fertilizer. Fessenden’s study quotes economist Bruce Babcock, who led a 2013 study critical of the program for the nonprofit Environmental Working Group. Babcock says the current crop insurance program provides incentives for farmers to plant on fragile or marginal land.

“If a farmer has to decide whether it’s risky to plant on particular ground, crop insurance makes planting slightly more likely,” Fessenden’s report quotes Babcock as saying.

Babcock also said the current crop insurance regime “crowds out” other forms of risk management that cost the taxpayer less.

Fessenden’s report quotes Babcock saying, “If they were really looking to manage risk, farmers could use off-farm income, diversification of crops, storage, and other macro risk-management tools that are more efficient.

“But we have to remember they don’t buy insurance for risk management benefits alone,” Babcock added. “They buy it because the subsidies make it worthwhile.”

Compares to Financial Crisis

Smith compares the current system of farm aid to the mortgage market prior to the financial crisis.

“It encourages increased risk-taking,” said Smith. “It’s sort of like the world of loan mortgages prior the financial collapse. It’s exactly that world where the government’s incentivizing risk-taking that’s not very responsible because it’s … financially profitable for the farmers to do that.

“Rolling back the subsidy to 1994 levels would save … $2 or $3 billion dollars [per year], … way more than we would have saved by reducing the food stamp program along the lines sought originally by the House Republicans in 2013 and 2012,” said Smith.

Ann N. Purvis, J.D. ([email protected]) writes from Dallas, Texas.

Internet Info

Helen Fessenden, “The Crop Insurance Boom,” Federal Reserve Bank of Richmond, First Quarter 2015: