Crop Insurance. Crop Insurance

Transcription

1 Crop Insurance Farmers in the United States and elsewhere face risks the average person seldom considers. When we experience a dry summer most of us consider it an extra day at the beach; for the farmer it can mean crop failure. For the farmer, their farm is not only their business; it is their livelihood. Farming is a business; therefore insurance is usually purchased to offset their business risk. Because of the unpredictable nature of farming, including the weather, insurance is often expensive. Even so, a bad year that is uninsured can lead straight to bankruptcy. Agricultural insurance typically covers four primary categories: 1. Crop insurance for damaged or lost crops; 2. Property and casualty insurance for liability, such as an injured employee or coverage for physical property (livestock is typically not included); 3. Livestock insurance; and 4. Specialized insurance for certain types of farming with unique perils and challenges. Many states have specialized insurance companies that work with them to cover perils unique to the area. Farmers in some states may need coverage for hail or windstorms, for example, which are not typical perils in other farming regions. There may also be insurance cooperatives in some areas of the United States that address specific concerns of the region. Because these cooperatives may be able to offer lower premiums for the same coverage they are an asset for local farmers. Buying crop and farm insurance makes sense for many reasons; government subsidies may be offered to farmers to offset a portion of their insurance Page 3

2 premium. Increased coverage levels may also be available for some crops. Protection for input costs and harvest values may be available. There is another very important reason to purchase crop insurance: it may serve as collateral for operating loans. Most banks and financial institutions who loan to farmers want assurance that there is insurance in place in case a crop failure occurs. This is the bank s protection so that loans may be repaid even if the crop fails. Buying crop insurance policies is one way to manage the risk of crop failures or substantially low yields. Crop insurance agents and other agribusiness specialists assist farmers in developing a successful insurance management plan. In order to understand crop policies and how they apply it is necessary to know certain abbreviations that are commonly used: ACT The Federal Crop Insurance Act, (& U.S.C et seq.) AGR Adjusted Gross Revenue AIP Approved Insurance Provider AMS Agricultural Market News Service APH Actual Production History CAT Catastrophic Risk Protection CCC Commodity Credit Corporation CIH Crop Insurance Handbook CSREES Cooperative State Research, Education, and Extension Service ERS Economic Research Service DAS Data Acceptance System DSSH Document and Supplemental Standards Handbook FCIC FSA Farm Service Agency FCIC Federal Crop Insurance Corporation IRS Internal Revenue Service LAM Loss Adjustment Manual MPCI Multiple Peril Crop Insurance NAP Noninsured Crop Disaster Assistance Program NASS National Agriculture Statistical Service PHTS Policyholder Tracking System RMA Risk Management Agency Page 4

3 SBI Substantial Beneficial Interest USDA United States Department of Agriculture When considering crop insurance policies farmers must always carefully consider how the plan will work in conjunction with their other risk management strategies. The goal is always to achieve the best possible outcome each crop year. As one would expect, crop insurance insures crops. Of course there is more to it than that, just as there are with other types of insurance coverage. The farmer must decide the level of coverage that is best for him and his farm and he or she must qualify for the type of coverage desired. There are three basic types of crop insurance: 1. Yield-based coverage; 2. Revenue-based coverage; and 3. Named-peril plans. Yield-based plans, as the name implies, covers the crop yield. If the fields do not yield the quantity they normally would, an insurance payment is received. Yield based plans may be based either on the farm s individual yield history (but only if enough data exists to qualify for such a plan), or they may be based on the county s group average yield expectations. This is a very important difference that will be discussed later in this chapter. Revenue insurance plans insure the farmer for expected revenue, as opposed to yield from the fields. This is a higher level of coverage, as it usually includes insurance against two factors: low yield and low market prices. Farmers generally have a variety of options, even in this category. In most cases, he or she can buy this type of insurance based on their individual farm history, or based on the history of farm production in the county. Named-peril plans cover certain perils that are specified within the policy. An example of this type of insurance is crop-hail plans. For specific farming areas, these kinds of named-perils plans may be a good value. The crop is insured against a specific kind of damage or loss, and the farmer can choose to be insured to a variety of levels, with and without deductibles. This kind of insurance can be a good choice if the individual farms a single crop. In this case, there may be only certain perils that are of concern to the farmer - and he or she can often find a policy for that specific peril. Page 5

4 Livestock Insurance The raising and farming of livestock can be just as risky as crops. The same kinds of challenges exist, including changes in market prices, the possibility of reduced yields (as in dairy farming), and sickness or death of farm animals. Livestock insurance can provide coverage to reduce the risk of loss. Much of the decisions to purchase or not purchase livestock insurance depends upon the farmer s tolerate for risk. The more coverage purchased, the higher the cost. If the farmer is willing to assume some of the risk, he or she can save premium dollars. Premium cost can also be reduced by choosing higher deductibles. This will bring down the cost of the policy; the degree of savings will depend upon the amount of the deductible chosen. Policy cost may also be lowered by accepting less insurance coverage (versus full coverage). Can the farmer afford a lower level of coverage (lower percentage of the loss experienced)? The farmer must balance these options against his or her needs for cash flow in order to maintain their farming business. Property and Casualty (P&C) Every farmer needs to carry liability insurance, especially if he or she will be utilizing hired hands to work the farm. Personal injury is not the only possibility for the farmer. Farming equipment is very expensive. What if vandals decide to take the farm s combine for a ride? While this kind of crime is less common because now even combines have security features, it is still possible for the farmer to become the victim of theft or vandalism. Agricultural production is inherently risky. We expect damage from weather related events, pests, and diseases but the risks from liability-related issues is also high. Adjusted Gross Revenue: Agent Responsibilities Agents have responsibilities to any insured party, but if the agent participates in Adjusted Gross Revenue (AGR) policies their responsibilities are specifically stated by the United States Department of Agriculture. Agents that market AGR crop insurance have specific responsibilities including: Page 6

5 1. Agents must explain all requirements to participate in the AGR program sufficiently to farmers (generally referred to in the handbook as producers ). 2. Agents must inform the insureds of the additional underwriting requirements if electing the 80 percent crop coverage level. 3. Agents must explain revenue reporting and supporting record requirements to the crop producer. 4. Agents must assist the producers in the completion of the Annual Farm Report and related AGR forms. When necessary agents or other insurance representatives must assist producers in the filing of: a. Farm reports, b. Inventory and accounts receivable reports, c. Agricultural commodity profiles, d. Notice of Loss reports, e. Requests to use a previous tax entity s tax returns. 5. Agents must calculate the Preliminary AGR. For new insureds, agents are required to compute, quote, and enter preliminary AGR s on the Revenue Report. Agents must explain to the insured that: a. A written request for reconsideration of the approved AGR or for mutual consent cancellation of the policy may be submitted by the insured to the AIP if the approved AGR calculated by the verifier is less than 95 percent of the preliminary AGR. b. A request for reconsideration or mutual consent cancellation must be made within 30 calendar days of the date the approved AGR was mailed or made available in some way to the insured. If the requests are not filed timely, the approved AGR will be considered accepted. c. During the reconsideration, AIPs may correct errors in AGR computations or in the application of RMA-approved procedures. Corrections will not be subject to additional reconsideration. 6. Agents must inform the insured that mutual consent cancellations are not allowed for an insurance year subsequent to the insurance year the application was accepted (carryover policy) if they are not satisfied with the approved AGR. 7. Agents must review farm reports for completeness and accuracy and obtain the insured s signature and date. Page 7

6 8. Agents must obtain records and documentation required for program participation forwarding them to the verifier. This includes discussing and documenting how post-production costs such as packing, cooling, palletization charges and rebates. 9. Agents must explain approved AGR to the insured. Upon receipt of the approved AGR the agent or insurance representative must be able to explain: a. The approved AGR and coverage provided. b. That failure to follow the approved Farm Report may result in either reduced indemnities or a reduction in the amount of coverage if it was discovered at the time of loss that the insured didn t qualify for the 80 percent coverage level (if that level had been selected). Premiums would still be based on the approved AGR even if indemnities were reduced. 10. Agents must refer any requests for field visits for inventory determination to the appropriate AIP s representative. If necessary, AIPs will make farm visits to determine beginning or ending inventories. Crop Producer Responsibilities Farmers (often referred to as producers) also have responsibilities, as stated in the Adjusted Gross Revenue Standards Handbook for AGR policies; these include: Filing Annual Farm Reports Farmers (called producers) or other insured entities are responsible for filing Annual Farm Reports. Newly insured producers must report allowable income, allowable expenses from insurable agricultural commodities produced during the five-year AGR base period and the insurable commodities they intend to produce during the tax period for the current insurance year. For subsequent insurance years, insureds must update allowable income and allowable expenses for the most recent year in the AGR base period. Farmers must report the insurable commodities they intend to produce during the tax period for the current insurance year. Insureds must also report the amount, the expected value (less added value of post-production operations, if applicable) for all insurable commodities the farmer expects to produce during the tax period for the insurance year. Insureds must also report any planned operational changes for the insurance year that has the possibility of reducing the allowable income below the average income history on the Annual Farm Report. Annual Farm Reports must be submitted by the sales closing date each insurance year. Page 8

7 It is possible to use other formats or documents that contain the same information as required by the Farm Report. If the insured individual provides the information by some means other than the Farm Report form, the documents must be accompanies by the following signed certification statement in order to be accepted: I certify that to the best of my knowledge and belief all of the information o this form is correct. I understand this form may be reviewed or audited and that information inaccurately reported or failure to retain records to support information on this form may result in a re-computation of the approved adjusted gross revenue. I also understand that failure to report completely and accurately may result in sanctions under my policy, including but not limited to voidance of the policy, and in criminal or civil false claims penalties (18 U.S.C and 1014; 7 U.S.C. 1506;31 U.S.C and 3730) and any other applicable federal statutes. The Farm Report form must be signed and dated to certify that the information provided is true and accurate. If the either or both the signature and date are missing the Farm Report will not be accepted. It would also not be accepted if it was filed after the sales closing date. Farmers must maintain acceptable supporting records. Insureds must retain acceptable hard copy income and expense records for three insurance years after certifying the information for AGR purposes. A copy must be provided as requested for AGR field reviews, RMA program compliance reviews, or when an indemnity is claimed due to crop loss. Reviewers are not authorized to assemble acceptable supporting records for insureds from other sources, such as tax accountants, packers, elevators, processors, and so forth; this is the insured s responsibility. Notification of Changes to Reported Expected Commodities Following the Annual Farm Report filing, if planting intentions change or other changes are made to the farming operation that would affect coverage, insureds must contact their AIP to see if a revised Annual Farm Report needs to be made. Revisions after the filing date are allowed under Section 5(g) of the AGR policy as long as the producer has received approval from their approved insurance provider (AIP). Page 9

8 Liability for any reported commodity may not be increased for the current insurance year or accepted for a different commodity than listed on the filed Expected Commodity Report if the commodity has been damaged prior to the request. An inspection of planted or growing commodities (upon which increased liability is requested) is required prior to approval of a revised Annual Farm Report. Increases in liabilities are limited to those that result from standard calculations using the accepted revised information. Revisions of Intended Commodity Reports may also result in revisions to approved AGRs, approved expenses, and premium rates. Farmers with fiscal tax years, especially those beginning several months after the sales closing date, may need to request revisions to their Annual Farm Reports in the Intended Commodity Report section in order to accurately reflect the expected income the commodity will produce. Such requests must be made before the beginning of the fiscal year. Additional Acreage If the insured farmer obtains additional acreage, whether bought, leased or rented, after the Sales Closing Date and the expected income from the commodities on the acreage was not included on the insurance year s Intended Commodity Report, the insured must notify the AIP of the acreage added and of the intended commodities. If the AIP does not permit revision of the report the insured must then maintain separate accounting records that are acceptable to the AIP of the income and expenses for the commodities produced on the new acreage. If this is not done, the income will be considered as revenue to count if an indemnity is claimed and the expenses will be included in the insurance year s expenses. The following insurance year, insurable commodities produced on the new acreage must be included commodities on the Annual Farm Report. Crop Changes Due to Unavoidable Disasters If a drought, flood, or other unavoidable natural disaster occurs within the insurance period preventing a farmer from planting or producing intended commodities so that he or she substitutes another crop in its place, the liability reported for the intended commodities will remain in effect (Intended Commodity Report not revised). However, any allowable income and allowable expenses from the substitute crop will be used for indemnities and for AGR history purposes. Insureds must notify AIPs if unable to plant or produce intended crops and if substitute commodities will be produced. Simply stated, the farmer must notify their insurance provider of the circumstances leading up to the revised crop plan. Page 10

9 If the approved adjusted gross revenue (AGR) is less than 95 percent of the preliminary AGR, the insured may request in writing reconsideration of the approved AGR, or mutual consent cancellation of the existing policy. Reporting Events that Result in Probable Loss Insureds must report any event that will result in a probable loss of covered revenue to their insurance carrier through the agent servicing their policy. In response, their insurance agent must give notice of loss within 72 hours following the initial discovery that allowable income for the insurance year could fall below the amount of revenue covered (approved AGR x the coverage level elected). Notice may be made by telephone or in person. Any notice not given in writing must be confirmed in writing soon thereafter and received by the AIP within 15 days of the original notice of loss. An AIP may not accept a notice of loss later than 15 days after the insured files his or her farm tax forms for the insurance year. Requests for extensions to file tax forms will not be considered a farm tax form. Abandonment, Disposal or Destruction of Crop An insured farmer must notify their approved insurance provider (AIP) if he or she intends to abandon, dispose of, or destroy any agricultural commodity and obtain the carrier s consent prior to doing so. If consent was not given and the AIP does not inspect the agricultural commodity within seven days following the farmer s notification, the insured may abandon, dispose of, or destroy the crop without the insured s approval. If the AIP determines that expenses associated with the sale of an agricultural commodity would be greater than the allowable income from the sale, the AIP will not include the potential revenue when determining the revenue to count when calculating an indemnity due the farmer from a loss. Producer Claim Cooperation Required Of course, any insured must cooperate during settlements and investigations of claims. This would include protecting the damaged crops from further damage by providing sufficient care if the cost of such care does not exceed the value of the agricultural commodity. Farmers must also allow their insurance carrier to inspect the damaged crop and allow samples to be removed to determine the extent of the damage. Furthermore, insureds must provide their AIP with records and documents requested and permit the AIP to make copies of them. If the insurance carrier so requests, the insured must provide a complete marketing record from a disinterested third party of each agricultural commodity. For production that was sold directly to consumers, written records developed at the time of the crop sale must be provided. If the insured processed or packed the insured crop, the final settlement sheets showing the disposition of the Page 11

10 commodities and marketing records reconcilable with the income reported for tax purposes must be provided. If the insurance carrier requests it, the insured must submit to an examination under oath and establish the total production and revenue received for all agricultural commodities. Obviously, most crop claims would not involve this much attention, but if the AIP has any doubts about the requested claim, they may legally go to this extent. In all types of insurance claims, the insured must adequately document their loss. This is also true of claims for crop loss. If an indemnity is claimed the insured must furnish the following: 1. Proof of the loss of production or revenue caused by perils covered under their policy; 2. Documentation of the extent that the Farm Report was carried out; 3. A copy of applicable farm tax forms and any amendments to it for the insurance year involved; 4. Any documentation required by the insurance carrier to convert the allowable income and expenses for the insurance year to an accrual accounting method; 5. An accurate record of inventoried agricultural commodities; 6. An accurate record of beginning and ending accounts receivable for the insured s tax year, if applicable. Verifiable records of such accounts must also be provided. 7. A completed claim for indemnity no later than 60 days following the filing of his or her farm tax forms for the insurance year. If the farm income taxes are not filed by July 1 (for those who use this date) immediately following the insurance year, the indemnity will be denied. The claim must include all the information requested by the insurance carrier. When a claim is filed, the insurance carrier must determine that the insured has complied with all policy provisions. AGR policy determinations include, but may not be limited to: 1. Insurance is in place covering the reported loss; 2. The insured revenue (allowable income) is based upon the normal sale price of the crop that was damaged or lost. 3. The loss was suffered by the individual or entity insured and is not extended to any other person or entity that may have a share in the crop; Page 12

11 4. The insurance is based on historic AGR information as documented on the insured s farm tax forms and the insurance year s Farm Report; 5. The insured has provided a Farm Report to the carrier on an acceptable form or in an acceptable format. This report would include the AGR history of allowable income and expenses, copies of the insured s farm tax form. The Farm Report must contain: a. The AGR history of allowable income and expenses; b. Copies of the insured s farm tax forms used for the AGR history; c. An accounting of the allowable income expected on the crop; d. Any changes to the farming operations, such as changes in crops grown, farm size, changes to the insured s share of crops, farming practices, or market conditions or prices; e. Any damage to any perennial crop that happened prior to the beginning of the insurance year or any other condition that might have reduced the insured s allowable income form previous levels; and f. Any IRS changes including changes in accounting practices or tax entity, and changes in tax entities, such as the formation of a partnership or corporation. Risk Management Agency (RMA) The Risk Management Agency (RMA) of the United States Department of Agriculture (USDA) provides policies for more than 100 crops. This number would actually be higher if every insurance plan available for crops insured in every county was counted. RMA conducts studies to determine the feasibility of insuring other crops. Federal crop insurance policies generally consist of the Common Crop Insurance Policy, the specific crop provisions, and policy endorsements and special provisions. USDA s Farm Service Agency manages the Noninsured Crop Disaster Assistance Program (NAP) that provides financial assistance to farmers of non-insurable crops when low yields, loss of inventory, or prevented planting happens. When insurance companies participate in crop insurance plans they must use RMA-approved standard procedures, training, forms, and completion instructions. All procedures, forms, and completion instructions must be submitted for approval in accordance with the FCIC Documents Standards Handbook. Page 13

12 There are different types of policies available; of course it is important to select the policy that is right for the circumstances. Farmers typically consider USDA facilitated and subsidized crop insurance for the following circumstances: The farmer s high debts to asset ratios limit the farmer s ability to self insure. Having insurance will limit the exposure to revenue shortfalls when yields are substantially below normal. The crop insurance, in this case, is a substitute for equity. If the farm is growing, the owners need to leverage existing equity versus using the equity to self-insure. In that case risk control tools would substitute for equity. If the farm has moderate to low debt to asset ratio, and the owner wants to limit potential reductions in net work, insurance makes sense. In this case the farmer likely prefers a predictable income rather than relying solely on self-insurance. There are several federally facilitated, but privately delivered, crop insurance contracts available. There are also other types of policies from the private sector that farmers might utilize, such as hail insurance, that are not government subsidized. Like all types of insurance, benefits are triggered by specific events, such as county yield shortfalls. These may be referred to as county revenue index shortfalls. What is Crop Yield Insurance? Agents usually specialize in crop and farm insurance; the types of coverage are too important to be sold by an agent who does not understand how the policies fit individual circumstances or requirements. Crop Revenue Coverage (CRC) CRC is becoming the most popular form of federally reinsured crop insurance. It combines a minimum yield guarantee and a minimum revenue guarantee. This protects the farmer s cash flow from a loss of either yield or revenue (if prices fall). The farmer chooses the level of the farm s average yield (between 50% and 85%) as the minimum yield guarantee. Based on CBOT futures market prices, Crop Revenue Coverage sets a base price in February and a harvest price in October for soybeans, and in November for corn. CRC will protect the farm s minimum yield at the higher of these two prices. Page 14

13 Basically, crop revenue coverage is replacement value coverage. This type of coverage is more expensive because it offers more coverage. Multiple Peril Crop Insurance (MPCI) Multiple Peril Crop Insurance is available for most insured crops. This is the original form of federally reinsured crop insurance. The farmer chooses a level from 50 percent to 85 percent of their average yield and MPCI guarantees that yield. If the farmer experiences a yield loss, he or she receives a set price per bushel for the crop. Prices will be specified. MPCI covers replant costs and prevented planting situations as well. Less expensive than CRC, MPCI is a good way to protect the farmer s cash flow or input costs against weather-related yield losses. MPCI is the most common crop insurance policy available through the Federal Crop Insurance Program (FCIC). The FCIC, which is overseen by the Risk Management Agency, underwrites crop insurance policies for a wide variety of crops in the U.S. The actual policies are sold and serviced by private insurance companies. Coverage is available on over 76 crops in primary production areas in the United States (not all areas are considered primary and may not have such insurance available). Most insurance policies provide between 50 and 75 percent of the actual production history (APH) for the farms. APH plans are based on individual farm production rather than county averages. These policies offer an indemnity election from 60 to 100 percent of the Federal Crop Insurance Corporation expected market price, which must be selected at the time of purchase. Minimum Catastrophic Risk Protection (CAT) coverage is available for an administration fee (not a premium rate) of $60 per crop per county. A waiver of the CAT administrative fee is available for producers who qualify as small or limited-resource farmers. MPCI coverage provides protection against low farm crop yields, poor quality, late planting, replanting costs, and prevented planting. Several crops are included under MPCI coverage, including almonds, apples, beans, canola, citrus, citrus trees, corn, grain, sorghum, soybeans, upland cotton, extra long staple cotton, cranberries, dry beans, figs, Florida fruit trees, millet, nursery, peaches, peanuts, pears, peas, peppers, plums, prunes, raisins, popcorn, potatoes, rice, safflower, wheat, barley, oats, rye, flax, stone fruit, sugar beets, sugarcane, sunflower seeds, sweet corn, tobacco, tomatoes, and walnuts. Page 15

14 MPCI benefits include cash-flow protection, good loan collateral, added confidence when developing crop-marketing plans, stability for long-term business plans, and family security. The U.S. government shares in the premium costs. Even though the government shares in the premium, all MPCI policies are available through private insurance agents. Crop insurance agents can describe the different insurance products available with applicable premiums and policy terms. The agent will help the farmer select the best coverage based on the farmer s particular farm operation, risk management needs, and personal budget. Multiple Peril Crop Insurance is a continuous policy; it remains in effect for each crop year after the original application is accepted. Producers may cancel the policy, a covered crop, a county, or a specific crop in a specific county after the first effective crop year. To do so, the farm must provide a written notice to his or her insurance provider on or before the cancellation date shown in the applicable crop provisions. Farmers (also called producers) must request policy changes from their insurance provider on or before the sales closing date for a change of price election or coverage level. Requests to increase the maximum eligible prevented planting acreage above the limitations contained in the crop policy must be made by the sales closing date for the applicable crop. Contract changes involving a successor-in-interest application and corrections of a producer s name, address, identification number, administrator, and so forth may be made at any time. Each crop year the farmer must submit an acreage report by unit for each insured crop. The acreage report must be signed and submitted by the producer on or before the acreage reporting date contained in the Special Provisions for the county for the insured crop. If a crop sustains damage farmers should immediately notify their insurance provider. Income Protection (IP) Income protection plans provide a fixed revenue guarantee based on the same prices used for crop revenue coverage, but IP does not provide a minimum bushel guarantee. It protects on a limited level basis against falling prices at harvest time. Since it does not provide the higher replacement coverage it is a lower priced coverage. Revenue Assurance (RA) Revenue Assurance plans is similar to income protection plans but they allow a full range of unit structure that is more like the CRC plans. If all the farm s crops Page 16

15 are combined into a single insured unit an additional discount in premium may be possible. Group Risk Income Protection (GRIP) GRIP is an income based crop plan that performs very much like an income protection plan over the county. Expected revenue is determined for the county on a per acre basis. It is typically possible to buy higher levels of coverage with a Group Risk Income Protection plan, but unless the county income falls below the prescribed trigger level based on the ending fall price and county yield, no indemnity is paid. These yields are typically determined four to six months following harvest. GRIP (as well as group risk plans) does not cover replant costs or prevented planting losses. Cost per acre for GRIP is higher than MPCI plans and comparable to CRC plans, depending upon the amount of insurance purchased. A disclaimer form must be signed acknowledging that the individual farm operation has no guarantee for its production or revenue. There is also Group Risk Plans (GRP) that will be discussed in this chapter. Add-On Protection FCS arranges crop insurance through different insurance companies. Some insurers may offer add-on protection to increase the revenue guarantee or replant protection. Add-on features will cost additional premium. There are many types of crop insurance, but all plans may not be available in all areas areas. Some policies are not available nationwide. Some plans may be tested in pilot programs available only in selected states or counties, for example. Yield-Based Crop Plans There are two types of yield-based crop insurance plans: those that pay based on an individual farm s previous average yields and those that pay based on the county s group average crop yields. Actual Production History Plan (APH) The Actual Production History plan (APH) insures against yield losses to a particular farm from natural causes such as drought, excessive moisture, hail, wind, frost, insects, and disease. The farmer selects the amount of average yield he or she wishes to insure, typically between 50 and 75 percent; some areas may allow as high as 85 percent coverage. The farmer selects the percent of the predicted price he or she wants to insure, typically between 55 and 100 percent of the crop price established annually by RMA. If the harvest is less than the Page 17

16 yield insured the farmer is paid an indemnity based on the difference. Indemnities are calculated by multiplying this difference by the insured percentage of the established price selected when crop insurance was purchased. Actual Production History, or APH, allows farmers to insure their yield based on their own proven yield history. This type of coverage has been used since the mid-1980 s and was the type most farmers had. Insurance contract guarantees are based on individual insurance units within a particular farm. If losses occur, they are calculated for each insurance unit. What is a unit of insurance in this case? Units are a section of the farm. Other items will enter into the definition of a unit, including land ownership, irrigation, and rental arrangements that pertain to that unit of the farm. A medium-sized farm may have several insurance units, each of which have separate bases for establishing the yield guarantee and determining indemnities associated with yield shortfalls. When a farm insures a crop, all units of the same crop in the same county must be insured; it is not possible to choose which units will be insured and which will not be. Group Risk Plan (GRP) The Group Risk Plan is a bushel-based plan that uses county averages to determine whether or not there is a loss, which would result in an indemnity payment. Various levels can be chosen, based on expected county yield. Once county yields are available (typically four to six months after harvest) if losses occur, GRP participants would be paid. It never pays an indemnity based on individual farm losses. Since individual loss is not considered, participants must sign a disclaimer form to that effect. GRP plans do not cover the cost to replant or pay for prevented planting losses. GRP is typically similar in cost to MPCI, depending upon the amount of protection purchased. The Group Risk Plan (GRP) triggers on county yield rather than individual farm yield. This is a group approach because it looks at all farms in a particular county to determine policy guarantees. GRP policies use a county index as the basis for determining a loss. When the county-yield for the insured crop, as determined by the National Agricultural Statistics Service (NASS), falls below the trigger level chosen by the farmer, an indemnity is paid. Payments are not based on the farmer s individual crop losses but rather on yield levels for the county. Yield levels are available for up to 90 percent of the expected county yield. GRP protection involves less paperwork and costs less than the farm-level coverage (APH plans). However, it is important to know that losses on the Page 18

17 insured farm will not trigger insurance payments, even if the losses can be substantiated. GRP policies always base their indemnity payments on county losses, not individual losses. GRP plans provide a more stable base since overall county yields are less variable; smaller deductibles and greater coverage is permitted under GRP than under APH since individual farm variances are not an issue. Farmer Joe may be less dependable in his farming practices than most farmers in a county so Farmer Joe may have more losses as a result of his lazy farming practices. Basing his insurance on the county rather than his particular farm will mean less risk for the issuing insurance carrier. Like most group policies there is greater security for the insurer when a group is involved. As every agent knows, no type of policy is perfect and GRP (Group Risk Plan) is no exception. Specifically, there are three shortcomings that must be considered: 1. The first occurs due to the definition of the policy itself since it is based on county yields. Individual farms do not always coincide with county yields even when the farmer does everything correctly; an individual farm may have a poor crop yield while the county yield was normal. It can also work in reverse: the county may experience a substantial shortfall, providing an insurance indemnity for the farmer, even though his particular farm did well. Therefore, the farmer who needs (and even deserves) an insurance payment for a poor yield may not receive it if the county has generally experienced a normal or high yield. 2. The GRP plan does not have a prevented planting or replant provision; the APH plan does. 3. The GRP plan does not have crop quality provisions while the APH does. A farmer may have a quantity of crop, but not quality of crop. In other words, the farmer may have plenty of what he grew, but if the quality brings a poor price he may still suffer a financial loss. Despite these disadvantages, most crop agents and farmers feel there are also many advantages to GRP contracts, including: 1. First and foremost, the premium rate is generally considered affordable; premiums for GRP plans are lower than for APH plans. This is not surprising since the amount of risk for insurers is lower for GRP plans than for APH plans. It is felt by many insurers that there are hidden action risks for Actual Production History plans (APH) since the farmer may be a poor businessman, a lazy farmer, or actually do something that causes his crops to fail. The APH insured farmer may realize he can trigger payment Page 19

18 by his own actions and be tempted to utilize poor farming techniques since he will be paid for his crop failure. 2. The GRP policy requires less paperwork than the APH plan since the information required for proven yields is not necessary. It won t matter how the farm has previously yielded on crops since payment is triggered by county yields, not individual yields. 3. The GRP polices may be better suited to farmers who rent their land, or significant amounts of their land, since prior yields may not exist so figures cannot be produced for an APH plan. The GRP policy is not complicated. The yield at which the GRP triggers is calculated by multiplying the expected county yield set by the USDA Risk Management Agency (called RMA) by the desired coverage level. While there are various options, most policyholders choose 85% and 90% coverage. If expected county yield for a crop is 120 bushels, or example, a coverage level of 90% would equate into 120 X 0.90 equals 108 bushels. If the county yield, as determined by NASS/USDA information, falls below the 108 bushel level, the farm will receive an indemnity payment even if their particular yield is higher. While this sounds like an ideal situation the agent and policyholder must remember that if their particular farm experiences a lower-than-normal yield they will not receive an indemnity check if the county yield is normal or higher-thannormal. Their policy pays based only on the county yield, not on the yield of their particular farm. The GRP contract has a disappearing deductible. With a disappearing deductible it is possible to get the whole deductible back with a 100% loss. The deductible is returned because percent loss is multiplied by protection, which does not include a level of coverage. 1 Disappearing deductible contracts are also used for protection from hail damage. When there is a loss GRP policies always use Indemnity equals dollar protection times the percentage of loss, as our previous example demonstrated. It is often written as: Indemnity = $ Protection X % loss. The value of the loss is calculated by multiplying the value of protection by the percentage of the loss. The GRP policy calls the percent of loss the payment factor. Under the GRP policy the maximum protection available is defined as: Maximum protection = Expected county yield X Indemnity price X Department of Agricultural Economics, Michigan State University Staff Paper Page 20

19 While there can be variances, the appropriate scale factor is in the range of 1.25 to The expected county yield and the indemnity price are established prior to the purchase of the insurance policy. It might be assumed that a GRP policy, based on county yields, is favorable to the farmer but this is not always true. Many farmers may be better at their trade than others; this might mean they would be penalized by a personal bad crop year if the county yields have always been substantially lower than their farm s yield. Therefore, if a farm has several years experience growing crops, the farmer may wish to compare their farm with county yields to determine if the GRP policy is more favorable than a policy based on personal farm yields (APH plan Actual Production History). Professional farmers know the yields of their land. The first step in deciding between a county yield policy and a farm yield policy is graphing the farm s crop yield versus the county s crop yield. Specific factors are used, including: Soil types farmed versus a representative sample of county soils; Drainage on the farm compared to county drainage; Farm irrigation versus county irrigation; Microclimate; and Spatial diversification of the farm across the county. Many farmers have land that is spread across the county; one parcel may be on one side of the county and the other parcel on the opposite side, for example. These different locations often mean different soil conditions or water availability or any other variances that create a difference of crops and yield. One parcel may be very close to county yields while another parcel of land is far above the average county yields. When comparing farm yields to county yields it is often necessary to standardize farm yields so that an average is possible to achieve. In other words the yearly crop yields are added together and divided by the number of years being considered. This produces an average farm yield. The same is done for the county yields for the exact years used for the farm to achieve an average county yield. This might mean that the years 1998 through 2008 were used for both the average of the farm and the average of the county. It would not work if different crop years were used for averages since individual years produce individual results based on weather and other conditions. If the farm s average crop yields are higher than the county s average crop yields, subtract the difference from each farm s yield (different parcels of land Page 21

20 may have different crop averages). If the farm s average yield is less than the county s average yield, add the difference to each farm yield. While averaging will not guarantee how future crops will perform it is likely to provide a dependable base from which to make insurance decisions. The closer the farm crop yields track county crop yields the better a GRP policy will perform. If the farms do not track county crop yields closely, then some years a farm policy would have worked better while in other years a county crop policy would have been more advantageous, depending upon the year of discussion. Obviously it is harder to choose a crop insurance policy if the farm s crop yield is routinely well above or well below the average county crop yield. There is no way to be sure what the future will bring. When viewing average crop yields, the more time available the better the resulting criteria will be. At least ten years is needed when seeking average crop yields for the purpose of choosing an insurance plan, but twenty years is far better. Many farms that keep crop yield records today may not have done so twenty years ago. In those cases, some research might be needed on the part of the farm owners. Researching old income records, for instance, might provide insight into the crop yield that year. Once averages are available for both the farm and the county, it is necessary to evaluate what the net yield would be if the insurance payment were added to the farm yield. Since most years will not experience an insurance payment, there will be no change in the figures for those years, but for those years where an insurance payment might have been triggered this will change the resulting figures. Under a county policy, benefits would only be triggered based on county yields and whether or not those yields were lower than expected, triggering a policy payment. Under a farm yield policy, benefits would only be triggered if the yield were less than the normal farm yield, based on previous year s yield experience. GRP plans permit farms to scale up coverage to compensate for the fact that a farms average yield might be greater than the expected county yield; farm yields are typically more variable than a county s average yield. As we know, the law of large numbers would affect the average county yields since many farms are considered; an individual farmer will not have the greater numbers to stabilize their farm s crop averages. Farms that have many years of tracking data will do a better job of determining which insurance is right for them. As we gain better data, computer software often is utilized to track average crop yields and determine which type of insurance best suits the particular farm. Past weather data is often used to determine the crop yields that were most likely to have occurred. Yield correlations are imperfect because weather events Page 22

21 do not hit all locations equally; some areas may have more water than others, or other conditions may exist to offset the weather and the conditions that result. The greater the distance between farm locations the lower the likelihood of being hit by the same weather event, such as wind storms. Even the same event may not hit all farms equally, since such things as soil conditions, crop plantings, or other factors may make a difference. Something that may be overlooked is the effect of the farm s location on averages. A farm located in the center of the county is more likely to correlate to the averages of the county; a farm on the edge of the county lines is more likely to differ from county averages because it is affected by another county s events and weather. An extreme weather event might especially affect just one or two farms on the edge of the county. Under a GRP policy this could mean no insurance payment even though the farm s crops were badly damaged. The opposite could also be true; an extreme weather event that hit the middle of the county might bring down county yields significantly, yet have totally missed the farm on the edge of the county. The farmer would then receive an indemnity payment (based on county yields) even though his farm was not affected. When considering how insurance might have affected the farmer, it is important to consider the possible indemnity payment less the premium paid. Insurance always has a premium; in some years that premium will seem insignificant if a crop loss was experienced and covered by the policy. In other years the premium will seem high when no indemnity was collected. Farms have many expenses; the goal is to have a crop that covers those expenses and produces a profit. Yield thresholds are described in terms of revenue requirements; that is, having enough yield that bills are paid and a profit realized. The question is simple: what yield would be required to cover the variable costs of farming, taxes, loans, acquire new equipment if needed, and still provide the farmer and his family with a comfortable lifestyle? There are three equations that are considered: 1. Farm yield; 2. Farm yield plus net (indemnity payments less premium) from APH plans; and 3. Farm yield plus net (indemnity payments less premium) from GRP plans. Coverages for APH and GRP are typically 75 percent and 90 percent respectively. In some cases GRP will be the better choice, but it always depends upon the situation. Either type of insurance substantially reduces the farmer s risk but choosing the plan that best fits the farm s needs is essential to good risk Page 23

22 management. Where farm parcels are spread across the county, GRP plans are often the plan of choice since multiple farm locations are more likely to reflect county yield averages than would a single farm at a single location. If farm yields correlate to county yields at 0.9 or better, GRP should be an effective yield risk transfer tool. If correlation is in the range of 0.85 to 0.90 GRP is generally a good yield risk transfer tool, but this does not replace the farmers need to clearly consider management of their yield basis risk. It is always best to reduce risk (for any type of insurance policy) in any way possible than to rely upon insurance to reduce or eliminate the risk involved. If the correlation is less than 0.80 GRP plans are of questionable use as a yield risk transfer tool and probably inferior in this case to APH plans. GRP plans are not reliable for higher yielding farms unless their yields are closely following county yields. Higher yielding insurance units tend to have a lower variation in yield. With lower variation, the chance of receiving an indemnity payment under the APH insurance plan is lower. GRP, with 90 percent coverage, can often transfer more risk from a lower risk farm than can APH plans with 75 percent coverage. In all cases, this is assuming that the farm and county yields have been properly analyzed and the figures used were correct. It is not possible to analyze and choose the correct insurance policy when figures are not accurate. Farm yields that are above or below the county average yield does not necessarily mean the GRP plan is either right or wrong for any particular farm. The key is always whether or not the farm closely follows an average county yield since that is what payments are based upon. If the farm yield does not effectively track to the county yield, the farm is gambling on receiving insurance payments in low-yield years. Gambling on insurance is never an effective way to reduce risk. As we said, farms that are spread across the county through various land parcels are best suited for GRP plans since the more farms in the equation the more likely average farm figures will correspond to county averages. We know that all the farm parcels will not be hit with the same weather events, but enough probably will to correlate to the county averages. Farmers do not necessarily have all their farming parcels located in the same county; it is likely that there will be parcels in other counties. Farmers are allowed to have different policies, with each based upon the applicable county of the farming parcel. It is possible that the farmer might choose a GRP plan in one county and an APH plan in the other. There will be less paperwork for GRP plans Page 24