How Large is the 2012 Crop Insurance Underwriting Loss? 1

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1 Disclaimer: This web page is designed to aid farmers with their marketing and risk management decisions. The risk of loss in trading futures, options, forward contracts, and hedge-to-arrive can be substantial and no warranty is given or implied by the author or any other party. Each farmer must consider whether such marketing strategies are appropriate for his or her situation. This web page does not represent the views of Kansas State University. How Large is the 2012 Crop Insurance Underwriting Loss? 1 Press reports suggest 2012 crop insurance underwriting losses might reach $40 billion. But how much of these extreme estimates are based in reality versus Washington rhetoric? Many of those large estimated underwriting losses are being used to make arguments for selected changes in the Farm Bill. The underwriting results on the 2012 book will not be nearing completion until this time next year, after the Farm Bill has become law. The people in the best position to know the size of the underwriting loss are the Approved Insurance Providers (AIP), at least on their own book, because in the worst-hit areas, loss adjusting has started. However, they are not talking, so that leaves the field open for lots of speculation. The USDA Chief Economist in a radio interview suggested the underwriting losses might reach $20 billion. This estimate was his upper limit on the loss unless crop conditions become worse than expected. The Chief Economist s office is the group that generates the World Agricultural Supply Demand Estimates (WASDE), so he has the best available data among government, grain trading firms, and academic economists. 1 Prepared by G. A. (Art) Barnaby, Jr., Professor, Department of Agricultural Economics, K-State Research and Extension, Kansas State University, Manhattan, KS 66506, July 25, 2012, Phone , [email protected].

2 The question then becomes, what is the size of loss ratio necessary to generate a $20 billion underwriting loss? Currently about 38-39% of the national book of premium is generated by corn. Assuming that relationship holds for 2012, then the premium for 2012 would be about $10.7 billion with corn generating $4.12 billion in premium based on the author s estimates. If we assume 1988 state corn loss ratios, then the loss ratio for corn would be about 3.51, generating approximately a $10.3 billion underwriting loss. Then the question is, what will be the required loss ratio on the remaining 61% of the book to reach a $20 billion loss? It will require a loss ratio of 2.47 to generate a $9.67 billion underwriting loss on the remaining book to generate a $20 billion underwriting loss. This would result in a national book loss ratio equal to about Has the national crop insurance book ever hit a loss ratio over 2.80? The highest national book loss ratio was in 1993 at The author does not have complete data for 1988 but the corn loss ratio was 3.20, lower than the 3.51 loss ratio used in the corn estimate, and soybeans were Therefore, the combined 1988 corn-soybean loss ratio would be approximately A 2.62 loss ratio, measured on corn and soybeans only, and then applied to the national book would generate an underwriting loss of $17.3 billion. Participation was also low in 1988 and few crops were insured. Because the insurance pool is larger and more diversified, it will require more severe weather than in 1988 to reach the 2.62 loss ratio in Years 1989 through 2011 have complete crop insurance data, unlike Soybeans account for about 20% of the book s premium and when combined with corn s 40%, these two crops represent 60% of the book. The remaining 40% of the book s premium is generated by all other crops. If we assume the corn loss ratio reaches the estimated 1988 level of 3.51 and the remaining 60% of the book that includes soybeans has a loss ratio of 1.95, the same as the 1988 soybean loss ratio, the result is a $16.8 billion underwriting loss. The combined loss ratio for the national book would need to be 2.58 to generate a $16.8 billion underwriting loss. At this point the crop losses are not as large as it was in 1988, but this could easily change. In Table 1 are all of the national historical loss ratios that include all crops, all plans, and all coverages. The largest observed national loss was in 1993 at 2.19, 1989 at 1.49 and 2002 at 1.39 (Tables 2, 3 and 4). The loss ratio necessary to generate a $10 billion underwriting loss would need to be over 1.94 and is the most likely result for 2012 (Table 5). That is a higher loss ratio than in any of the historical years, except The loss ratio necessary to generate a $15 billion underwriting loss would need to be over 2.40 which has never been reached (Table 5). A $20 billion underwriting loss would require a 2.87 loss ratio and one would expect this to be the upper limit on losses. There is some question if the 2012 crop has had enough damage to generate a national loss ratio on corn to equal The most current USDA data suggests the losses are worse in Indiana but better in Iowa and Minnesota. It is rare for the national loss ratio to 2

3 exceed 2.00 and it is also rare for a state loss ratio to exceed 5.00 where the AIP s have a stop loss in the reinsurance agreement. The rare year was 1993 when the national loss ratio was over 2.0 and Minnesota s loss ratio was over 6.0. Therefore, any suggestion the underwriting losses will exceed $20 billion is premature. The 2012 underwriting losses will likely be between $10 and $12 billion. If we assume no rain for the next month then a $15 to $20 billion loss is possible and it would be a record loss ratio. Summary. The fact is that the estimated underwriting losses are just speculation. No one really knows the size of the crop insurance claims because future weather and rain events are unknown. The weather factor effectively is uncertainty rather than a risk that can be quantified. The first real insurance estimates will begin when the National Agricultural Statistical Service (NASS) releases its first estimate of state corn and soybean yields in early August. If those NASS yields are lower than 1988 trend adjusted yields, then likely the 2012 underwriting losses will be over $15 billion and generate a record loss ratio on the national insurance book. Otherwise the losses will likely be under $15 billion. Table 1. National Crop Insurance Loss Ratios, All Crops, All Plans, All Coverages Year Loss Ratio Year Loss Ratio Source: Risk Management Website at: 3

4 Table Crop Year Statistics for Crop Insurance, All Coverage and All Plans 4

7 Table 5. The Break Even National Loss Ratio for a Given Level of Underwriting Loss Underwriting Loss Required National Loss Ratio $40 billion 4.74 $30 billion 3.80 $20 billion 2.87 $15 billion 2.40 $10 billion