A&O Subsidies

RMA partners with private insurance companies, which sell and service  federal crop insurance policies. The 2011 SRA’s Cap on A&O Expense Subsidies Has Stabilized Overall Costs, but Subsidies Have Fluctuated Widely by Crop, State, and County

The 2011 SRA’s cap on A&O expense subsidies—payments to insurance  companies to cover the cost of selling and servicing crop insurance  policies—stabilized the program’s overall costs, but subsidies have  fluctuated widely by crop, state, and county. For example, the average A&O subsidy per policy in  California decreased by 32 percent from 2010 to 2011, when the subsidy  declined for two of the state’s leading insured crops, almonds and grapes. As a result of the revised calculation method, overall A&O subsidies have  become more stable since 2010, staying at about $1.4 billion per year  from 2011 through 2015. By considering an  adjustment to the A&O expense subsidy calculation method that reduces  the effects of changes in premiums caused by changes in crop prices or  other factors, when it renegotiates the SRA, RMA could reduce year-to- year fluctuations in the A&O expense subsidies that companies receive at  the crop, state, and county levels. The Federal Crop Insurance Program’s Target Rate of Return Does Not Reflect Market Conditions

The federal crop insurance program’s target rate of return—the average  annual rate of return that insurance companies are expected to earn— does not reflect market conditions. A 2009 USDA-commissioned study,  which RMA used in SRA renegotiations, estimated a reasonable rate of  return for crop insurance providers for 1989 through 2008 based on  economic factors, such as interest rates, which are subject to changes in  market conditions. The average of the two methods was 9.6 percent. Two Opportunities Exist for the Federal Government to Reduce the Delivery Costs of the Program

We identified two opportunities for the federal government to reduce its  delivery costs for the crop insurance program: (1) by reducing the target  rate of return or (2) by reducing the portion of premiums that participating  insurance companies retain. If the target rate of return was reduced by 4.9 percentage  points, from the current target rate of 14.5 percent to 9.6 percent—the  average reasonable rate that we calculated for 2009 through 2015—on  the companies’ 2015 retained premiums of $7.42 billion, the companies’  expected underwriting gains would decrease by $364 million. Even if the target rate of return remained unchanged, reducing  companies’ portion of retained premiums would reduce their expected  underwriting gains because they would earn their rate of return on a  smaller premium base. According to this report, part of the  justification for the companies to share in the program’s underwriting  losses was that it would encourage the companies to more carefully  adjust farmers’ loss claims. The Agricultural Risk Protection Act of 2000, however, improved RMA’s  ability to monitor farmers’ loss claims and companies’ adjustment of these  loss claims by enhancing the agency’s data mining capabilities. In addition, the portion of program premiums that participating insurance  companies retain—which provides the companies with financial incentive  to accurately adjust farmers’ loss claims—has changed little since 2000. Such an adjustment could generate significant cost  savings for the program. However, because a provision in the 2014 farm  bill requires that any revised SRA is to be budget neutral with respect to  estimates of future underwriting gains for the companies, any savings that  could be achieved through the SRA by reducing companies’ expected  future underwriting gains as a result of reducing the portion of premiums  retained by participating insurance companies are not allowed under  current law and would also require congressional action to repeal this  provision in the 2014 farm bill. Matter for Congressional Consideration

To reduce the cost of delivering the crop insurance program, Congress  should consider repealing the 2014 farm bill requirement that any revision  to the standard reinsurance agreement not reduce insurance companies’  expected underwriting gains, and directing the Risk Management Agency  to, during the next renegotiation of the agreement, (1) adjust the  participating insurance companies’ target rate of return to reflect market  conditions and (2) assess the portion of premiums that participating  insurance companies retain and, if warranted, adjust it. Appendix I: Objectives, Scope, and Methodology

Our objectives were to examine (1) the changes, if any, in the distribution  of administrative and operating (A&O) expense subsidies due to the  implementation of the 2011 standard reinsurance agreement’s (SRA)  national cap on subsidies, (2) the extent to which the federal crop  insurance program’s target rate of return reflects market conditions and  (3) opportunities, if any, for the federal government to reduce its delivery  costs for the program. This study derived, for the 20 years from 1989  through 2008, the annual rate of return on equity that companies  participating in the federal crop insurance program should be expected to  earn.
Why GAO Did This Study

To implement the federal crop insurance program, USDA's RMA partners with private insurance companies, which sell and service policies. In 2010, USDA negotiated an agreement with insurance companies to set a national cap on the annual payments it makes to them for expenses and a target rate of return.
GAO was asked to examine (1) the changes in expense payments to companies due to the cap, (2) the extent to which the program's target rate of return reflects market conditions, and (3) opportunities for the federal government to reduce its delivery costs for the program. GAO analyzed RMA data on payments to companies for their expenses, conducted an updated analysis based on a USDA-commissioned study of the annual rate of return that companies should be expected to earn, and interviewed RMA officials.

What GAO Found

The U.S. Department of Agriculture's (USDA) Risk Management Agency (RMA) makes payments to insurance companies to cover the cost of selling and servicing federal crop insurance policies. A cap on these payments stabilized them at about $1.4 billion per year from 2011 to 2015. In capping the annual payment to companies, RMA sought to make these payments more stable and dependable for companies and agents, but payments have fluctuated widely by crop, state, and county because, as GAO's analysis shows, the method RMA uses for calculating payments has allowed large fluctuations at the policy level. Specifically, RMA calculates payments based on such factors as crop price, and a price change can cause a change in the payments. For example, the average payment for almonds decreased by 42 percent from 2010 to 2011 but increased by 75 percent from 2013 to 2014. RMA could reduce such fluctuations and achieve greater stability by considering adjustments to how the payments are calculated when it negotiates a new agreement with companies.
The crop insurance program's target rate of return—the average annual rate of return that insurance companies are expected to earn—does not reflect market conditions. A 2009 USDA-commissioned study found that a 12.8 percent rate of return was reasonable for participating companies for 1989 through 2008 based on economic factors, such as interest rates. RMA used this study in 2010 negotiations with insurance companies to set a 14.5 percent target rate. According to GAO's analysis, which updated information in the study for 2009 through 2015, the reasonable rate of return declined, averaging 9.6 percent.
GAO identified two opportunities to reduce federal delivery costs for the program.
First, given that GAO's analysis shows that the target rate of return does not reflect market conditions, that rate could be reduced. As a result, companies would earn a lower rate of return on their existing base of retained premiums. At the 2015 premium level, if the target rate were reduced by 4.9 percentage points, from the current rate of 14.5 percent to 9.6 percent, the companies' expected annual underwriting gains would decrease by $364 million.
Second, the portion of premiums retained by companies could be reduced so that they would earn a rate of return on a smaller premium base. The portion of premiums retained by companies has changed little, averaging 77 percent since 2000, while USDA has retained the rest. Part of the justification for companies' retaining a significant portion of premiums was that they needed financial incentive to more carefully adjust farmers' loss claims. The need for this incentive decreased after a statutory change in 2000 improved RMA's ability to monitor those claims and companies' adjustment of them. Reducing the premiums that companies retain by 5 percentage points could reduce companies' annual underwriting gains by up to $100 million.
However, a provision in the Agricultural Act of 2014 requires any changes negotiated for a new SRA be budget neutral. To realize savings, such changes would require congressional action to repeal this provision. If Congress were to direct RMA to adjust the target rate in future negotiations or assess the portion of premiums companies retain, the agency could generate significant cost savings for the program.

What GAO Recommends

Congress should consider repealing the Agricultural Act of 2014 provision that any revision to the agreement with insurance companies not reduce their expected underwriting gains and direct RMA to (1) adjust companies' target rate of return to reflect market conditions and (2) assess the portion of premiums that companies retain and adjust it, if warranted. GAO also recommends that RMA consider adjusting the method it uses to determine payments to insurance companies for expenses. RMA stated it will take steps to implement GAO's recommendation.