by Siddhartha Jha
Arbol focuses on disrupting insurance, specifically weather insurance. Before we discuss the specifics of weather insurance it is important to understand the concept in its simplest terms which will help set the stage for why we need to disrupt it.
In this three-part series, we will take you through the basics of insurance, different types of weather and agriculture insurance, some of the pitfalls with the current solutions as well as cost analysis.
In part one, we discussed the basic types of insurance, as well as the basics of weather and agriculture insurance.
In part two of this series, we discuss weather and agriculture insurance in the United States which lays the foundation for the global framework of these policies.
Crop Insurance in the USA
The USA is the biggest providers of Crop Insurance. So, it is important to understand its policy framework as most other countries offer policies that are subsets of its policy.
In the USA, the government has had a strong involvement in the crop insurance landscape. The government has entered into a partnership with private crop insurance providers, to offer crop insurance on an equal-opportunity basis to agricultural producers nationwide. Approved insurance providers (AIPs) use independent licensed agents to market this insurance.
Every year, approved insurance providers (AIPs) enter into a contract called the Standard Reinsurance Agreement (SRA) with the Federal Crop Insurance Corporation (FCIC) to administer the crop insurance program by marketing, underwriting, and adjusting claims for crop insurance policies. The insurance providers transmit data to the Federal government. They are also responsible for both the training and monitoring of agents and staff.
The crop insurance company or approved insurance provider (AIP) agrees to indemnify (that is, to protect) the insured (farmer, rancher or grower) against losses which occur during the crop year. Losses must be due to things, which are unavoidable or beyond the insured’s control such as drought, freeze, and disease. Some policies offer coverage due to adverse weather events such as the inability to plant due to excess moisture or losses due to the quality of the crop. In most cases, the insurance covers loss of yield or revenue exceeding a deductible amount. Farmers, ranchers or growers can experience a loss of revenue due to low production and/or changes in the market price. The types of coverage available vary by crop and county due to the differences in each crop. Over 100 crops are insured including tree crops, livestock, grains, and pasture.
Crop insurance tends to come in single-peril or multi-peril form. Single-peril Crop Insurance covers against damage of a specific type of harm to crops such as hail, drought, or pests. Multi-Peril Crop Insurance (MPCI) provides protection from a variety of naturally occurring perils or hazards. The Crop Provisions for each crop list the covered causes of loss specific to that particular crop. Although crops vary somewhat, most provide coverage against adverse weather conditions, fire, insects, plant disease, wildlife, earthquakes, volcanic eruptions, and failure of irrigation supply. Most federal crop insurance policies are of the multi-peril style and provide coverage for loss of production/yield or how much a crop produces. Some plans combine yield and price coverage. They cover a loss in value due to a change in market price during the insurance period, in addition to the perils covered by the standard loss of yield coverage.
The major types of MPCI plans in the USA are Actual Production History(APH), Actual Revenue History, Yield Protection Plan, and the Revenue Protection Plan.
The Actual Production History (APH) plan of insurance is the oldest Federal Crop Insurance plan available. It provides the producer protection against a loss of production, or how much the crop produces, due to nearly any unavoidable, naturally occurring events. This plan of insurance guarantees the producer a yield based on the actual production history of his/her crops, which is why it is called the APH plan.
The Actual Revenue History is based on the insured’s revenue history for the crop that is insured. The guarantee amount is calculated based on the insured’s production and revenue history. A loss occurs when the revenue to count for the current year falls below the insured’s guaranteed revenue.
The Yield Protection plan is very similar to the APH plan but is only available on crops that are eligible for Revenue Protection. TheYield Protectionplan of insurance provides protection against a loss of production. It works the same as the APH plan but instead of using a price election established by RMA, the price is established according to the applicable board of trade/exchange as defined in the policy document called the Commodity Exchange Price Provisions (CEPP). The price used is called the Projected Price. TheProjected Price is used to calculate the guarantee, premium and loss payments.
The Revenue Protection Plan provides protection against a loss of revenue caused by price increase or decrease, loss of production, or a combination of both. It is available for the same crops where YP coverage is available.
The RP plan uses the Commodity Exchange Price Provisions to establish the pricing, however, it is a little different from the YP plan as it uses two different price discovery periods. The projected price is determined in the same manner as YP and is used to calculate the premium, replant and Prevented Planting payments. The harvest price is released near harvest time. This price is used to calculate an indemnity.
Loss assessment process
In the event of a loss, the farmer has various obligations regarding loss notification. The loss should be reported to the insurance agent within 72 hours of the discovery of damage. In the case of drought, the loss is not immediate and farmers are advised to contact their agent as soon as they feel a loss is present. The farmer has to continue to care for the crop using “good farming practices” and protect it from further damage, if possible. Finally, the farmer has to get permission from the crop insurance company before destroying or putting any crop to an alternative use. The loss reporting process by the farmer has a number of subjective factors that can lead to delays or disputes in the case of insurance payment.
After a loss is reported, the crop insurance company will assign a crop insurance adjuster to appraise the crop and assess the loss. The insured farmer must maintain the crop until the appraisal is complete. If the company cannot make an accurate appraisal, or the farmer disagrees with the appraisal, the company can have the farmer leave representative sample areas. These representative sample areas of the crop are to be maintained — including normal spraying if economically justified — until the company conducts a final inspection. Failure to maintain representative sample areas could result in a determination that the cause of loss is not covered. Therefore, no claims payment is due to the producer.
The loss assessment process discussed above includes numerous subjective components that add ambiguity and can lead to disputes between farmers and insurance companies. For example, the farmer’s need to maintain “good farming practices” is highly subjective and leaves ample room for disagreements between insurers and farmers.
Crop insurance plans also carry deductibles to discourage moral hazard as described above. The average deductible for crop insurance policies in the United States sold is 25 percent, which means a farmer must lose 25 percent of their crop or the value of their crop before they receive any benefit from crop insurance.
Disputes between insurers and farmers over crop insurance damages can be very detrimental to farmers. The farmer often has two chief methods of redress, either arbitration or initiating legal action. Official arbitration procedures can be extremely expensive for the farmer costing thousands of dollars. Initiating legal action can also be expensive and add to months of delays in receiving payments. The case of Bruhn Farms in 2016 is instructive in the challenges faced by farmers when disputes arise (Bruhn Farms Joint Venture v. Fireman’s Fund Insurance Company, №15–2202 (8th Cir. May 25, 2016). Bruhn Farms had a crop-hail insurance policy that provided coverage for direct loss due to hail. During the policy period, Bruhn experienced a hail loss and filed a claim with its insurer. Over a month went by and Bruhn did not hear from an adjuster. Bruhn requested permission from the insurer to harvest the crops and leave check strips for the adjuster. The insurance company eventually sent a team of adjusters, but during the two days they were on-property there was inclement weather so the adjusters spent time in the barn and in the cars, not inspecting the property. Bruhn’s expert testified that the adjusters did not spend enough time on the property investigating the loss. The adjusters finally determined that over 4,100 acres of soybeans were damaged by hail. Using adjustment procedures from the National Crop Insurance Services (NCIS) manual, they found losses ranging from 2.3% to 71.4%. Bruhn did not agree with the adjusters’ calculations and refused to sign the provided proof of loss. Regardless, the insurance company issued payment to Bruhn based upon their calculations, which was $25,000 apart from what Bruhn estimated. The case had to be appealed and Bruhn had to engage in extensive legal action over the dispute
(https://www.propertyinsurancecoveragelaw.com/2016/06/articles/insurance/crop-insurance-policies/). Numerous such examples of disputed policies taking extended periods of time due to lapses in regulations or insurance company service obligations or disputed damage amounts can be found. For many farmers, a lengthy and expensive dispute process is not a viable option and it is likely many accept a lower damage payment as a result.
USA Crop Insurance Penetration
In the United States, the core agriculture belt featuring corn and soybeans tends to have the highest adoption of crop insurance. In Iowa for example, approximately 90% of acres are covered by MPCI policies, and most are of the Revenue Protection variety. Insurance rates are very high in the large core belt due to high subsidies for the policies provided by the Federal government, averaging around 60% of the premium. The penetration rates for the principal crops are shown below:
With such high degrees of penetration in the USA, it may seem there is not much of a market for alternatives such as Arbol in this country. However, the availability of crop insurance varies considerably by crop and region. This leaves large gaps in coverage for many crops especially those outside of the mainstream agriculture areas, specifically specialty crops. The term
“specialty crops” refers to “fruits and vegetables, tree nuts, dried fruits, and horticulture and nursery crops (including floriculture)” (7 U.S.C. 1621). This definition covers an estimated 400 agricultural commodities, including fresh and processed fruits and vegetables, tree nuts (excluding peanuts), a range of nursery plants (trees, shrubs, flowering plants), herbs and spices, coffee and tea, and also honey and maple syrup, according to U.S. Department of Agriculture (USDA) guidelines.
According to RMA, federal crop insurance covered roughly 73% of USDA-reported specialty crop acreage. This compares to an estimated 85% of planted acreage for major field crops covered by federal crop insurance. (USDA data is available for a subset of 38 specialty crops.) Market penetration, however, often varies widely by the type of crop. For fruits and tree nuts, the share of federally insured acres ranges from less than 1% (strawberries) to nearly 90% (plums/prunes). For vegetables and melons, insured acres range from 5% of total acres (e.g., fresh beans, sweet potatoes) to more than 80% of acres (e.g., dry peas, potatoes, citrus). See the two charts below:
Coverage is still unavailable for many other specialty crops. Specialty crops that do not have access to federal crop insurance include asparagus, beets, broccoli, carrots (fresh and for processing), cashews, cauliflower, celery, chives, dates, eggplants, garlic, hazelnuts, leeks, lettuce, some melons, spinach and other leafy greens, squash, and most root crops. Specialty crops have a number of impediments from increasing the availability of traditional crop insurance, such as small acreages, multiple crop varieties, and farming practices and fewer pricing indicators all of which increase the costs and complexity of loss assessment. This explains why even for many crops with available insurance, coverage percentage varies considerably and is concentrated in the main growing states such as California.
In terms of liabilities, the specialty crop market has been growing rapidly along with production. RMA data indicate that liabilities for specialty crops (excluding apiaries) totaled $16.2 billion, or about 16% of the total liability for all federally insured crops compared to $8 billion in 2000. Specialty crops accounted for an estimated $561 million in total crop insurance premium subsidies received in 2015 or about 9% of total subsidies paid that year. The average premium subsidy paid by the federal government in 2015 was 64% for specialty crops with a wide variation for specific crops ranging from about 50% for tree nuts and melons to 90% or greater for crops such as potatoes, citrus, and banana trees.
Organic crops are a rapidly growing segment of the USA agriculture landscape with sales of organic food up 8.4% from the previous year hitting a record $43 billion in 2016. Acreage in 2017 increased 30% compared to 2016 and the number of farms grew 15% to over 17,000 by 2017. The crop insurance framework has struggled to keep pace with such growth owing to some key differences between organic and traditional farming. Until the year 2014, organic farming insurance was hampered by the fact that organic farming practices were not classified under “good farming practices”. This meant that the insurance assessor could disqualify an organic farm from receiving damage compensation since the farmer is required to show maintenance such good practices to receive loss payments. Another issue faced with organic farms is their lower average yield compared to crops grown using traditional practices. Therefore, without a yield adjustment for an organic farm, a yield protection crop insurance policy indexed to average yields in an area that includes traditional farms will not pay out appropriately for an organic farm. Organic farms were further hampered by USDA surcharges placed on premiums instead of subsidies received by traditional crop insurance plans. Finally, the price assumed for organic farm goods was not well specified and given their price premium to conventional produce, the usual prices used by RMA for crop insurance were not suitable.
The 2014 farm bill fixed some of the above issues such as removing the surcharge and lowering yield estimates for organic farms versus traditional farms. The introduction of whole farm income insurance whereby a wide variety of crops and farming practices can be insured as a single farm unit income is also an option for organic farm crop insurance. The RMA also introduced the option for organic farmers to use their contract price, if they have one, instead of the conventional product price in an attempt to better target pricing for organic farms. Nevertheless, organic farm insurance penetration remains relatively low. As of data available most recently, insurance penetration is below 50%, with various crops much lower than that.
So while the United States is well covered, there are still many gaps in coverage as well as regulations that keep insurance protection out of reach for many agribusinesses and crop types leaving them under or uninsured.
Stay tuned for part three of this series, we will explain insurance cost structure and parametric and index insurance.
And, here’s part one for reference.