Improved Farm Financial Safety Net based on Revenue Insurance By Dr. G. Art Barnaby, Jr. Professor Agricultural Economics Kansas State University “Policy Options and Consequences for the 2012 Farm Bill”, 2011 AAEA & NAREA Joint Annual Meeting, July 24-26, 2011 Pittsburgh, PA Email barnaby@ksu.edu Check out our WEB page at http://www.AgManager.info 1

USDA Risk Tools are Derivatives of Puts, Insurance, or a Combination 2 2

Marketing Loan, Counter Cyclical, Ad Hoc Aid, SURE & ACRE are Insurance with 100% of Premium Paid by USDA All risk management tools including ACRE, SURE, Marketing Loan, etc. are derivatives of options and insurance. FSA Programs could be rated and farmers pay a share of the premium, similar to crop insurance. If farmers paid premium they would buy less coverage under the FSA program and it would increase the inflow of dollars and reduce the cost for those risk programs. 3 3

Common Crop Insurance Policy (CCIP) All contracts will use the same price election and is a major change from previous crop insurance contracts. As a result, all CCIP contracts have the same yield guarantee. RP-HPE is YP plus a Yield Adjusted Asian Put option. RP is RP-HPE plus a Yield Adjusted Asian Call option. 4 4

Common Crop Insurance Policy Values for Example Corn Farm 5

Reasons APH is lower than Expected Yield Yields are not adjusted for improved technology. Because of hail & wind, irrigated corn farmers can produce a zero yield but they don’t produce a 400 bushel yield to offset the loss year. Area wide disaster years creating multiple loss years and causing a decline in APH’s. New farmer or new crop with no history. 18 18

Reasons APH is lower than Expected Yield Crop rotations that will cause yields in an APH to be more than 10 years old. This is especially an issue in the Great Plains that requires rotation on dryland acres. A loss claim causes a reduction in guarantee and increases premiums. The reduction in guarantee caused by a claim is unique to crop insurance, but premiums may increase for other lines. If the low APH provides no protection then the premium rate does not matter. 19 19

Move APH Closer to Expected Yield 5 year Olympic average APH would use more current yields. This rule of thumb would account for much of the technology improvement. An APH close to expected yield would improve the insurance guarantee at all coverage levels. Would allow 1 loss in 5 years with no reduction in guarantee. The Rated APH based on all 5 years of yields would set premium rates; currently in present system. 21 21

State Loss Ratios Ranked by Liability ` ` ` 33 33

Non-Price Rationing of Risk Protection Because ACRE and SURE are “free”, Policy Makers have imposed a payment limit to ration payments. If it is risk management and not transfer payments then in most years there will be no payment but payments are “large” in loss years. For example, if ACRE were to pay $1 per acre, then it would cover 73,000 acres, but in a catastrophe year paying $200, it would only cover 365 acres. Direct Payments would pay $40,000 or $80,000 over 2 years. Farmer needs to collect every other year from ACRE to match DP. Is that risk management? 34 34

If Crop Insurance were Transferred from Private Insurance Companies to FSA A large part of the crop insurance infrastructure would be lost. Would USDA employees be able to sell the same number of contacts sold by a commission compensated only agent force, causing a reduction in participation? If a future Congress were to eliminate farm support payments and layoff all of the FSA and RMA employees, would Iowa still be planted to corn? After elimination of farm support programs, will private insurance companies be able to offer insurance coverage on perils besides hail, at “affordable” rates to America’s farmers, especially in the Great Plains? 36 36

Thank You DR. G. A. “ART” BARNABY, JR. KANSAS STATE UNIVERSITY Sponsored by Southwest Agribusiness Group Lubbock, Texas EMAIL: barnaby@ksu.edu; PHONE: 785-532-1515 Check out our WEB page at WWW.AgManager.info Copyright 2011, All Rights Reserved 37 37