The verdict is in – crop insurance, as currently structured, results in massive overspending on the part of the federal government.
Just how much overspending? According to a recent study by agriculture economist Bruce Babcock from Iowa State University, the 2012 drought resulted in almost $7 billion in unnecessary payments. To put this in perspective, the FY 2013 budget request for the entire National Science Foundation is only $7.37 billion.
What caused this colossal overspending? The federal government subsidizes 60 percent of the cost of farmers’ crop insurance policies. The goal is admirable: to protect farmers from losses due to unforeseeable circumstances, such as natural disasters. But the subsidies are so large they encourage farmers to over-insure their crops by purchasing the Cadillac of crop insurance policies, termed “revenue protection.”
Under simple “yield protection” policies, farmers insure yield-per-acre and, if yields fall (such as, due to a drought or flood) they receive a per-acre payout at a price determined before the policy’s purchase. Under “revenue protection-harvest price exclusion” policies, farmers insure the revenue-per-acre, so if prices fall, the farmer is made whole.
Revenue protection policies protect farmers against both falling prices and falling yields. They offer farmers the best of both worlds, and go even further. When yields fall and prices rise, revenue protection pays out the yield-per-acre at the higher market price, making payouts to farmers both larger and more likely. This increased coverage costs a pretty penny, but fortunately for farmers, the majority of those pennies come from the taxpayer.
This wouldn’t be a $7 billion problem, except that Uncle Sam also encourages insurance companies to sell these policies by agreeing to bear part of the burden when catastrophe strikes. Therefore, when disaster occurs, it’s the taxpayer who is on the hook for large payouts. According to Babcock, “in 2012, taxpayers will absorb almost 75% of the gross underwriting loss.”
Had farmers opted for one of the other policies, the payouts would have provided something closer to the farmers’ actual losses, which Babcock estimates to be around $6 billion. But most of the claims filed were insured through the revenue protection policy, resulting in a payout of $12.7 billion. For a program that’s designed to be a safety net, paying out more than twice the estimated loss seems generous, to say the least.
With the Senate’s latest Farm Bill headed to committee mark-up this week, let’s hope that sensible steps are taken to protect taxpayers while still protecting farmers. Otherwise, natural disasters will continue to wreak havoc – on the taxpayer wallet.