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**United States Department of Agriculture---2007 Farm Bill Theme
Papers**

**Risk Management**

**Executive Summary**

**May 2006**

This paper is the first in a series of briefing papers that assess
general views advanced during the 2007 Farm Bill Forums convened by
Secretary Mike Johanns in 2005 as well as additional policy ideas that
have emerged in recent months. This paper describes the risks
agricultural producers face; discusses current key risk management
programs and tools available to producers through the private sector and
government; and concludes with a discussion of program alternatives.
These alternatives are generalized approaches for dealing with concerns
raised about current programs. They are not meant to be exhaustive or
represent specific farm bill proposals. Rather, they are presented as
candidates for further public discussion on potentially effective
approaches for development of the 2007 Farm Bill.

**Risks Facing Agriculture**

Agricultural risks are generally organized into five categories:
***price*** ***risk**; **production risk**; **income risk**; **financial
risk ***(related to the cost of and access to debt); and
***institutional risk*** (related to changes in laws or regulations).
Agricultural producers have a variety of options available to help them
manage risks. However, not all options are available to all producers,
and because agriculture is diverse, producers face different risks and
need different risk management tools at their disposal. The Federal
government does not try to eliminate risks for most types of businesses,
because doing so could encourage risky business choices that would be
inconsistent with market incentives. Even so, a government role may be
appropriate where risk management tools are inadequately provided by the
private sector, where there are special risks such as weather in
agriculture, or where there is a policy to offset undesirable or
inequitable market outcomes, despite economic inefficiencies that may
result.

**Federal Government Approaches to Agricultural Risk Management**

Key Federal programs that help reduce farmers' price, production and
income risks include payments made under commodity programs. These
include direct payments, counter-cyclical payments, and marketing
assistance loan benefits, conservation programs, and crop insurance. In
addition, ad hoc disaster and market loss assistance has been authorized
by Congress regularly.

Many farm programs are administered through the Commodity Credit
Corporation (CCC). CCC outlays include commodity program payments,
expenses of several USDA trade and conservation programs, and outlays
for ad hoc and emergency assistance, but exclude crop insurance. Total
CCC outlays peaked in FY 2000 at \$32.6 billion due to declining market
prices for major crops and supplementary economic loss assistance
payments enacted by Congress. In FY 2004, CCC outlays dropped to only
\$10.6 billion as prices for major crops strengthened. But markets for
major crops reversed and outlays nearly doubled to over \$20 billion in
FY 2005, and are forecast to remain above \$20 billion in FY 2006 and FY
2007. Federal crop insurance costs, because of statutory increases in
subsidy levels and increased participation, have risen from about \$1
billion per year in the mid 1990s to an expected average of \$3.1
billion during the 2002-05 crop years.

**Distribution of benefits under current programs.** An examination of
data on farm program benefits reveals a number of conclusions:

-   **Payments by Crop.** Of total commodity program payments during
    2002-05, 93 percent are estimated to go to wheat, rice, corn,
    soybean, and upland cotton producers. However, these five crops
    accounted for an estimated 21 percent of total farm cash receipts in
    2005.

-   **Payments in Relation to Crop Production Value.** In terms of
    market value for the five major crops that account for most
    payments, payments ranged from a low of an estimated four percent
    for soybeans, to 17 percent for wheat, 23 percent for corn, 50
    percent for cotton, and a high of 63 percent for rice during the
    2002-2005 crop years.

-   **Farms Receiving Government Payments.** Farm financial survey data
    indicate 39 percent of all farms received government payments
    in 2004. Farms specializing in ***rice*** received an average of
    \$53,700 in 2004; ***cotton*** farms averaged \$49,300; and ***cash
    grain and soybean*** farms averaged \$19,000 per farm, but cash
    grain and soybean farms accounted for 54 percent of payments made.

-   **Payments by Farm Typology.** Commercial farms accounted for nearly
    17 percent of the farms receiving government payments in 2004, but
    received 56 percent of total government payments. Rural residence
    farms accounted for about half of the farms receiving payments but
    only 17 percent of total payments. However, rural residence farms
    accounted for 58 percent of major conservation program payments
    which are largely associated with the land retirement programs.

-   **Payments by Income.** About 9 percent of all farm households
    receiving payments had incomes of \$200,000 or more and received 23
    percent of all government payments in 2004. About 44 percent of farm
    households receiving payments had incomes of less than \$50,000 and
    received about 32 percent of all farm payments. About 12 percent of
    farms had net cash farm incomes over \$100,000 and received 42
    percent of payments.

**Crop Insurance and Ad Hoc Disaster Assistance.** Federal Crop
Insurance was overhauled in 2000 to increase participation through
expanded crop and livestock coverage and increased subsidies. In 2005,
acres covered were up 20 percent from 2000, and liability was up 30
percent. Buy-up coverage has increased sharply. Overall, crop insurance
policies are purchased on two-thirds of the total U.S. crop value and
for 85 percent of the value of program crops. For livestock, new pilot
insurance policies are being offered, but participation remains low. The
actuarial performance of crop insurance has steadily improved over time,
although subsidies have increased, including the costs of delivery. Yet
despite the increase in participation and coverage levels, Congress has
continued to provide ad hoc disaster assistance to producers, making
available \$14 billion to livestock and crop producers since 1998.

**Conservation.** Natural resource conservation will be examined in a
subsequent theme paper. The theme is discussed here because there are
many conservation activities that farmers, ranchers, and communities may
undertake to reduce their risks. Under USDA conservation programs,
production and yield risks may be reduced by financial assistance,
technical assistance and stewardship programs.

**Economic and Policy Issues for Federal Agricultural Risk Management
Programs**

Price and income support, crop insurance, disaster, and conservation
programs constitute substantial resources directed at farm risk
mitigation.

**Risk Mitigation.** While providing substantial income enhancement,
government price and income support programs appear to be blunt
instruments for reducing income variability or risk. For example, direct
payments are fixed and do not take income variability into account.
While counter-cyclical payments are negatively correlated with price,
they are based on a fixed production level and do not take the income
effect of changing yields into account. Marketing loan benefits, while
triggered by low prices, enable the producer to lock in a return at
least equivalent to the loan rate on all current production. Thus, the
loan program may overcompensate when production is marketed at prices
above the level used to lock in the loan benefit. In addition, a
producer does not receive the loan benefit on lost production, thus
reducing income risk protection. A large national crop loss may greatly
reduce production eligible for loan benefits and, if it causes higher
prices, may also reduce counter-cyclical payments, again failing to
mitigate income risks.

In recent years, crop insurance has had large increases in participation
and coverage levels, improved actuarial performance, and higher program
costs. Still, ad hoc disaster assistance continues to be made. While 66
percent of U.S. crop value is covered by an insurance policy, insured
liability is only 39 percent of U.S. crop value. Trying to increase
enrolled crop acres with higher premium subsidies for all producers
would result in high costs per added acre enrolled. Availability of crop
insurance remains limited for some specialty crops, livestock, livestock
forage and whole farm policies.

**Level and Comprehensiveness of Support.** Government payments are not
distributed evenly across the country or by farm size or type of farm.
This fact raises questions about the equity of program benefits.
Payments under the price and income support programs are heavily
concentrated in the central and southern parts of the United States,
reflecting production of program crops, with a large proportion of the
payments going to the largest farms with the highest net farm incomes.
Conservation payments are more evenly distributed among farms and
ranches.

**Resource and structural effects.** Farm programs have become more
market-oriented over time. Yet, today's programs still contain elements
that provide incentives for resource use that may be inconsistent with
market signals. For example, the marketing assistance loan program
assures a per unit return on all current production at least equal to
the loan rate, regardless of how low market prices fall. Studies
indicate the marketing assistance loan and crop insurance programs have
increased planted acreage, although the size of the effects are
debatable. In some instances, the land brought into production is
economically marginal, environmentally sensitive, or otherwise poorly
suited for crop production. Similarly, the sugar and dairy programs
provide incentives to produce more than otherwise by maintaining market
prices above where they would likely be in the absence of the programs.
To the extent that the supported prices for sugar and dairy products
exceed the market prices that would prevail in the absence of the
programs, consumers of those products pay more.

Commodity programs may also affect farm size and farmland values. While
program payments may help some producers remain in business in the short
term by augmenting income, program payments may provide a means for
other producers to outbid competitors for farmland and expand their
operations. While varying by region, studies indicate commodity programs
raise U.S. farmland values. Higher farmland values will directly benefit
farm operators who own and invest in farmland and may indirectly benefit
those farming by improving their access to credit and making additional
land purchases easier. However, higher land prices may also deter new
entrants into farming and constrain expansion by limited resource farms;
increase farmers' costs; increase investment in farmland by nonfarmers;
and increase the tax burden of landowners.

**Program cost.** Commodity program costs have increased sharply, about
doubling since FY 2004. Costs are expected to remain well above the
average of the 1990s. Federal crop insurance costs have steadily
increased under statutory increases in subsidy levels and increased
participation, rising from about \$1 billion per year in the mid 1990s
to an expected average of \$3.1 billion during the 2002-05 crop years.
Ad hoc disaster assistance has been consistently provided in recent
years with costs of nearly \$3 billion in calendar 2005. In addition,
the dairy and sugar price support programs add to consumer costs and can
result in stock accumulation by the government which can be difficult to
manage. High costs are an issue in the current Federal budget
environment where deficits are large and persistent and there is
pressure to curb spending.

**WTO implications.** Under the Uruguay Round Agreement on Agriculture
of the WTO, the United States is limited in the amount and type of
support allowed under domestic farm programs. In addition, under the
on-going negotiations under the Doha Development Agenda, the United
States has proposed more stringent limitations on domestic farm support
in combination with increased market access and elimination of export
subsidies. If the U.S. proposals are adopted in the WTO, domestic policy
reform is likely to be needed, especially in key amber box
programs---the marketing assistance loan program and the dairy and sugar
price support programs. In addition, Brazil's successful challenge to
U.S. cotton programs has significant direct and indirect implications
for farm programs.

**Alternative Approaches to Agricultural Risk Management**

Three broad approaches for addressing risk management programs are
discussed. The options are not meant to be exhaustive or to represent
specific farm bill proposals. They are presented as candidates for
further public discussion to help inform the 2007 Farm Bill.

**Alternative 1:** *Use the existing structure of farm programs but make
them more WTO consistent, reduce their effects on resource use and farm
structure, and better target them to producers in greatest need of
assistance.* The goals of this option could be met with reduced
marketing assistance and price support loan rates, reduced
counter-cyclical payment rates, higher direct payment rates, and
stricter payment limitations. Programs would be less vulnerable to WTO
challenges, resource effects would be lessened, payments could be more
targeted toward smaller and mid-size farms, but program benefits would
remain concentrated with traditional crops and greater reliance would
have to be placed on crop insurance or the private sector to manage
income variability.

**Alternative 2:** *Replace marketing assistance loans and
counter-cyclical payments with a program that pays producers based on
revenue shortfalls.* This option would replace marketing loans and
counter-cyclical payment programs with a program designed to stabilize
revenue. To fully develop this approach, many questions must be answered
on program design (level of guarantee? single commodity revenue or a
whole farm revenue? revenue on an individual farm or in a region or
nationally?) and program delivery (government or private sector?). This
approach would generate cost savings and generally be more effective at
stabilizing farm income than our current programs, but could affect
supply, demand and prices depending on how the program is constructed
and the level of the revenue guarantee. Savings could be used to address
other needs or more commodities than under current programs, and WTO
concerns may be reduced but not eliminated.

**Alternative 3*:*** *Phase out marketing assistance loans, direct and
counter-cyclical payments and use savings to expand crop insurance
coverage, fund farm savings accounts or expand conservation, rural
development, or other programs.* Eliminating direct and counter-cyclical
payments and marketing assistance loans would reduce Federal spending
substantially, lead to a more market-oriented agricultural sector and
remove the negative aspects of current programs to expand production and
plant certain crops. However, the reduction in payments to traditional
program crops and expansion in conservation, rural development, and
other programs could result in a significant shift in benefits from
producers of traditional program crops to producers of non-program crops
and livestock. Implementation would be gradual over several years to
limit adverse effects on land and asset values. Greater reliance would
have to be placed on the development and use of private sector risk
management tools to manage income risk.