Crop Insurance: Opportunities Exist to Reduce the Costs of Administering the Program
Published: 2009-04-29T00:00:00

Fast Facts:

Highlights:
section_title: Why GAO Did This Study
paragraphs: The U.S. Department of Agriculture (USDA) administers the federal crop insurance program with private insurance companies, which, in turn, work with insurance agencies that sell crop insurance. In 2008, according to USDA, the program cost $6.5 billion, including about $2.0 billion in allowances to insurance companies to cover their administrative and operating (A&O) expenses, such as salaries and sales commissions to agencies. GAO was asked to examine (1) the reasons for recent substantial increases in A&O allowances, and the purposes for which insurance companies use these allowances, and (2) insurance agencies' expenses for selling federal crop insurance policies, and questionable practices, if any, that agencies use to compete for business among farmers. GAO analyzed USDA and private insurers' data, among other things.
section_title: What GAO Found
paragraphs: Between 2000 and 2009, companies' A&O allowances nearly tripled, primarily because USDA's calculation method for A&O allowances considers the value of the crop, rather than the crop insurance industry's actual expenses for selling and servicing policies, which generally remained stable. This increase in the A&O allowances occurred without a proportional increase in the number of policies, acres, or amount of insurance coverage purchased. The higher A&O allowances occurred because of higher crop prices since 2006. Per policy, the allowance rose from a national average of $836 in 2006 to an expected $1,417 in 2009. Companies have used most of the higher allowances to raise commissions, in an effort to compete for insurance agencies' portfolios of crop insurance policies. USDA data show that commissions increased more sharply in states with historically larger insurance underwriting gains, which add to company profits. For example, the average commission paid per policy in 5 Corn Belt states increased by 86 percent from 2006 to 2007, and by 43 percent in the other 45 states. Companies reported to USDA that their expenses to administer the program in 2007 exceeded their allowances. However, GAO determined that these expenses exceeded allowances largely because of the higher commissions paid to insurance agencies. According to GAO's analysis, crop insurance agencies' sales commissions have outpaced their expenses for selling policies. Commissions per policy increased by an average of about 16 percent per year from 2000 to 2009, compared with an increase of about 3 percent per year for insurance agents' wages, which are the largest factor in agencies' expenses. For 2007 through 2009, commissions will exceed wage-adjusted commissions by $2.87 billion. According to USDA officials, higher commissions can create more incentive for rebating, which is the practice of offering something of monetary value to farmers to attract their business. USDA prohibits this practice, as do most states. USDA and state insurance regulators are working to reduce the potential for this practice.

section_title: Letter
paragraphs: Federal crop insurance protects participating farmers against the financial  losses caused by natural disasters, such as droughts, floods, and  hurricanes, as well as declines in crop prices. In 2008, the crop insurance  program provided about $90 billion in insurance coverage for 272 million  acres of farmland at a cost of $6.5 billion to the federal government. To  implement the federal crop insurance program, the U.S. Department of  Agriculture’s (USDA) Risk Management Agency (RMA) partners with 16  private insurance companies, which sell and service the insurance policies  and share a percentage of the risk of loss and opportunity for gain  associated with the policies. RMA pays insurance companies a percentage  of the premiums on policies sold to cover the administrative and operating  (A&O) expenses of selling and servicing these policies. These expenses  are generally described in RMA guidance and can include company  overhead, such as employee salaries, fees paid to insurance adjusters to  verify claims, and sales commissions paid to the insurance agencies and  their agents who sell crop insurance to farmers. These agencies and agents  generally operate independently of the 16 insurance companies and can  change companies from year to year.
We have reported for many years on the costs of the crop insurance  program associated with A&O allowances. In May and June, 2007, we  testified that RMA should ensure that expenses for delivering the crop  insurance program are reasonable. Specifically, we noted that the federal  government spent more than $6.8 billion from 2002 through 2006 to  administer the program—with A&O allowances accounting for over half of  these expenditures—and recommended that Congress authorize RMA to  renegotiate its agreement with the companies that sell and service crop  insurance policies. Subsequently, Congress, through the Food,  Conservation, and Energy Act of 2008 (the 2008 Farm Bill), reduced the  A&O allowance payment rate for most crop insurance policies by 2.3  percentage points, effective in 2009. This reduction is expected to result in  financial savings of almost $1 billion through 2013. The 2008 Farm Bill also  directed RMA to consider alternative methods for determining A&O  payment rates as well as other methods, taking into account current  financial conditions, to ensure the continued availability of the program. In  2006, we identified the need for better oversight of the federal crop  insurance program to ensure that its funds are spent as economically,  efficiently, and effectively as possible. Furthermore, in 1997, we reported  that A&O allowances exceeded the companies’ expenses that can be  reasonably associated with selling and servicing crop insurance policies.  We noted that alternative arrangements for determining A&O allowances  offered potential for savings. These alternative arrangements included  paying companies a flat fee per policy, plus a lower percentage of the  premium on the policy. Furthermore, we noted that USDA’s Farm Service  Agency had administered a type of crop insurance—catastrophic  insurance—at a lower cost to the government than did private insurance  companies.
While the 2008 Farm Bill reduced the A&O allowance rate, other factors  also affect A&O allowances to insurance companies. Because allowances  are a percentage of insurance premiums, they increase when the value of  policies that companies sell increases, such as when crop prices rise.  According to USDA, since 2007, the prices for major crops—such as corn,  soybeans, and wheat—have been among the highest on record, and prices  in 2009 and beyond are expected to remain relatively high. In response to  these rising crop prices, A&O allowances increased from about $960  million in 2006 to about $2 billion in 2008.
In this context, you asked that we examine (1) the reasons for the  substantial increases in A&O allowances in recent years, and the purposes  for which insurance companies use these allowances, and (2) insurance  agencies’ expenses for selling federal crop insurance policies, and  questionable practices, if any, that agencies use to compete for business  among farmers.
To examine the reasons for the substantial increases in A&O allowances in  recent years and the purposes for which insurance companies use these  allowances, we interviewed RMA officials and officials from each of the 16  companies that participate in the federal crop insurance program. In  addition, we reviewed and analyzed RMA and company data concerning  companies’ uses of the allowances from 2000 through 2007. The sources of  these data included expense reports that the companies submitted to RMA  listing the amounts that they charge to various expense categories. We  also reviewed RMA’s reporting guidelines for companies and discussed  these guidelines with company officials. In addition, we reviewed  examples of companies’ contracts with insurance agencies. We selected  these contracts on the basis of the volume of business between the  insurance company and the agency and, when possible, regional diversity.  For the purpose of this report, commissions include profit-sharing  bonuses that an insurance company pays to an insurance agency on the  basis of profits for a given year and transfer bonuses that a company pays  to an agency that transfers its portfolio of crop insurance policies that it  sells (book of business) to the company. To examine insurance agencies’  expenses for selling federal crop insurance policies, and questionable  practices, if any, that agencies use to compete for business from farmers,  we interviewed officials of eight insurance agencies and reviewed  documents that some of these officials provided. We also interviewed  officials from trade associations representing insurance agents. In  addition, we interviewed officials from RMA and the National Association  of Insurance Commissioners (NAIC), an association of state insurance  regulators, and discussed with RMA its investigations of questionable  competitive practices.
We conducted this performance audit from January 2008 through April  2009 in accordance with generally accepted government auditing  standards. Those standards require that we plan and perform the audit to  obtain sufficient, appropriate evidence to provide a reasonable basis for  our findings and conclusions based on our audit objectives. We believe  that the evidence obtained provides a reasonable basis for our findings  and conclusions based on our audit objectives. Appendix I contains more  detailed information on our scope and methodology.
subsections: section_title: Background
paragraphs: Farming is an inherently risky enterprise. In conducting their operations,  farmers are exposed to financial losses because of production risks— droughts, floods, hurricanes, and other natural disasters—as well as price  risks. For decades, the federal government has played an active role in  helping to mitigate the effects of these risks on farm income by promoting  the use of crop insurance.
Through the federal crop insurance program, farmers insure against losses  on more than 100 crops. The federal government encourages farmers’  participation by subsidizing their insurance premiums and acting as the  primary reinsurer for the private insurance companies that take on the risk  of covering, or “underwriting,” losses to insured farmers. These companies  achieve underwriting gains when insurance premiums exceed the claims  they must pay farmers for crop losses, and they incur underwriting losses  if claims paid on the policies exceed the premiums. To cover the expenses  of selling and servicing crop insurance policies, the federal government  pays companies an A&O allowance. In turn, insurance companies use this  money to cover their overhead expenses, such as payroll and rent, and to  pay commissions to insurance agencies and agents. Companies also incur  expenses associated with verifying—adjusting—the amount of loss  claimed. These loss adjustment expenses include, for example, travel  expenses to farmers’ fields. The relationships among the federal  government, private insurance companies, agencies, agents, and farmers  are illustrated in figure 1.
To encourage widespread participation in the crop insurance program, the  federal government pays the costs of selling and servicing crop insurance  policies through the A&O allowance. As designed, this allowance increases  when companies sell policies to more farmers, insure additional acreage,  or sell a higher level of insurance coverage on acres that are already  insured. However, A&O allowances can also increase as a result of higher  crop prices without corresponding changes in the number of policies sold  to farmers, insured acreage, or levels of coverage. Such increases in A&O  allowances—when decoupled from the federal crop insurance program’s  interest in promoting more insured acreage and higher levels of  coverage—can create additional incentives for insurance companies to  expand their market share by raising commission rates.
In 2008, RMA provided about $2.0 billion in A&O allowances and an  estimated $1.5 billion in underwriting gains to crop insurance companies.  Figure 2 shows the A&O allowances and underwriting gains or losses paid  to companies for 2000 through 2008.
Taking into account all payments, the crop insurance program cost  taxpayers about $31 billion for 2000 through 2008, according to the most  recent available estimate from the Center for Agricultural and Rural  Development at Iowa State University. According to our analysis, RMA  paid about $1.93 for every $1.00 in payments to farmers, with the other  $0.93 going to insurance companies over the period. Since 2006, when  crop prices began to rise sharply, RMA has paid about $2.29 for every  $1.00 that reached the farmer, with the balance going to insurance  companies.
The policies that insurance companies underwrite and service are sold by  more than 12,000 insurance agents. Some insurance agencies sell only  crop insurance, while others also sell other lines of property and casualty  insurance, such as automobile insurance and homeowner’s insurance.  These agencies, which are generally independent contractors and receive  sales commissions for selling the policies, can sell policies on behalf of  multiple crop insurance companies. Farmers must purchase policies by  certain “sales closing” dates. These dates correspond to a time before  planting season for a given crop in a certain region of the nation.
RMA is responsible for administering the federal crop insurance program  through a cooperative financial agreement called the standard reinsurance  agreement (SRA), which can be renegotiated once during a 5-year period,  or as directed by Congress. The SRA incorporates the terms and  conditions by which the private insurance companies that sell and service  crop insurance policies are to abide. Under the 2008 Farm Bill, RMA may  renegotiate the financial terms and conditions of the SRA, effective for the  2011 reinsurance year, beginning July 1, 2010. According to RMA officials,  this effort will begin in the spring of 2009. For 2008 and 2009, RMA  approved 16 insurance companies to provide federal crop insurance.
Premiums for the policies are set by RMA and depend, in part, on the price  of the insured crop, although premiums also vary according to the type of  insurance plan and the coverage levels that farmers select. A&O  allowances are calculated as a fixed percentage of the premium, and they  vary depending upon the plan and coverage levels, as shown in table 1.
For most policies, the 2008 Farm Bill reduced the A&O allowance rate by  2.3 percentage points beginning in 2009. However, the bill provides an  exception to cover higher loss adjustment expenses when needed.  Specifically, if a state’s losses are 20 percent higher than the total  premiums for that state, only one-half of the 2.3 percentage-point  reduction would apply. In addition, the reduction in the A&O allowance  rate was larger for area insurance plans than for other plans.
The 2008 Farm Bill also repeals a provision of the Federal Crop Insurance  Reform and Department of Agriculture Reorganization Act of 1994 that  allowed providers to implement “premium reduction plans” with RMA  approval. Through these plans, companies could offer a premium discount  to farmers that is equal to the amount that the companies’ A&O expenses  fell below their A&O allowances for a given year. Thus, these plans offered  an incentive for companies to reduce A&O expenses, because they  allowed companies to compete for more business by, in effect, reducing  the premiums they charged farmers for crop insurance. RMA established  guidelines for the submission of the plans in a final interim rule in the  Federal Register on July 20, 2005. In commenting on this rule, state  insurance regulators expressed concerns that the plans would result in  industry consolidation, reducing competition in the long run, and that the  plans could create pressure for insurance companies to reduce essential  operating expenses, thereby disadvantaging newer companies compared  with larger, established companies.
State insurance regulators also expressed concerns that the plans  constituted a legal form of rebating, the practice of offering something of  monetary value to farmers to attract their business. Rebating is generally  prohibited by the SRA and by most states, and the 2008 Farm Bill limits the  compensation an individual can receive for selling or servicing a crop  insurance policy in which he or she has a substantial beneficial interest.
section_title: Higher Crop Prices Sharply Raised A&O Allowances, and Insurance Companies Used a Large Share of These Increases to Compete for More Business
paragraphs: Companies’ A&O allowances nearly tripled from 2000 to 2009, primarily  because the method that RMA uses to calculate A&O allowances considers  the value of the crop and not the crop insurance industry’s actual  expenses for selling and servicing policies. Companies spent a large share  of their higher A&O allowances on commission payments, in part in an  effort to compete for business from insurance agencies. They also  reported expenses that are not clearly related to selling and servicing  policies, such as legal fees.
subsections: section_title: Substantially Higher A&O Allowances Have Occurred Primarily Because of Sharp Increases in Crop Prices
paragraphs: A&O allowances nearly tripled—from $552 million in 2000 to an estimated  $1.6 billion in 2009, according to our analysis of RMA data. The change  from 2006 to 2009 was particularly large, rising from an average of $836  per policy to an expected $1,417 per policy. These increases occurred  primarily because RMA calculates the allowance as a percentage of the  premiums on crop insurance policies, rather than the crop insurance  industry’s actual expenses to sell and service policies. Crop insurance  premiums change when crop prices change. Thus, the allowance increased  sharply from 2006 through 2009, when the prices of major crops increased.
Figure 3 shows the prices for these crops—corn, soybeans, and wheat— that RMA used in calculating A&O allowances for 2000 through 2009.
These three crops represented about 71 percent of the crop insurance  premiums in 2008.
According to RMA, A&O allowances will decrease in 2009 because crop  prices are expected to decrease and because of the reduction in the A&O  allowance rate for most crop insurance policies, as mandated in the 2008  Farm Bill. However, the prices for corn, soybeans, and wheat—the top  three crops in the crop insurance program, by premium—are expected to  remain relatively high. Thus, using RMA’s estimate of premiums and the  current allowance rate, we estimated that allowances in 2009 will be  $1,417 per policy, 69 percent higher than in 2006, although down from  $1,751 per policy in 2008.
The current method for calculating A&O allowances has caused allowance  payments to increase along with crop prices, but without a proportional  increase in the number of policies, acres, or coverage levels. For 2000  through 2008, A&O allowances increased sharply despite a 13 percent  decrease in the number of crop insurance policies—the principal factor  affecting companies’ workloads and costs. This increase in A&O  allowances has also been substantially greater than the increase in the  number of acres covered by the program. Since 2000, the number of acres  insured has increased slightly—by 7 percent—excluding insurance for  pasture and rangeland. These types of insurance tend to cover large  acreages in a single policy and, therefore, add many acres to the program  without a proportional increase in the number of policies or in companies’  workloads. With the addition of pasture and rangeland insurance, the  number of acres insured has increased by 32 percent since 2000, but these  policies represent only about 1 percent of all crop insurance policies. Nor  are coverage levels—which have increased from an average of about 61  percent of crop value in 2000 to an average of 67 percent of crop value in  2008—a major factor in the rapid increase in A&O allowances.
Because crop prices are a principal factor in the method for calculating  A&O allowances, the allowance fluctuates as crop prices rise and fall.  Fluctuations make it more difficult for insurance companies to budget and  operate effectively over the long term. Although USDA expects that crop  prices will remain relatively high for the next several years, prices are also  expected to be volatile because of energy markets, among other things.  Crop prices are increasingly tied to these markets because of the growing  production of ethanol. When oil prices increase, ethanol prices generally  increase, which raises demand for corn, the primary ethanol feedstock.
section_title: Companies Have Used a Large Share of Higher A&O Allowances to Compete for More Business
paragraphs: Companies generally base insurance agencies’ commissions on a  percentage of the premiums that agencies bring to the companies. Thus, as  crop prices have increased, so have commissions. Figure 4 shows the  change in premiums, A&O allowances, and commissions from 2000  through 2009.
The geographic pattern in commission rates indicates that the companies  are using their A&O allowances to attract insurance agencies’ portfolios of  insurance policies—their “books of business.” Obtaining more books of  business helps companies increase their potential to earn underwriting  gains. As figure 5 shows, the highest average commission rates are in the  states that historically have had the largest underwriting gains.
While companies have paid higher commission rates in certain states, they  have also increased the rates nationwide. For example, from 2006 to 2007  in 5 major Corn Belt states—Illinois, Indiana, Iowa, Minnesota, and  Nebraska—the average commission rate increased from 17.6 percent of  premium to 20.3 percent. In the other 45 states, the average commission  rate increased from 13.0 percent of premium to 14.2 percent.
In terms of commission dollars, the average commission paid per policy  from 2006 to 2007 increased more in the 5 major Corn Belt states overall  than in the other states, rising by a total of 86 percent in these 5 states  compared with 43 percent in the other 45 states. For 2007, in the 5 Corn  Belt states, crop insurance companies paid a total of $506 million in  commissions—which is about $9 million more than the total A&O  allowance that the companies received from RMA for these states.  According to crop insurance company officials, having used their A&O  allowance for commissions, they rely on underwriting gains in such states  to pay their overhead expenses and fees to insurance adjusters, who verify  claims that are filed. Appendix II contains additional information on  commissions paid in 2006 and 2007.
Company officials confirmed that they increased commission rates to  compete for the insurance agencies’ books of business. Obtaining more  books of business helps companies increase their potential to earn  underwriting gains.
Because RMA sets the premiums for crop insurance policies, companies  cannot compete by reducing premiums. Nor do they often have the  opportunity to insure new crop acres or sell more policies overall. Thus,  one of the key ways for companies to increase their market share is to  draw insurance agencies (and their books of business) away from  competing companies by raising the agencies’ commission rates. In  addition, company officials told us that some insurance agencies have  considerable leverage in negotiating with companies for sales  commissions because these insurance agencies have long-standing  relationships with farmers whose crop insurance policies have historically  produced high underwriting gains. Thus, companies compete against one  another, offering higher and higher commissions until the increase in A&O  allowances is exhausted. Insurance agencies have benefited from the  increases in A&O allowances without selling more policies.
In addition to increasing commission rates in certain states, some  insurance companies seek to attract agencies’ books of business by  offering commission rates on the basis of the agency’s size. That is, many  of the commission contracts we reviewed provided higher commission  rates to agencies that sell insurance in larger quantities.
Even as they compete for insurance agencies’ books of business on  commissions, companies can also try to retain their current agencies’  business by providing in-kind services, such as policy processing services  and mailings to inform farmers about policies. These services usually  entail an investment in information technology, such as quoting software  that calculates farmer-specific premiums that agencies can use to market  the various policies.
RMA does not know how much an individual company spends on  commissions to each of the agencies with which it does business. RMA  guidelines for reporting under the SRA direct insurance companies to  report only their total commissions for each state in which they operate,  not commission amounts paid to individual agencies. Information by state  does not provide sufficient detail on commission expenses because such  data do not allow RMA to assess whether the compensation paid to  agencies is appropriate in relationship to the cost of selling and servicing  crop insurance. RMA would be better able to set the A&O allowance rate  when it renegotiates the SRA with insurance companies if it had more  detailed information on commissions provided to individual agencies, such  as commission data at the policy level. With such information on agencies’  commissions, as well as their costs, RMA could assess whether the A&O  allowances are reasonable for program delivery but not excessive, and  adjust allowances as needed. Data by policy would enable RMA to better  understand how compensation to agencies varies with agency size and the  characteristics of policies sold, such as the type of insurance plan and  expected underwriting gains. This understanding would enable RMA to  better anticipate the effects of adjustments in A&O allowances on  agencies. For example, this analysis may show that agencies that do  business primarily in a part of the state with historically high underwriting  gains received higher commission rates than agencies that do business in a  part of the state with lower underwriting gains.
section_title: Companies’ Reported Expenses Exceeded A&O Allowances, but High Commissions and Expenses That Were Inconsistent with RMA Guidance Explain This Difference
paragraphs: Despite the increases in A&O allowances, insurance companies reported  to RMA that their expenses for delivering federal crop insurance for 2007  exceeded their A&O allowances by about $244 million. Company officials  told us that new RMA regulations and recent changes have added a  significant administrative burden. For example, they noted, when RMA  introduces an insurance product, companies must update their  information systems, train staff, and take on additional work, and RMA  provides what companies view as insufficient time for them to do so.  Furthermore, although RMA guidelines have long directed companies to  perform additional review of all claims of more than $100,000, these  reviews became more frequent when crop values started to increase  significantly in 2007 and claim amounts rose accordingly. These activities  made company operations more costly, according to company officials.  Furthermore, insurance company officials told us that certain expenses  vary by region of the country. For example, companies that operate in  regions that tend to have crop losses more frequently incur higher overall  A&O expenses because of higher loss adjustment expenses. Nevertheless,  RMA officials noted that recent changes should have only marginally  affected the cost of doing business.
We found that the amount by which companies’ reported A&O expenses  exceeded allowances was largely due to the increased spending on  commissions, as well as to the reporting of expenses that was inconsistent  with RMA guidance, rather than to greater administrative burdens.  Although A&O allowances increased by 39 percent—from $960 million in  2006 to about $1.3 billion in 2007—companies increased the commissions  they paid to agencies by 58 percent—from $711 million to about $1.1  billion. Figure 6 shows A&O expenses for 2006 and 2007 and the A&O  allowances reported.
For individual agencies, commissions can be large, both in terms of actual  dollars and in relationship to A&O allowance rates. For example, in 2007,  companies paid 60 insurance agencies commissions that were at least $1.0  million and at least 20.0 percent of the premium value, which is about  equal to the average A&O allowance rate of 20.4 percent paid to  companies nationwide.
We also found that some insurance companies’ reporting of program  delivery expenses was inconsistent with RMA reporting guidance. For  2007, some companies reported profit-sharing bonuses, legal fees, and  other expenses that were not directly related to the selling and servicing of  crop insurance policies. RMA guidance states that these payments should  not be included in the expense report, and, according to RMA officials,  these payments are not program delivery expenses. For example, 10 of the  16 companies listed profit-sharing bonuses to insurance agencies as an  expense to deliver the program. Similarly, 6 of the 16 insurance companies  included reinsurance expenses that relate to business expansion, rather  than to program delivery. Specifically, insurance companies pay premiums  for commercial reinsurance to (1) reduce their risk of underwriting losses  and (2) increase their capacity to sell more insurance. According to RMA  guidance, reinsurance expenses should not be reported as A&O expenses.  RMA officials told us that these types of expenses should be paid from  underwriting gains because they are not associated with the direct sale  and service of federal crop insurance to farmers. Finally, we found one  company had included in its A&O expenses about $1 million in legal fees  to defend itself against a lawsuit from another crop insurance company.  However, the guidance notes that legal fees associated with delivering the  program should pertain to defending lawsuits related to servicing policies.  RMA officials agreed that such legal fees should not be included as an  A&O expense. RMA and company officials stated that RMA’s guidance on  allowable expenses should be clarified.
section_title: Insurance Agencies’ Commissions Have Outpaced Expenses, and Higher Commissions Can Create More Incentive for Rebating
paragraphs: The modest increase from 2000 through 2009 in insurance agencies’  expenses for selling policies has not been commensurate with the  dramatic increase in their commissions. Consequently, many agencies  have apparently seen substantial increases in their profits from their crop  insurance books of business; this is particularly true for states that have  had high underwriting gains, such as the Corn Belt states. The growth in  commissions can create more incentives for agents to engage in rebating,  although RMA has taken steps to reduce the potential for this practice.
subsections: section_title: Insurance Agencies’ Commissions Have Outpaced the Insurance Industry’s Expenses, as Measured by Growth in Wages
paragraphs: Insurance agents’ responsibilities can include (1) adequately informing  farmers about applicable crop insurance policy provisions and   (2) accurately preparing and completing the farmer’s insurance  application, certification of production history, acreage reports, and other  sales-related documents. Agents also must properly maintain the crop  insurance contract files. While acknowledging that their commissions have  increased, insurance agency officials stated that selling crop insurance  policies generally entails more work for agents and thus higher expenses  than for other lines of property and casualty insurance, and that those  expenses have increased in recent years. Table 2 provides examples of the  expenses that agencies incur in selling crop insurance.
Much of the insurance agencies’ work, according to the agency officials  with whom we spoke, is related to the time required to help farmers  choose the appropriate policy. These officials said agents generally   (1) meet individually with farmers at various times during the year to  update them on policies and compliance requirements, (2) mail farmers  information on deadlines for reporting to the insurance agent on the  number of acres planted and the amount of crop produced, and   (3) provide seminars and annual meetings to help farmers understand the  crop insurance options available to them. According to one insurance  agency official, to service a crop insurance policy, an agent interacts with  a farmer a minimum of six times a year. Another agency official told us  that agents need to meet with the farmers at least four times a year.
In addition, some of agencies’ crop insurance expenses are for services to  farmers that are not described in RMA guidance but that help insurance  agencies compete for farmers’ business. Crop insurance agency officials  told us that they compete on the basis of reputation, personal  relationships, and additional services. These officials also noted that they  advise farmers on how to best market their crops and increasingly provide  advanced mapping services to farmers, such as creating and printing  poster-size maps that display farmers’ crop areas to help farmers manage  their land. One insurance agency official said that the information  technology needed for such services constituted the agency’s biggest  expense outside of payroll.
Although insurance agency officials told us that their crop insurance  expenses are high, the documents they provided did not show that their  sales expenses have increased at the same pace as their commissions.  Because comprehensive information is not available on the expenses of  the thousands of agencies that sell crop insurance, we examined the  extent to which the growth in crop insurance commissions tracked trends  in insurance industry expenses. We used 2000 as the base year in which  crop insurance commissions are presumed to have been more closely  aligned with expenses, before the increase in the A&O allowance. We then  calculated what the commission per policy would have been for 2001  through 2009 if it had increased at the rate of change in insurance agents’  wages. We used the rate of change in insurance agents’ wages because,  according to industry officials, wages account for agencies’ largest  expense. For this analysis, we used commission data from RMA and  insurance agents’ wage data for all lines of insurance from the Department  of Labor’s Bureau of Labor Statistics. In view of the 2008 Farm Bill’s 2.3  percentage point reduction in A&O allowance rates for most insurance  plans, we assumed that 2009 commission rates would decline by half of  this amount—1.15 percentage points—relative to 2007, the most recent  year for which RMA data on actual commission rates were available.
On the basis of these assumptions, we found that the rate of increase in  commission per policy to crop insurance agencies has significantly  outpaced the rate of increase in insurance agents’ wages. That is, the  actual commissions increased by an average of about 16 percent per year  from 2000 through 2009, compared with an increase of about 3 percent per  year for commissions assumed to increase at the same rate as insurance  agents’ wages. Figure 7 shows these comparisons.
As figure 7 shows, with 2000 as a base year, if commissions had increased  at the rate of increase in insurance agents’ wages, the commission per  policy in 2007 would have been $382, but the actual commission per policy  that insurance companies paid to agencies in 2007 was $985—a difference  of $603 per policy. According to our analysis, in 2007, with about 1.14  million crop insurance policies, actual commission payments exceeded the  adjusted commissions by about $687 million. For 2007 through 2009,  estimated commission payments exceed the adjusted commissions by  about $2.87 billion.
Crop insurance industry officials with whom we spoke generally  acknowledged that insurance agencies received higher profits as a result  of increased commissions in 2007 and 2008. While some officials said  agencies’ more profitable financial years are balanced by less profitable  years, others said that the method for calculating A&O allowances needs  to be modified to bring it more in-line with reasonable expenses for  delivering the crop insurance program. Finally, a number of insurance  company officials supported limiting commissions, although they had  differing views on the best way to implement such limits.
section_title: Higher Commission Payments for Insurance Agencies Can Create More Incentive to Use Rebating to Compete for Farmers’ Business
paragraphs: According to RMA and NAIC officials, higher commissions have increased  the incentives for rebating. The RMA officials indicated that as  commissions have increased, the number of anecdotal reports of rebating  has also increased. They also observed that rebating is more prevalent in  states with higher commission rates. A number of insurance agency  officials told us that they lost business to competitors that they believed  engaged in rebating. According to RMA officials, rebating disrupts the crop  insurance market and discriminates against farmers who purchase smaller  policies. State insurance regulators also consider rebating unfair to  policyholders because it results in pricing based on the policyholder’s  relationship to an agent, rather than on risk.
RMA has determined that the incidence of illegal rebating of crop  insurance premiums has grown in recent years. To combat rebating, RMA  and NAIC have sought to improve communication and coordination  between RMA and states on complaints, ongoing investigations, data  analyses, and enforcement. In December 2007, RMA issued a bulletin  directing crop insurance companies to notify agencies that state regulators  and RMA were aware that rebating schemes were proliferating and that  RMA and states would work cooperatively to discover and eliminate such  schemes. In addition, in July 2008, RMA issued guidance on a 2008 Farm  Bill provision that bars compensation to an individual for selling or  servicing crop insurance if two conditions are met. Compensation is not  allowed, either directly, or indirectly through an entity, if (1) the individual  or a member of the individual’s family has a substantial beneficial interest  in the policy or plan of insurance and (2) total compensation from that  policy or plan exceeds 30 percent or the percentage specified in state law,  whichever is less, of the total of all compensation the individual receives  directly or indirectly for selling or servicing crop insurance. RMA and  NAIC officials told us that enforcing antirebating laws is difficult because  rebating is only uncovered when complaints are made, but these officials  believe that their recent actions will reduce the potential use of this  practice.
section_title: Conclusions
paragraphs: Federal crop insurance plays an important role in protecting farmers from  losses due to natural disasters, and the private insurance companies that  participate in the program are integral to its success. Nevertheless, in view  of increasing pressure to reduce federal budget deficits, A&O allowances  present an opportunity to reduce government spending without  compromising the crop insurance program’s safety net for farmers.
Because A&O allowances are linked to crop prices, the A&O calculation  method and higher crop prices have significantly increased A&O  allowances, and companies—competing for underwriting gains—have  passed a larger proportion of this allowance to insurance agencies,  especially in the Corn Belt. As a result, many insurance agencies have  experienced a kind of windfall. Although the 2008 Farm Bill reduces A&O  allowance rates, these allowances, as well as commissions for 2009, are  still likely to be well above the levels that occurred before crop prices  increased in recent years. In addition, because crop prices have become  increasingly volatile, the allowances are subject to large declines, which  could make it more difficult for insurance companies and agencies to  budget and operate effectively.
A&O allowances can better reflect reasonable business expenses, adjusted  for costs in different regions of the country. Linking A&O allowances to  reasonable expenses would also help stabilize the allowances that  insurance companies receive. Furthermore, the 2008 Farm Bill directs  RMA to consider alternative methods to determine the A&O allowance  rate that would also provide savings for taxpayers. This effort could be  more effective if RMA were to collect information on the commissions that  companies have paid to individual agencies, as well as the individual  agencies’ expenses. This information would enable RMA to appropriately  modify the A&O calculation method and monitor whether this revised  method produces sufficient allowances to cover reasonable expenses.
Finally, many companies reported expenses to RMA that were not clearly  related to selling and servicing crop insurance policies. Such reporting is  due, at least in part, to inadequate guidance. Improved guidance would  enable RMA to accurately track the insurance companies’ crop insurance  delivery expenses.
section_title: Recommendations for Executive Action
paragraphs: To better ensure that the A&O allowances provided to the crop insurance  industry are sufficient for program delivery, but not excessive, we  recommend that the Secretary of Agriculture direct the Administrator of  the Risk Management Agency to develop a new methodology for  calculating the A&O allowance so that it is more closely aligned with  expenses, in terms of dollars per policy, as was the allowance in place  before 2006, when crop prices increased sharply. SRA renegotiations  should achieve this goal. Once this alignment is completed, the  Administrator should minimize annual fluctuations in A&O allowances  that are unrelated to business expenses, while recognizing variations in  delivery expenses across regions of the country.
To assist in maintaining the relationship between A&O allowances and  reasonable business expenses, we further recommend that the Secretary  of Agriculture direct the Administrator of the Risk Management Agency to  require that companies annually report the commissions they paid to  insurance agencies, by policy, to the Risk Management Agency. The  agency should also conduct a study of the costs associated with selling  and servicing crop insurance policies to establish a standard method for  assessing agencies’ reasonable costs in selling and servicing policies.
Finally, to accurately track the insurance companies’ expenses for  delivering crop insurance, we recommend that the Secretary of  Agriculture direct the Administrator of the Risk Management Agency to  clarify the current guidance on reporting these expenses and specify what  expenses are permitted.
section_title: Agency Comments and Our Evaluation
paragraphs: We provided the Risk Management Agency with a draft of this report for  review and comment. RMA agreed with our findings and two of our three  recommendations. RMA did not agree with our recommendation that it  require companies to annually report the commissions they paid to  insurance agencies by policy. RMA expressed concern that collecting  commission data by policy would significantly increase its administrative  burden and that of insurance companies because some of the  compensation that companies pay to agencies is not usually paid by  policy. However, we believe that gathering and reporting data by policy  need not significantly increase the “administrative burden” that RMA  described. First, RMA, which currently collects commission data  aggregated at the state level, could require that companies report two  additional data fields in the policy records they currently submit to RMA— commission and other compensation. These records can already contain  over 300 such data fields. Once these changes are implemented, the  recurring costs should be minimal. In conjunction with these changes,  RMA could develop and provide allocation guidance to prorate  compensation that is not provided on a per-policy basis so that this  compensation could be apportioned to individual policies. Second,  providing policy-level data would eliminate the need for companies to  provide data aggregated at the state level, which could offset the  additional burden that RMA believes would result.
RMA also stated that more detailed commission data may not be valuable  in identifying true program delivery costs or in improving the A&O  reimbursement structure. Although we agree that commission data are not  an accurate reflection of true program delivery costs, we believe such data  would be valuable in improving the methodology that RMA uses to  calculate A&O allowances. Tracking commissions by state, as RMA does  currently, does not provide RMA with sufficient detail to take into account  differences among agencies, such as location and size. For example, more  detailed commission data may enable analysis showing that agencies that  do business primarily in a part of the state with historically high  underwriting gains received higher commission rates than agencies that do  business in a part of the state with lower underwriting gains. This kind of  information could enable RMA to better anticipate the effects of  adjustments in A&O allowances on agencies. Finally, given the magnitude  of commission payments—an estimated $1.7 billion in 2008—additional  reporting would result in analyses that would strengthen transparency and  accountability in the use of taxpayer funds.
We also added examples to this report to elaborate on the justification that  we provided in our draft report to RMA for this recommendation.
RMA also provided technical corrections that we incorporated into this  report as appropriate. RMA’s written comments and our responses are  presented in appendix III.
As arranged with your offices, unless you publicly announce its contents  earlier, we plan no further distribution of this report until 30 days from its  issue date. At that time, we will send copies of this report to appropriate  congressional committees; the Secretary of Agriculture; the Director,  Office of Management and Budget; and other interested parties. In  addition, this report will be available at no charge on GAO’s Web site at  http://www.gao.gov.
If you or your staffs have any questions about this report, please contact  Lisa Shames at (202) 512-2649 or shamesl@gao.gov or Susan Offutt at  (202) 512-3763 or offutts@gao.gov. Contact points for our Offices of  Congressional Relations and Public Affairs may be found on the last page  of this report. Key contributors to this report are listed in appendix IV.
section_title: Appendix I: Objectives, Scope, and Methodology
paragraphs: We were asked to examine (1) the reasons for the substantial increases in  administrative and operating (A&O) allowances in recent years, and the  purposes for which insurance companies use these allowances, and   (2) insurance agencies’ expenses for selling federal crop insurance  policies, and questionable practices, if any, that agencies use to compete  for business among farmers.
To examine the reasons for the substantial increases in A&O allowances in  recent years, and the purposes for which insurance companies use these  allowances, we interviewed U.S. Department of Agriculture (USDA)  officials from the Risk Management Agency (RMA) and officials from each  of the 16 insurance companies that participate in the federal crop  insurance program. In addition, we reviewed and analyzed RMA and  company data concerning companies’ uses of the allowances from 2000  through 2007. The sources of these data included expense reports that the  16 companies submitted to RMA listing the amounts that they charge to  various expense categories. We also reviewed reports that the companies  submitted to RMA listing the amount of commission and the commission  rate paid to insurance agencies by state during 2006 and 2007. For the  purpose of this report, commissions include profit-sharing bonuses that an  insurance company pays to an insurance agency on the basis of profits for  a given year and transfer bonuses that a company pays to an agency that  transfers its business to the company. In addition, we analyzed data from  RMA’s Summary of Business and reviewed RMA’s analysis of companies’  financial data.
For our analysis of company data, we used both data reported directly to  RMA as well as data from company expense reports. RMA data on  premiums were complete for all years. Company expense report data on  both premiums and commissions were complete for 2006 and 2007, but  were only partially complete for the other years (85 percent complete for  2000, 89 percent complete for 2001, 70 percent complete for 2002, 71  percent complete for 2003, 85 percent complete for 2004, and 89 percent  complete for 2005). Data were missing largely because of changes in  company structure, such as mergers, acquisitions, and companies’ going  out of business. We took the following steps to correct for the missing data  to avoid overstating any change over time (since data were more often  missing in earlier years). We assumed the data on commissions, as  reported in company expense reports, were missing to the same extent as  the data on premiums reported in the same place. We therefore adjusted  the data on total commissions paid, by year, by the same fraction  necessary to adjust the premiums reported on the company expense  reports to bring it up to the amount of premiums reported to RMA, which  we knew to be the more reliable number.
We also reviewed examples of companies’ contracts with insurance  agencies. We selected these contracts on the basis of the volume of  business between the insurance company and the agency and, when  possible, regional diversity. Furthermore, we reviewed RMA’s reporting  guidelines for crop insurance companies and discussed these guidelines  with company officials. In addition, we interviewed National Association  of Insurance Commissioners (NAIC) officials to better understand  allowable expenses.
To examine insurance agencies’ expenses for selling federal crop  insurance policies and questionable practices, if any, that agencies use to  compete for business from farmers, we interviewed officials of eight  insurance agencies and reviewed documents that some of these officials  provided, including their income statements. We based our selection of  insurance agencies on premium volume, regional location, crop type, and  proximity to crop insurance companies. We examined the extent to which  the growth in crop insurance commissions tracked trends in insurance  industry expenses. We used 2000 as the base year in which crop insurance  commissions are presumed to have been more closely aligned with  expenses, before the increase in the A&O allowance. We then calculated  what the commission per policy would have been for 2001 through 2009 if  it had increased at the rate of change in insurance agents’ wages. We used  the rate of change in insurance agents’ wages because, according to  industry officials, wages account for agencies’ largest expense. For this  analysis, we used commission data from RMA and insurance agents’ wage  data for all lines of insurance from the Department of Labor’s Bureau of  Labor Statistics. In view of the Food, Conservation, and Energy Act of  2008’s 2.3 percentage point reduction in A&O allowance rates for most  insurance policies, we assumed that 2009 commission rates would decline  by half of this amount—1.15 percentage points—relative to 2007, the most  recent year for which RMA data on actual commission rates were  available. We then calculated what the commission per policy would have  been for 2001 through 2009 if it had increased at the rate of change in  insurance agents’ wages. We also interviewed officials from trade  associations representing insurance agents. In addition, we interviewed  officials from RMA and NAIC and discussed with RMA its investigations of  questionable competitive practices.
In addressing the objectives, we also reviewed prior GAO work and  additional relevant academic studies assessing the federal crop insurance  program. Furthermore, we reviewed analyses of premium reduction plans  as well as the Federal Register listing and associated comments regarding  these plans. We did not independently verify the Bureau of Labor  Statistics, RMA, and company data, but we discussed with agency and  company officials, as appropriate, the measures they take to ensure the  accuracy of these data. For the purposes for which these data were used in  this report, these measures seemed reasonable. We conducted this  performance audit from January 2008 through April 2009 in accordance  with generally accepted government auditing standards. Those standards  require that we plan and perform the audit to obtain sufficient, appropriate  evidence to provide a reasonable basis for our findings and conclusions  based on our audit objectives. We believe that the evidence obtained  provides a reasonable basis for our findings and conclusions based on our  audit objectives.
section_title: Appendix II: Commissions, Percentage Change in Commission per Policy, and Underwriting Gains or Losses
paragraphs: Appendix II: Commissions, Percentage  Change in Commission per Policy, and  Underwriting Gains or Losses (216,112,758) (36,492,553) (289,751,007) (2,089,887) (1.7) (212,135,483) (163,381,278) (163,126,743) (4.0) (38,377,197) (146,898,874) (144,451,805) (42,324,473) (66,285,056) (3,110,142) (42,446,340) (22,158,038) (85,129,309) (2,260,430) (165,729) (5.0) (6,313,709) (39,087,279) (876,791) (9,580,108) (12,479,868) (4,473,986) (1,309,708) (16,972) (4.4)
section_title: Appendix III: Comments from the U.S. Department of Agriculture
paragraphs: Following are GAO’s comments on the Risk Management Agency’s letter  dated April 3, 2009.
subsections: section_title: GAO Comments
paragraphs: 1.  We do not agree that gathering and reporting data on commissions  paid to insurance agencies by policy would significantly increase the  “administrative burden” on RMA and insurance companies. First, RMA,  which currently collects commission data aggregated at the state level,  could require that companies report two additional data fields in the  policy records they currently submit to RMA—commissions and other  compensation. These records can already contain over 300 such data  fields. Once these changes are implemented, the recurring costs should  be minimal. In conjunction with these changes, RMA could develop  and provide allocation guidance to prorate compensation that is not  provided on a per-policy basis so that this compensation could be  apportioned to individual policies. Second, providing policy-level data  would eliminate the need for companies to provide data aggregated at  the state level, which could offset the additional burden that RMA  believes would result. Furthermore, given the magnitude of  commission payments—an estimated $1.7 billion in 2008—additional  reporting would result in analyses that would strengthen transparency  and accountability in the use of taxpayer funds. 2.  We disagree with RMA’s statement that more detailed commission data  may not be valuable. With data on commissions paid to insurance  agencies by policy, RMA would be better able to establish whether the  compensation paid to agencies is appropriate in relationship to the  agencies’ costs of selling and servicing crop insurance. Tracking  commissions by state, as RMA does currently, does not provide RMA  with sufficient detail to take into account differences among agencies,  such as location and size.  3.  We disagree with RMA’s assertion that we did not adequately justify  this recommendation in the draft provided to RMA. We noted the  following in the draft:   RMA does not know how much an individual company spends on  commissions to each of the agencies with which it does business.
Information by state does not provide sufficient detail on commission  expenses. RMA would be better able to set the A&O allowance rate  when it negotiates the standard reinsurance agreement (SRA) with insurance companies if it had more detailed information on  commissions provided to individual agencies.
With information on agencies’ commissions, as well their costs, RMA  could assess whether the A&O allowances are reasonable for program  delivery but not excessive, and adjust allowances as needed.
Nonetheless, we have provided additional examples in the report to  make our explanation more explicit.  4.  During the exit conference with RMA officials, we explained, as we had  in the draft report, that information at the policy level would inform  RMA of the amounts that companies pay agencies for selling and  servicing policies and thus would improve RMA’s position in  renegotiating the SRA. An RMA official told us that RMA knew from  commission data currently collected at the state level that agencies in a  given state earn commissions that are higher on average than those in  other states. We responded, however, that RMA cannot determine,  solely on the basis of state-level data, whether commissions vary  across agencies within a state.
section_title: Appendix IV: GAO Contacts and Staff Acknowledgments
subsections: section_title: Staff Acknowledgments
paragraphs: In addition to the individuals named above, Thomas M. Cook, Assistant  Director; Alisa Beyninson; Kevin S. Bray; Gary T. Brown; Barbara J.   El-Osta; James R. Jones, Jr.; Anne Rhodes-Kline; Benjamin Shouse; Carol  Herrnstadt Shulman; Nathaniel Taylor; and Marie Webb made key  contributions to this report. Also contributing to this report were Carl  Barden, Kim M. Raheb, and Jeremy Sebest.
section_title: Related GAO Products
paragraphs: Crop Insurance: Continuing Efforts Are Needed to Improve Program  Integrity and Ensure Program Costs Are Reasonable. GAO-07-944T.  Washington, D.C.: June 7, 2007.
Crop Insurance: Continuing Efforts Are Needed to Improve Program  Integrity and Ensure Program Costs Are Reasonable. GAO-07-819T.  Washington, D.C.: May 3, 2007.
Crop Insurance: More Needs To Be Done to Reduce Program’s  Vulnerability to Fraud, Waste, and Abuse. GAO-06-878T. Washington,  D.C.: June 15, 2006.
Crop Insurance: Actions Needed to Reduce Program’s Vulnerability to  Fraud, Waste, and Abuse. GAO-05-528. Washington, D.C.: September 30,  2005.
Crop Insurance: USDA Needs to Improve Oversight of Insurance  Companies and Develop a Policy to Address Any Future Insolvencies.  GAO-04-517. Washington, D.C.: June 1, 2004.
Department of Agriculture: Status of Efforts to Address Major Financial  Management Challenges. GAO-03-871T. Washington, D.C.: June 10, 2003.
Crop Insurance: USDA Needs a Better Estimate of Improper Payments to  Strengthen Controls Over Claims. GAO/RCED-99-266. Washington, D.C.:  September 22, 1999.
Crop Insurance: Increases in Insured Crop Prices and Premium Rates  Raise the Administrative Expense Reimbursement Paid to Companies.  GAO/RCED-98-115R. Washington, D.C.: March 20, 1998.
Crop Insurance: Opportunities Exist to Reduce Government Costs for  Private-Sector Delivery. GAO/RCED-97-70. Washington, D.C.: April 17,  1997.