Crop Insurance: Opportunities Exist to Improve Program Delivery and Reduce Costs
Published: 2017-07-26T00:00:00

Fast Facts:
To implement the federal crop insurance program, USDA partners with private insurance companies, which sell and service policies. In 2010, USDA negotiated a set rate of return with these companies—that is, how much companies can profit from these insurance policies.
However, we found that this expected rate of return was too high compared with market conditions. Reducing it could save the federal crop insurance program hundreds of millions of dollars a year.
We recommended that Congress consider directing USDA to adjust this expected rate of return.

Highlights:
section_title: Why GAO Did This Study
paragraphs: To implement the federal crop insurance program, USDA's RMA partners with private insurance companies, which sell and service policies. In 2010, USDA negotiated an agreement with insurance companies to set a national cap on the annual payments it makes to them for expenses and a target rate of return.
GAO was asked to examine (1) the changes in expense payments to companies due to the cap, (2) the extent to which the program's target rate of return reflects market conditions, and (3) opportunities for the federal government to reduce its delivery costs for the program. GAO analyzed RMA data on payments to companies for their expenses, conducted an updated analysis based on a USDA-commissioned study of the annual rate of return that companies should be expected to earn, and interviewed RMA officials.
section_title: What GAO Found
paragraphs: The U.S. Department of Agriculture's (USDA) Risk Management Agency (RMA) makes payments to insurance companies to cover the cost of selling and servicing federal crop insurance policies. A cap on these payments stabilized them at about $1.4 billion per year from 2011 to 2015. In capping the annual payment to companies, RMA sought to make these payments more stable and dependable for companies and agents, but payments have fluctuated widely by crop, state, and county because, as GAO's analysis shows, the method RMA uses for calculating payments has allowed large fluctuations at the policy level. Specifically, RMA calculates payments based on such factors as crop price, and a price change can cause a change in the payments. For example, the average payment for almonds decreased by 42 percent from 2010 to 2011 but increased by 75 percent from 2013 to 2014. RMA could reduce such fluctuations and achieve greater stability by considering adjustments to how the payments are calculated when it negotiates a new agreement with companies.
The crop insurance program's target rate of return—the average annual rate of return that insurance companies are expected to earn—does not reflect market conditions. A 2009 USDA-commissioned study found that a 12.8 percent rate of return was reasonable for participating companies for 1989 through 2008 based on economic factors, such as interest rates. RMA used this study in 2010 negotiations with insurance companies to set a 14.5 percent target rate. According to GAO's analysis, which updated information in the study for 2009 through 2015, the reasonable rate of return declined, averaging 9.6 percent.
GAO identified two opportunities to reduce federal delivery costs for the program.
First, given that GAO's analysis shows that the target rate of return does not reflect market conditions, that rate could be reduced. As a result, companies would earn a lower rate of return on their existing base of retained premiums. At the 2015 premium level, if the target rate were reduced by 4.9 percentage points, from the current rate of 14.5 percent to 9.6 percent, the companies' expected annual underwriting gains would decrease by $364 million.
Second, the portion of premiums retained by companies could be reduced so that they would earn a rate of return on a smaller premium base. The portion of premiums retained by companies has changed little, averaging 77 percent since 2000, while USDA has retained the rest. Part of the justification for companies' retaining a significant portion of premiums was that they needed financial incentive to more carefully adjust farmers' loss claims. The need for this incentive decreased after a statutory change in 2000 improved RMA's ability to monitor those claims and companies' adjustment of them. Reducing the premiums that companies retain by 5 percentage points could reduce companies' annual underwriting gains by up to $100 million.
However, a provision in the Agricultural Act of 2014 requires any changes negotiated for a new SRA be budget neutral. To realize savings, such changes would require congressional action to repeal this provision. If Congress were to direct RMA to adjust the target rate in future negotiations or assess the portion of premiums companies retain, the agency could generate significant cost savings for the program.
section_title: What GAO Recommends
paragraphs: Congress should consider repealing the Agricultural Act of 2014 provision that any revision to the agreement with insurance companies not reduce their expected underwriting gains and direct RMA to (1) adjust companies' target rate of return to reflect market conditions and (2) assess the portion of premiums that companies retain and adjust it, if warranted. GAO also recommends that RMA consider adjusting the method it uses to determine payments to insurance companies for expenses. RMA stated it will take steps to implement GAO's recommendation.

section_title: Letter
paragraphs: Federally subsidized crop insurance, which helps farmers manage the  risk inherent in farming, is one of the most important programs in the farm  safety net. Under the federal crop insurance program, farmers can insure  against losses caused by poor crop yields resulting from natural causes,  declines in crop prices, or both. To implement the program, the U.S.  Department of Agriculture’s (USDA) Risk Management Agency (RMA)  partners with private insurance companies, which sell and service the  insurance policies and share with RMA in the risk of loss and the  opportunity for gain associated with the policies. RMA has overall  responsibility for administering the federal crop insurance program,  including controlling costs and protecting against fraud, waste, and  abuse. RMA administers the program through a financial agreement  called the standard reinsurance agreement (SRA), which it negotiates  with insurers. RMA’s most recent renegotiation of the SRA—the 2011  SRA—was completed in 2010. The previous agreement was the 2005  SRA.
Under the Federal Crop Insurance Act, the federal government is to  reimburse insurance companies for the reasonable administrative and  operating (A&O) expenses associated with selling and servicing crop  insurance policies. The method for determining the level of this federal  subsidy is set in the SRA. RMA provides A&O payments, which are  based on a percentage of crop insurance premiums, to insurance  companies. These payments are intended to cover the companies’  expenses to sell and service policies. Crop insurance premiums and A&O  expense subsidies rise and fall in value with, among other things, the  price of the crop being insured. A&O expenses can include company  overhead, such as employee salaries; fees paid to insurance adjusters to  verify claims; and sales commissions and other compensation (e.g., profit  sharing) paid to the insurance agents who sell crop insurance to farmers.  In January 2017, the Congressional Budget Office (CBO) projected that  federal crop insurance would cost the federal government an average of  about $7.9 billion per year for 2017 through 2026. These costs include  payments to private insurance companies for program delivery; these  payments make up about one-third of the program’s total annual costs  and comprise a projected annual average of about $1.4 billion for A&O  subsidies and about $1.3 billion for companies’ underwriting gains. As  part of the crop insurance program, the federal government pays for an  average of about 62 percent of the premiums. Farmers pay the remaining  38 percent. These premium subsidies make up the majority of the  program’s overall costs. The SRA does not affect the premiums that  farmers pay.
In 2009, we reported on the cost of A&O subsidies. From 2006 through  2008, a period of rising major crop prices and crop insurance premiums,  A&O subsidies increased from about $960 million to about $2 billion per  year. To better ensure that the A&O subsidies provided to the crop  insurance industry are sufficient for program delivery, but not excessive,  we recommended that USDA develop a new methodology for calculating  the A&O subsidies so that they are more closely aligned with business  expenses. We also recommended that once this alignment was  completed, the RMA Administrator should minimize annual fluctuations in  A&O subsidies that were unrelated to business expenses, while  recognizing variations in delivery expenses across regions of the country.  RMA agreed with this recommendation. In 2010, partly in response to our  report, USDA completed SRA negotiations and implemented the 2011  SRA to reduce A&O subsidies, capping them for the most common types  of policies. The A&O subsidy for a crop insurance policy remains based  on a fixed percentage (e.g., 18.5 percent) of the premium, which means  that the dollar amount of the A&O subsidy rises and falls with the market  price of the crop being insured because the market price of the crop  affects the dollar amount of the premium. However, if the total A&O  subsidies for policy types that are subject to the cap exceed the capped  amount, the A&O subsidies for these policy types are proportionally  reduced to make the total A&O subsidies for these policies equal to the  capped amount.
The SRA sets the terms of the program’s risk sharing between  participating insurance companies and the government—in particular, the  portion of total premiums (the sum of the portion paid by farmers and the  premium subsidies provided by the government) that are “retained” by the  insurance companies and the portion of claims payments to farmers that  are the responsibility of the insurance companies. These allocations  determine the companies’ and the government’s share of each year’s  program underwriting gain or loss. An insurance company’s rate of return  on crop insurance for a given year is the company’s underwriting gain (or  loss) divided by the premiums on which the company retains a risk of loss  or an opportunity for gain. A 2009 USDA-commissioned study derived the  annual rate of return that companies participating in the federal crop  insurance program should be expected to earn. This annual rate of  return should produce earnings that are equal to earnings from alternative  investment opportunities relative to the risk assumed—a reasonable or  market-based rate of return. This study found that from 1989 through  2008, participating insurance companies’ actual rate of return on equity  averaged 17.1 percent and that a reasonable rate of return on equity  during this period was an average of 12.8 percent. The current target rate  of return on retained premiums for federal crop insurance providers, as  set by the 2011 SRA, is 14.5 percent.
The cost of the federal crop insurance program has come under scrutiny  as the nation’s budgetary pressures have increased. In a January 2017  report on the federal government’s fiscal future, we stated that, absent  policy changes, the federal government’s fiscal path is unsustainable and  that to change the long-term fiscal path, policymakers will need to  consider policy changes to the entire range of federal activities and  spending. Any savings found in the crop insurance program could be  used for deficit reduction or other needs such as other farm program  priorities. For example, part of the savings achieved by the 2011 SRA  was used for the Pasture, Rangeland, and Forage crop insurance  program.
In November 2015, a provision in the Bipartisan Budget Act of 2015  established a target rate of return on retained premiums of 8.9 percent for  crop insurance providers. CBO projected that the resulting 10-year  savings would be about $3 billion. However, this provision was repealed  in a December 2015 transportation bill.
In this context, you asked us to review issues related to the program  delivery costs of the federal crop insurance program. This report  examines (1) the changes, if any, in the distribution of A&O expense  subsidies due to the implementation of the 2011 SRA’s national cap on  subsidies; (2) the extent to which the federal crop insurance program’s  target rate of return reflects market conditions; and (3) opportunities, if  any, for the federal government to reduce its delivery costs for the  program.
To address these objectives, we reviewed, among other things, sections  of 2011 SRA drafts and the final 2011 SRA; RMA documents on the  development and implementation of the 2011 SRA; crop insurance  industry documents; provisions of the Food, Conservation, and Energy  Act of 2008 (2008 farm bill), the Agricultural Act of 2014 (2014 farm bill),  the Agricultural Risk Protection Act of 2000; prior GAO reports; and  standards for internal control in the federal government. We also  interviewed RMA officials to discuss the development and implementation  of the 2011 SRA. To examine the changes, if any, in the distribution of  A&O expense subsidies due to the implementation of the 2011 SRA’s  national cap, we reviewed and analyzed RMA crop insurance data by  state, county, and crop for 2010 through 2015. We chose this period to  examine changes associated with the implementation of the 2011 SRA  because it contained the most recent data available at the time of our  review. We analyzed changes in A&O subsidies per policy by state,  county, and crop to identify and summarize trends during 2011 through  2015.
To examine the extent to which the federal crop insurance program’s  target rate of return reflects market conditions, our work included  reviewing a 2009 USDA-commissioned study. This study derived, for  the 20 years from 1989 through 2008, the annual rate of return on equity  that companies participating in the federal crop insurance program should  be expected to earn. We identified the major factors that the study used  to estimate the reasonable rate of return and collected data on these  factors from sources of financial information, such as Value Line  Investment Survey. Using the two models that the USDA-commissioned  study used, we then estimated the reasonable rate of return for 2009  through 2015, years that were not included in the study. In addition, for  the 20 years from 1996 through 2015, we summarized RMA data on the  actual rates of return on retained premiums of participating insurance  companies. To examine opportunities for the federal government to  reduce its delivery costs for the program, we also reviewed and  summarized RMA data on companies’ underwriting gains and risk sharing  as expressed by total program premiums and premiums retained by  companies for the 20 years from 1996 through 2015. We also reviewed  the 2005 SRA and 2011 SRA sections on risk sharing, as well as crop  insurance industry documents, including industry responses to 2011 SRA  drafts. Regarding RMA’s program monitoring, we reviewed RMA  documents on data mining and other program integrity efforts; USDA  Office of the Inspector General reports; and previous GAO reports,  including our 2005 report on fraud, waste, and abuse and our 2012  report that examined RMA’s data mining.
To evaluate the reliability of the RMA data, we reviewed an assessment  for a previous GAO study, reviewed agency documentation related to the  data systems, and obtained updated information on the data systems  from knowledgeable officials. We assessed the reliability of the data from  the 2009 USDA-commissioned study and the financial information  sources by reviewing relevant documentation.  In addition, for one of the  financial information sources, we reviewed an assessment for a previous  GAO study. In each case, we concluded that the data were sufficiently  reliable for the purposes of this report. A more detailed discussion of our  objectives, scope, and methodology is presented in appendix I.
We conducted this performance audit from April 2015 to July 2017 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 we obtained provides a reasonable basis for our findings  and conclusions based on our audit objectives.
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 the  risk of crop revenue loss resulting from declines in production, price, or  both. 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.
subsections: section_title: A&O Subsidies
paragraphs: RMA partners with private insurance companies, which sell and service  federal crop insurance policies. Under the Federal Crop Insurance Act,  RMA pays these companies A&O subsidies to cover the reasonable  expenses of selling and servicing crop insurance policies. Prior to the  changes implemented in the 2011 SRA, RMA calculated A&O subsidies  by using a fixed percentage of a policy’s premium. This fixed percentage,  which is called the A&O subsidy rate, varies by the type of insurance  policy. In 2015, these rates ranged from 12 percent to 21.9 percent. The  most common type of insurance policy is revenue protection, which has  had an A&O subsidy rate of 18.5 percent since 2011. The price of the  crop being insured is one of the factors in the premium amount. As a  result, A&O subsidies rise and fall over time with changes in crop prices.  For example, from 2000 to 2009, insurance companies’ A&O subsidies  nearly tripled as a result of increases in crop prices during that time  frame. This increase in the A&O subsidies occurred without a proportional  increase in the workload for selling and servicing policies as expressed by  the number of policies, acres, and the amount of insurance coverage  purchased. To address the increases in A&O subsidies, the 2008 farm bill  directed RMA to consider alternative methods for determining A&O  payment rates as part of the 2011 SRA, stating that changes should take  into account current financial conditions of the program and ensure  continued availability of the crop insurance program to producers on a  nationwide basis.
Besides crop price changes, changes in premium rates cause changes in  premium amounts and, in turn, A&O subsidies. RMA sets premium rates, which are a percentage of the insured crop value. Premium rates can  change because of changes in a farm’s crop yield history and RMA  updates of county premium rates that reflect past loss experience.
Insurance companies’ expenses include overhead (e.g., employee  salaries and rent), fees paid to insurance adjusters to verify loss claims,  and commissions paid to insurance agents. Insurance agencies’  expenses include salaries and benefits, training, rent and equipment,  software to aid farmers’ decisions, and legal services. Insurance agents’  responsibilities can include (1) informing farmers about applicable crop  insurance policy provisions and (2) accurately preparing and completing a  farmer’s insurance application, certification of production history, acreage  reports, and other sales-related documents.
section_title: Risk Sharing and Underwriting Gains
paragraphs: The federal government is the primary reinsurer for the private insurance  companies that take on the risk of covering, or “underwriting,” losses to  insured farmers. The SRA sets the terms of the risk sharing between the  participating insurance companies and USDA. The insurance companies  retain part of the premiums and associated risk, and USDA holds the  remaining premiums and risk. In addition, the 2005 SRA introduced a  quota share provision, under which each company cedes to USDA a  percentage of its underwriting gains or losses. The 2005 SRA set the  quota share at 5 percent.
section_title: Crop Insurance Program Costs to the Government
paragraphs: In accounting for the crop insurance program’s costs to the government,  the major categories are the following:
Premium subsidies. Premium subsidies are provided by the  government on behalf of farmers. As of January 2017, CBO projected  that premium subsidies from 2017 through 2026 would average about  $6.2 billion per year.
A&O subsidies. The government pays A&O subsidies to participating  insurance companies to cover the companies’ expenses to sell and  service crop insurance policies. As of January 2017, CBO projected  that A&O subsidies from 2017 through 2026 would average about  $1.4 billion per year.
Companies’ underwriting gains/losses. The government pays  underwriting gains to participating insurance companies in  accordance with the SRA’s gain/loss sharing provisions. The term  refers to companies’ retained premiums minus their share of the  indemnities paid to farmers followed by adjustments based on the  SRA’s gain/loss sharing and quota share provisions. As of January  2017, CBO projected that companies’ underwriting gains from 2017  through 2026 would average about $1.3 billion per year.
Excess losses. Excess losses are total indemnities—payments to  farmers for losses—minus total premiums (i.e., premiums paid by  farmers plus premium subsidies provided by the government). As of  January 2017, CBO projected that excess losses from 2017 through  2026 would average about -$1 billion per year, meaning that  indemnities are projected to average about $1 billion less than total  premiums per year.
Figure 1 shows an overview of the program.
Figure 2 shows the A&O subsidies and underwriting gains that the  government paid to insurance companies for program delivery from 2000  through 2015. In 14 of these 16 years, companies had underwriting gains,  with underwriting losses in 2002 and 2012. From 2000 through 2015,  companies’ underwriting gains averaged $884 million per year. From  2011 through 2015—the first 5 years in which the 2011 SRA has been in  in effect—companies’ underwriting gains averaged $773 million per year.  As of March 2017, preliminary RMA information indicates that 2016  underwriting gains will be about $2.6 billion. If 2016 underwriting gains  were $2.6 billion, then during the 6 years in which the 2011 SRA has  been in effect, companies’ underwriting gains would average about $1.1  billion per year.
As mentioned above, CBO projected that A&O subsidies and companies’  underwriting gains would average about $1.4 billion and $1.3 billion,  respectively, per year from 2017 through 2026. Thus, projected federal  payments to the companies for delivering the federal crop insurance  program would comprise about one-third of projected total program costs,  which CBO projected would be about $7.9 billion per year.
A provision in the 2014 farm bill requires that any revised SRA is to be  budget neutral with respect to estimates of future underwriting gains for  the participating insurance companies, and the estimated total A&O  subsidies cannot be less than the amounts that would have been  provided under the previous SRA. The 2014 farm bill conference  manager’s report states that a renegotiated SRA should not be used as a  means of achieving further cuts in the federal crop insurance program.  During the farm bill debate, according to a Congressional Research  Service report, some Members of Congress argued that such cuts, if any,  should be made by Congress so it could claim the budget savings toward  either deficit reduction or to offset the cost of any new legislative  initiative. In addition, the 2014 farm bill requires that if any SRA savings  are realized, they have to be used to increase participating insurance  companies’ underwriting gains or A&O payments. The conference report  to the 2014 farm bill noted that crop insurance funding had been reduced  over the previous 6 years, including in the 2008 farm bill and the 2011  SRA.
section_title: The Federal Government’s Monitoring of the Program
paragraphs: In part to improve the government’s ability to ensure the integrity of the  federal crop insurance program, Congress passed the Agricultural Risk  Protection Act of 2000. The act provided RMA with new tools for  monitoring and controlling program abuses. Among other things, the act  required the Secretary of Agriculture to use data mining—a technique for  extracting knowledge from large volumes of data that was made possible  by advances in computing—to administer and enforce the crop insurance  program. RMA uses data mining to detect potential cases of fraud, waste,  or abuse. For example, RMA and the insurance companies use data  mining results to conduct reviews of policies with anomalous loss claim  payments. According to RMA documents, RMA’s data mining efforts have  improved program monitoring. RMA estimates that from 2001 through  2014, its data mining to identify anomalous policies resulted in $1.1 billion  in cumulative cost avoidance—or, reduction in the amount of indemnities  claimed (i.e., losses claimed by farmers).
section_title: The 2011 SRA’s Cap on A&O Expense Subsidies Has Stabilized Overall Costs, but Subsidies Have Fluctuated Widely by Crop, State, and County
paragraphs: The 2011 SRA’s cap on A&O expense subsidies—payments to insurance  companies to cover the cost of selling and servicing crop insurance  policies—stabilized the program’s overall costs, but subsidies have  fluctuated widely by crop, state, and county. When negotiating the 2011  SRA, RMA adjusted the A&O subsidy calculation method by applying a  national cap on the overall annual A&O subsidies. The cap was  successful in stabilizing the overall subsidy amount. However, the revised  calculation method has allowed changes in crop prices to result in  substantial fluctuations in the subsidies for many crops as well as states  and counties. For example, the average A&O subsidy per policy in  California decreased by 32 percent from 2010 to 2011, when the subsidy  declined for two of the state’s leading insured crops, almonds and grapes.  The average A&O subsidy per policy in California increased by 66  percent from 2013 to 2014, when the subsidy for almonds and grapes  and other crops produced in California increased.
subsections: section_title: RMA Adjusted the A&O Subsidy Calculation Method by Applying a National Subsidy Cap
paragraphs: In developing the 2011 SRA, RMA sought to stabilize A&O subsidies to  help make the program more sustainable over time. To control  government costs and stabilize fluctuations in A&O subsidies from year to  year, RMA considered revisions to the A&O subsidy calculation method  when negotiating the 2011 SRA and ultimately chose to apply a national  A&O subsidy cap. Specifically, through a revised subsidy calculation  method, RMA capped annual A&O subsidies for the most commonly used  types of policies and set a minimum annual subsidy for these policy  types. The cap controls government costs when crop prices rise, and  the minimum protects companies against low market prices. Because  A&O subsidies remain linked to crop prices under the revised calculation  method, initial A&O subsidy calculations may exceed the cap during  years when crop prices are high. Under such circumstances, RMA has  applied an “adjustment factor” to bring down overall annual A&O subsidy  expenses to within the capped amount. For a given year, the adjustment  factor is equal to the capped A&O subsidy amount divided by the total  dollar amount of unadjusted A&O subsidies for all policies. RMA applies  this adjustment factor to each policy by multiplying it by the policy’s  unadjusted A&O subsidy amount. For example, in 2011 the total amount  of unadjusted A&O subsidies was $2.12 billion, and the cap was $1.22  billion, or 58 percent of the unadjusted amount. Thus, the adjustment  factor was 0.58.
As a result of the revised calculation method, overall A&O subsidies have  become more stable since 2010, staying at about $1.4 billion per year  from 2011 through 2015. Figure 3 shows the average A&O subsidy per  policy for 2000 through 2015. The average A&O subsidy per policy  increased from $418 in 2000 to $834 in 2006. Then, as a result of higher  prices for major crops, such as corn, soybeans, and wheat, the average  subsidy increased sharply, reaching $1,756 in 2008. Crop price declines  brought down the average A&O subsidy per policy to $1,200 by 2010.  Although the prices of corn, soybeans, and wheat increased again in  2011, the 2011 SRA’s cap on total A&O subsidies for the most common  types of policies prevented the average A&O subsidy per policy from  increasing, holding it at $1,178. From 2011 through 2015, the overall  average A&O subsidy per policy was relatively stable, ranging from  $1,139 to $1,189.
section_title: A&O Subsidies Have Fluctuated Substantially for Many Crops
paragraphs: Based on our analysis of RMA data, we found that for many crops the  average A&O subsidy per policy fluctuated substantially between 2010  and 2015. Changes in crop prices and the A&O subsidy adjustment factor  affected the extent of these fluctuations. The average A&O subsidy per  policy for each of the three leading crops—corn, soybeans, and wheat— fluctuated modestly during this period. The fluctuations were larger for  many of the other crops. Figure 4 shows the annual percentage changes  for corn, soybeans, and wheat, and figure 5 shows the changes for  almonds, apples, and grapes. For corn, the largest change was a 7  percent increase in 2015. For soybeans, the largest change was a 6  percent decrease in 2013. For wheat, the largest change was an 11  percent decrease in 2014. In contrast, as shown in figure 5, the  fluctuations for almonds, apples, and grapes were larger. For example,  the changes for almonds exceeded 29 percent in each year except 2013,  including an increase of 75 percent in 2014. In addition to almonds,  apples, and grapes, many other crops had large changes. For example,  the average A&O subsidy for cotton increased 36 percent in 2011, and for  peanuts increased 49 percent in 2013. Appendix II shows the annual  percentage changes in the average A&O subsidy per policy for all crops  that were insured under the federal crop insurance program during 2011  through 2015.
section_title: Fluctuations in A&O Subsidies Varied among States and Counties
paragraphs: Based on our analysis of RMA data, we found that the level of fluctuation  in A&O subsidies varied among states and counties. Figure 6 shows the  annual percentage change in the A&O subsidy per policy nationwide and  for California, Iowa, and Texas since 2010; we selected these three  states to review more closely because they have substantial crop  insurance program participation, and they are located in different regions  of the country. The 2011 SRA’s cap on nationwide A&O subsidies  stabilized the changes in the nationwide average A&O subsidy per policy  in a relatively narrow range, as shown in the figure.
As shown in the figure, California’s average A&O subsidy per policy was  volatile between 2011 and 2015. California’s average subsidy per policy  decreased by 32 percent in 2011 and then increased during the next 4  years, especially in 2014, when it increased 66 percent. The A&O subsidy  adjustment factor, which was 58 percent in 2011 and increased to 71  percent in 2014, contributed to California’s 2011 decrease and its 2014  increase. Iowa, where the leading insured crops are corn and soybeans,  experienced substantially less fluctuation than California. Texas’s  average subsidy per policy increased by 21 percent in 2011. That  increase coincided with increases in the prices of cotton and wheat,  Texas’s two leading insured crops in 2011. Texas’s average subsidy per  policy decreased by 6 percent and 9 percent in 2013 and 2015,  respectively.
Appendix III shows the annual percentage changes in the average A&O  subsidy per policy for each of the 50 states from 2011 through 2015.
Figure 7 shows the percentage change in the average A&O subsidy per  policy by county from 2011 through 2015. As shown in the maps, many  counties had substantial fluctuations in their average A&O subsidy per  policy.
According to a crop insurance industry organization document, a large  decrease in A&O subsidies for a state can disrupt program delivery in that  state. In the 2011 SRA, RMA sought to stabilize A&O subsidies,  according to an RMA document, which states that “because the A&O  subsidy will be less vulnerable to extreme commodity price changes,  companies and their agents will enjoy more stable and dependable  subsidies in the future to support the cost of delivering the program,”  making the program more sustainable over time. Furthermore,  according to the RMA document, by providing relatively stable A&O  payments and a cap on agent commissions, the new SRA will allow for a  more sustainable delivery system in the future, protecting producers,  companies, and taxpayers.
RMA had previously considered other A&O subsidy calculation methods  to reduce fluctuations in A&O subsidies. For example, in the 1990s, RMA  considered a fixed amount per policy plus a percentage of the policy’s  premium. More recently, in its first two drafts of the 2011 SRA, RMA  proposed the use of reference crop prices—rather than market prices—to  calculate A&O subsidies. In general, a reference crop price is a fixed  amount that does not change from year to year. Reference crop prices  have been used in other farm programs to stabilize farmers’ incomes.  Specifically, RMA proposed the use of reference crop prices in calculating  A&O subsidies for seven major commodities—corn, soybeans, wheat,  grain sorghum, cotton, barley, and rice. The proposed reference prices  were based on a 10-year average (1999 through 2008) of each crop’s  market price. However, the crop insurance industry expressed concerns  about RMA’s reference crop price proposal. For example, according to an  RMA document, many companies noted price volatility factors in  comments on the draft SRA. This document said that price volatility  factors have become significant in the determination of premiums for the  increasing number of revenue-based policies and, consequently, the A&O  subsidy for those policies. This document also said that using reference  prices alone to stabilize the A&O subsidy accounts for levels of high  commodity prices, but ignores changes in price volatility. In addition, this  RMA document stated that incorporating reference crop prices for the  seven major commodities could affect areas of the country differently,  depending on the types and mixture of crops in each area. RMA  ultimately removed its reference crop price proposal from the 2011 SRA  and replaced it with the current calculation method to cap overall A&O  subsidies.
Although the current calculation method has resulted in relatively modest  fluctuations in A&O subsidies for corn, soybeans, and wheat, it has not  done so for other crops or for all states and counties. In some cases,  double-digit decreases were followed by double-digit increases. As  mentioned earlier, RMA’s intention was to stabilize A&O subsidies.  Without stability in A&O subsidies, the sustainability of the program’s  delivery system in states and counties that experience large fluctuations  may be compromised. For example, according to crop insurance industry  organization documents, reductions may adversely affect the services  provided to farmers. In addition, fluctuations may make it more difficult for  insurance agencies to operate and budget effectively. By considering an  adjustment to the A&O expense subsidy calculation method that reduces  the effects of changes in premiums caused by changes in crop prices or  other factors, when it renegotiates the SRA, RMA could reduce year-to- year fluctuations in the A&O expense subsidies that companies receive at  the crop, state, and county levels.
RMA officials acknowledged to us that large fluctuations have occurred  for some crops, states, and counties. However, the officials said that an  advantage of the current method is its ease of administration and that the  crop insurance industry has become familiar with and understands it.  While changing the calculation method may add complexity, not changing  it will likely result in continued large annual fluctuations for some crops,  states, and counties.
section_title: The Federal Crop Insurance Program’s Target Rate of Return Does Not Reflect Market Conditions
paragraphs: The federal crop insurance program’s target rate of return—the average  annual rate of return that insurance companies are expected to earn— does not reflect market conditions. A 2009 USDA-commissioned study,  which RMA used in SRA renegotiations, estimated a reasonable rate of  return for crop insurance providers for 1989 through 2008 based on  economic factors, such as interest rates, which are subject to changes in  market conditions. Interest rates have decreased since 2008, and our  analysis that updated the information in the USDA-commissioned study,  in which we estimated the reasonable rates of return for 2009 through  2015 (years not included in the study), shows that the market-based  (reasonable) rate of return has declined.
The USDA-commissioned 2009 study was based on the premise that  government intervention should reflect competitive, market-based  outcomes. The 2009 study derived the annual rate of return on equity that  insurance companies participating in the federal crop insurance program  should be expected to earn. This annual rate of return should produce  earnings that are equal to earnings from alternative investment  opportunities relative to the risk assumed—a reasonable or market-based  rate of return. To determine a reasonable rate of return for companies  participating in the federal crop insurance program, the USDA- commissioned study averaged the results obtained from using two  generally accepted methodologies: the capital asset pricing model and  the discounted cash flow model. We conducted our updated analysis  using the two methods that the 2009 study used. Our capital asset pricing  model calculations estimate that the average reasonable rate of return  from 2009 through 2015 was 9.7 percent. Our discounted cash flow  model calculations estimate that the average reasonable rate of return  was 9.6 percent. The average of the two methods was 9.6 percent. We  also note that the reasonable annual rate of return generally trended  downward from 2009 through 2015 and reached a low of 8.8 percent in  2015. Lower interest rates contributed to the decrease in the reasonable  rate. For example, from 2008 to 2015, one measure of an average  interest rate—U.S. Treasury securities—fell from 3.1 percent to 1.4  percent.
An overview of the results of our updated analysis based on the 2009  study and our summary of RMA data on the actual rates of return on  retained premiums of participating insurance companies for the 20 years  from 1996 through 2015 is presented in table 1. Appendix V provides  more information on the USDA-commissioned study, its results for 1989  through 2008, and our updated analysis for 2009 through 2015.
According to a document from a crop insurance industry organization,  participating insurance companies’ financial returns under the 2011 SRA  have been lower than expected. The average rate of return on retained  premiums for the first 4 years that the 2011 SRA was in effect—2011  through 2014—was less than the 14.5 percent target rate, and companies  had underwriting losses in 2012, when a major drought occurred.  However, 4 years is a short time for assessing the rate of return. The  2009 study noted that the federal crop insurance program has significant  catastrophe exposure. According to the study, with most lines of  insurance that have a significant catastrophe exposure, insurers expect to  earn significant profits in non-catastrophe years and significant losses in  years with catastrophes. As a result, average returns over relatively short  sample periods are not necessarily indicative of the long-term pattern of  returns.
Participating insurance companies’ actual rate of return can vary  significantly from year to year. Table 2 shows the participating insurance  companies’ actual rate of return on retained premiums for each year from  1996 through 2015. The average actual rate of return for these 20 years  was 18.0 percent. During the 5 years that the 2011 SRA has been in  effect—2011 through 2015—the average rate of return on retained  premiums was 9.4 percent. A major reason the rate of return during  these 5 years was less than the target rate was because the rate dropped  to -15.3 percent in 2012. In that year, a major drought caused  underwriting losses. Because the 2011 SRA’s target rate of return is 14.5  percent, additional years of experience would, on average, likely result in  an increase in the average rate of return under the 2011 SRA. For  example, as of March 2017, preliminary RMA information indicates that  the 2016 rate of return on retained premiums will be about 35 percent. If  the 2016 rate of return on retained premiums were 35 percent, then in the  6 years in which the 2011 SRA has been in effect, companies’  underwriting gains during those 6 years would average about 13.7  percent.
section_title: Two Opportunities Exist for the Federal Government to Reduce the Delivery Costs of the Program
paragraphs: We identified two opportunities for the federal government to reduce its  delivery costs for the crop insurance program: (1) by reducing the target  rate of return or (2) by reducing the portion of premiums that participating  insurance companies retain. A reduction of either the target rate of return  or the portion of premiums that companies retain would reduce  companies’ expected underwriting gains because those gains are equal  to the companies’ rate of return multiplied by the premiums that  companies retain. (As mentioned earlier, premium subsidies make up the  majority of the federal crop insurance program’s costs. Information about  our recent reports that identified potential actions that Congress or RMA  could take to reduce the cost of the program and achieve budgetary  savings is in app. VI.)
subsections: section_title: Reducing the Target Rate of Return
paragraphs: Given that our analysis shows that the federal crop insurance program’s  target rate of return does not reflect market conditions, an opportunity  exists for the federal government to reduce the program’s delivery costs.  Adjusting the target rate of return to reflect market conditions could  produce significant cost savings. For example, if the target rate of return  was reduced by 3.5 percentage points, from the current target rate of 14.5  percent to 11.0 percent—the average reasonable rate that we calculated  for 1996 through 2015—on the companies’ 2015 retained premiums of  $7.42 billion, the companies’ expected underwriting gains would decrease  by $259 million. If the target rate of return was reduced by 4.9 percentage  points, from the current target rate of 14.5 percent to 9.6 percent—the  average reasonable rate that we calculated for 2009 through 2015—on  the companies’ 2015 retained premiums of $7.42 billion, the companies’  expected underwriting gains would decrease by $364 million. With such  a cost savings for a single year, the savings for the program would be  significant over time with either reduction. As we reported in January  2017, absent policy changes, the federal government’s fiscal path is  unsustainable, and to change the long-term fiscal path, policymakers will  need to consider policy changes to the entire range of federal activities  and spending. We have also reported that Congress and executive  branch agencies can act to improve the efficiency and effectiveness of  government programs and activities.
However, any savings that the federal government could achieve through  the SRA by reducing companies’ expected future underwriting gains as a  result of reducing the target rate of return cannot be implemented without  congressional action to repeal a provision in the 2014 farm bill. This  provision requires that any revised SRA be budget neutral with respect to  estimates of future underwriting gains for the companies participating in  the crop insurance program. In addition, the 2014 farm bill requires that if  any SRA savings are realized, they have to be used to increase  underwriting gains or A&O subsidies. If Congress directs RMA to adjust  the participating insurance companies’ target rate of return to reflect  market conditions, the underwriting gains that insurance companies can  expect to receive would decrease. Such a reduction would not affect the  premiums that farmers pay, but such an adjustment would reduce the cost of the crop insurance program and achieve budgetary savings for the  federal government.
section_title: Reducing the Portion of Premiums that Companies Retain
paragraphs: In addition to the rate of return, participating insurance companies’  underwriting gains are affected by the portion of premiums that they  retain. Even if the target rate of return remained unchanged, reducing  companies’ portion of retained premiums would reduce their expected  underwriting gains because they would earn their rate of return on a  smaller premium base. The companies would have a smaller underwriting  stake, retaining a smaller portion of underwriting gains or losses. The  extent of sharing in premiums—and the associated opportunities for gains  and risk of losses—between the federal government and the companies  has long been a subject of debate. For example, according to a report by  a former USDA official, the degree of this sharing has been controversial  since the beginning of the public-private partnership created by the  Federal Crop Insurance Act of 1980. According to this report, part of the  justification for the companies to share in the program’s underwriting  losses was that it would encourage the companies to more carefully  adjust farmers’ loss claims. According to a crop insurance industry  organization document, the structure of the program is such that  companies have dollars at risk on every policy and are thus financially  incentivized to reduce fraudulent loss claims.
The Agricultural Risk Protection Act of 2000, however, improved RMA’s  ability to monitor farmers’ loss claims and companies’ adjustment of these  loss claims by enhancing the agency’s data mining capabilities. Since  2001, RMA has used its enhanced data mining capabilities to identify  policies with anomalous loss claims as compared to similar policies in a  geographic region. For example, RMA and the companies review these  policies with anomalous loss claims. As a result of its enhanced data  mining capabilities, RMA’s ability to monitor companies’ adjustment of  loss claims has improved. Furthermore, with more recent technological  advances, such as the inclusion of satellite data in data mining methods,  RMA’s data mining ability has continued to improve. According to RMA  documents, the agency’s data mining efforts have improved program  monitoring. RMA estimated its data mining resulted in $1.1 billion in  cumulative cost avoidance—reduction in the amount of indemnities  claimed—from 2001 through 2014.
Moreover, the 2005 SRA reduced the companies’ share of the premiums  and their potential underwriting gains or losses through a quota share  provision. A quota share is a type of reinsurance contract in which the  insurer—in this case, the insurance companies participating in the crop  insurance program—and the reinsurer—in this case, the federal  government—share premiums, gains, and losses according to a fixed  percentage. The quota share concept was introduced in the 2005 SRA as  a way to transfer underwriting gains from the companies to the  government in order to generate a reduction in program costs, according  to RMA officials. Under quota share provisions in the 2005 SRA and 2011  SRA, each company ceded to USDA a percentage of its premiums and  potential underwriting gains or losses. The 2005 SRA’s quota share was  5 percent, and the 2011 SRA’s quota share was 6.5 percent. For  example, in 2010, the quota share reduced companies’ retained  premiums by $319 million (5 percent) from $6,382 million to $6,063  million and reduced companies’ underwriting gains by $101 million (5  percent) from $2,017 million to $1,916 million. Thus, the quota share  increased the government’s underwriting gains by $101 million and  reduced program delivery costs by that amount.
Although RMA’s program monitoring has improved since 2000 and even  with the implementation of a quota share, there has been little change in  the level at which companies are allowed to retain premiums and share in  program underwriting gains or losses—which provides companies with  financial incentive to carefully adjust farmers’ loss claims. In 2000,  insurance companies retained $1,895 million (75 percent) of the  program’s $2,538 million in total premiums. In 2004, the insurance  companies retained $3,140 million (75 percent) of the program’s $4,186  million in total premiums. In 2015, 14 years after RMA implemented the  Agricultural Risk Protection Act of 2000’s data mining activities and 10  years after RMA implemented a quota share, the insurance companies  retained $7,422 million (76 percent) of the program’s $9,744 million in  total premiums. Thus, during the period that RMA was improving its  program monitoring, the portion of premiums that companies retained  stayed about the same, the crop insurance program grew, and the  potential amount of companies’ underwriting gains increased. The last  time RMA had an opportunity to assess and change the level of sharing in  program gains or losses was in 2010 when it completed renegotiating the  SRA.
Reducing the portion of premiums that companies retain by, for example,  5 percentage points, could save the government tens of millions of dollars  per year by increasing the government’s share of the insurance coverage,  thereby giving the government more opportunity to reduce its cost by  achieving underwriting gains. For example, in 2009, the SRA’s quota  share provision, which reduced the premiums that companies retained by  5 percentage points, resulted in program cost savings of $121 million for  that year. An additional adjustment in the portion of premiums that  companies retain could result in comparable savings.
As mentioned earlier, we reported in January 2017 that, absent policy  changes, the federal government’s fiscal path is unsustainable.  However, any savings that could be achieved through the SRA by  reducing insurance companies’ expected future underwriting gains as a  result of reducing the portion of premiums that participating companies  may retain would require congressional action to repeal a provision in the  2014 farm bill. This provision requires that any revised SRA be budget  neutral with respect to estimates of future underwriting gains for the  companies. In addition, the 2014 farm bill requires that if any SRA  savings are realized, they have to be used to increase underwriting gains.  Given fiscal pressures and the improvement in RMA’s program  monitoring, an assessment and possible adjustment in the portion of  premiums that participating insurance companies retain may be  warranted.
section_title: Conclusions
paragraphs: Federally subsidized crop insurance, which helps farmers manage the  risk inherent in farming, is one of the most important programs in the farm  safety net. USDA and private insurance companies share in the risk of  loss and the opportunity for gain associated with crop insurance policies.  The 2009 USDA-commissioned study estimates an annual rate of return  that would allow insurance companies participating in the crop insurance  program to have expected earnings that are equal to earnings from  alternative investment opportunities relative to the risk assumed—a  reasonable or market-based rate of return. However, the reasonable rate  of return has declined since the 2011 SRA. This decline indicates that the  current target rate of return for the federal crop insurance program  exceeds the reasonable rate of return. If Congress were to direct RMA to  adjust the participating insurance companies’ target rate of return to  reflect market conditions, the underwriting gains that insurance  companies receive would potentially be reduced, and any such reduction  would not affect the premiums that farmers pay. Such an adjustment  would, however, reduce the expected cost of the crop insurance program  and achieve expected budgetary savings for the federal government,  which could be used for deficit reduction or other purposes, such as other  farm programs or enhancements of crop insurance products available to  farmers. However, any savings that could be achieved through the SRA  by reducing companies’ expected future underwriting gains as a result of  reducing the target rate of return would require congressional action to  repeal a provision in the 2014 farm bill because this provision requires  that any revised SRA is to be budget neutral with respect to estimates of  future underwriting gains for the companies.
In addition, the portion of program premiums that participating insurance  companies retain—which provides the companies with financial incentive  to accurately adjust farmers’ loss claims—has changed little since 2000.  The last time RMA had an opportunity to assess and change the level of  portion of premiums retained was in 2010 when it completed  renegotiating the SRA. Given the improvement in RMA’s ability to monitor  the program, an additional assessment and possible adjustment in the  portion of premiums retained by participating insurance companies may  be appropriate. Such an adjustment could generate significant cost  savings for the program. However, because a provision in the 2014 farm  bill requires that any revised SRA is to be budget neutral with respect to  estimates of future underwriting gains for the companies, any savings that  could be achieved through the SRA by reducing companies’ expected  future underwriting gains as a result of reducing the portion of premiums  retained by participating insurance companies are not allowed under  current law and would also require congressional action to repeal this  provision in the 2014 farm bill.
Moreover, RMA sought to make A&O expense subsidies more stable and  dependable when it negotiated the 2011 SRA, and the current calculation  method has resulted in relatively modest fluctuations in A&O expense  subsidies for corn, soybeans, and wheat, the program’s three leading  crops. However, our analysis shows the SRA’s calculation method also  resulted in substantial subsidy fluctuations for many crops, states, and  counties with double-digit decreases followed by double-digit increases in  some cases. Because large decreases in A&O expense subsidies can  disrupt program delivery, and the sustainability of the program’s delivery  system in states and counties that experience large fluctuations can be  compromised, an adjustment to the A&O expense subsidy calculation  method that reduces the effects of changes in premiums caused by  changes in crop prices or other factors when RMA renegotiates the SRA,  could help RMA reduce year-to-year fluctuations in the A&O expense  subsidies that companies receive at the crop, state, and county levels.
section_title: Matter for Congressional Consideration
paragraphs: To reduce the cost of delivering the crop insurance program, Congress  should consider repealing the 2014 farm bill requirement that any revision  to the standard reinsurance agreement not reduce insurance companies’  expected underwriting gains, and directing the Risk Management Agency  to, during the next renegotiation of the agreement, (1) adjust the  participating insurance companies’ target rate of return to reflect market  conditions and (2) assess the portion of premiums that participating  insurance companies retain and, if warranted, adjust it.
section_title: Recommendation for Executive Action
paragraphs: To reduce year-to-year fluctuations in the administrative and operating  expense subsidies that companies receive at the crop, state, and county  levels, we recommend that the Secretary of Agriculture direct the  Administrator of the Risk Management Agency to consider adjusting the  administrative and operating expense subsidy calculation method in a  way that reduces the effects of changes in premiums caused by changes  in crop prices or other factors when it renegotiates the standard  reinsurance agreement.
section_title: Agency Comments and Our Evaluation
paragraphs: We provided USDA with a draft of this report for review and comment.  RMA, responding on behalf of USDA, stated in its written comments (see  app. VIII) that it had no comment on the matter for congressional  consideration. RMA also stated that, consistent with our recommendation,  it will examine with insurance companies the potential to reduce  variations in A&O expense subsidies the next time the SRA is  renegotiated.
RMA stated that the 2011 SRA produced substantial savings for  taxpayers of approximately $4.5 billion, which was accomplished with no  significant disruption of service. RMA also stated that our report omits the  SRA’s success. We agree that the 2011 SRA produced successful  results, and we discuss some of them in our report. For example, the  report states that the Office of Management and Budget estimated the  2011 SRA’s 10-year budgetary savings would be about $6 billion and that  the national cap on annual A&O expense subsidies controls government  costs when crop prices rise. In addition, the report states that the 2011  SRA’s national cap on annual A&O subsidies was successful in stabilizing  the overall subsidy amount. In addition, we noted that for the three  leading crops—corn, soybeans, and wheat—A&O subsidy fluctuations  were relatively modest and linked these modest fluctuations to the 2011  SRA’s A&O subsidy calculation method. However, as we state in the  report, our analysis also found substantial subsidy fluctuations for many  crops, states, and counties.
Further, RMA stated that our report gives the impression that the cap on  A&O expense subsidies negatively impacted service to farmers and that  stabilizing A&O subsidies would not lead to any discernible difference in  service to farmers. However, crop insurance industry organization  documents suggest that reductions in A&O subsidies could have negative  effects. As we state in the report, according to crop insurance industry  organization documents, reductions in A&O subsidies may adversely  affect the services provided to farmers. Furthermore, in the 2011 SRA,  RMA sought to stabilize A&O subsidies, according to an RMA document,  which states that “because the A&O subsidy will be less vulnerable to  extreme commodity price changes, companies and their agents will enjoy  more stable and dependable subsidies in the future to support the cost of  delivering the program,” making the program more sustainable over time.  According to this RMA document, by providing relatively stable A&O  payments and a cap on agent commissions, the new SRA will allow for a  more sustainable delivery system in the future, protecting producers,  companies, and taxpayers.
As agreed with your office, unless you publicly announce the contents of  this report earlier, we plan no further distribution until 30 days from the  report date. At that time, we will send copies of this report to the  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 the GAO website  at http://www.gao.gov.
If you or your staff members have any questions about this report, please  contact me at (202) 512-3841 or morriss@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 IX.
section_title: Appendix I: Objectives, Scope, and Methodology
paragraphs: Our objectives were to examine (1) the changes, if any, in the distribution  of administrative and operating (A&O) expense subsidies due to the  implementation of the 2011 standard reinsurance agreement’s (SRA)  national cap on subsidies, (2) the extent to which the federal crop  insurance program’s target rate of return reflects market conditions and  (3) opportunities, if any, for the federal government to reduce its delivery  costs for the program.
To address these objectives, we reviewed, among other things, sections  of 2011 SRA drafts and the final 2011 SRA; Risk Management Agency  (RMA) documents on the development and implementation of the 2011  SRA; crop insurance industry documents; provisions of the Food,  Conservation, and Energy Act of 2008 (2008 farm bill), the Agricultural  Act of 2014 (2014 farm bill), the Agricultural Risk Protection Act of 2000;  prior GAO reports; and standards for internal control in the federal  government. We also interviewed RMA officials to discuss the  development and implementation of the 2011 SRA.
To examine the changes, if any, in the distribution of A&O expense  subsidies due to the implementation of the 2011 SRA’s national cap on  subsidies, we reviewed and analyzed RMA crop insurance data by state,  county, and crop for 2010 through 2015. We chose this time frame to  examine changes associated with the implementation of the 2011 SRA  because it contained the most recent data available at the time of our  review. We analyzed changes in A&O subsidies per policy by state,  county, and crop to identify and summarize trends during 2011 through  2015. We used A&O subsidies per policy because RMA used this  benchmark in its development of the 2011 SRA. The RMA data we used  provided unadjusted A&O subsidy amounts (i.e., the amounts before  adjustment in accordance with the 2011 SRA’s cap on total A&O  subsidies for policy types that are subject to this cap). Based on the 2011  SRA’s provisions and information from RMA officials, we performed  calculations to convert these amounts to adjusted A&O subsidy amounts.  We compared our adjusted A&O subsidy amounts with other RMA data— such as state and national totals—to confirm that our adjustments were  accurate.
To examine the extent to which the federal crop insurance program’s  target rate of return reflects market conditions, our work included  reviewing a 2009 study commissioned by the U.S. Department of  Agriculture (USDA), the Rate of Return Update - 2008: Reasonable Rate  of Return Section 3.1. This study derived, for the 20 years from 1989  through 2008, the annual rate of return on equity that companies  participating in the federal crop insurance program should be expected to  earn. We identified the major factors that the study used to estimate the  reasonable rate of return and collected data on these factors from  sources of financial information such as Value Line Investment Survey.  We then extended the study’s results to estimate the reasonable rate of  return on equity for 2009 through 2015, years that were not included in  the study. In addition, for the 20 years from 1996 through 2015, we  summarized RMA data on the actual rates of return on retained premiums  of participating insurance companies. Additional information on our  methods for this objective is in appendix V.
To examine opportunities, if any, for the federal government to reduce its  delivery costs for the program, we reviewed and summarized RMA data  on companies’ underwriting gains and risk sharing as expressed by total  program premiums and premiums retained by companies for the 20 years  from 1996 through 2015. We also reviewed the 2005 SRA and 2011 SRA  sections on risk sharing, as well as crop insurance industry documents,  including industry responses to 2011 SRA drafts. Regarding RMA’s  program monitoring, we reviewed RMA documents on data mining and  other program integrity efforts, USDA Office of the Inspector General  reports, and previous GAO reports including our 2005 report on fraud,  waste, and abuse, and our 2012 report that examined RMA’s data  mining.
To evaluate the reliability of the RMA data, we reviewed an assessment  for a previous GAO study, reviewed agency documentation related to the  data systems, and obtained updated information on the data systems  from knowledgeable officials. We assessed the reliability of the data from  the 2009 USDA-commissioned study and the financial information  sources by reviewing relevant documentation. In addition, for one of the  financial information sources, we reviewed an assessment for a previous  GAO study. In each case, we concluded that the data were sufficiently  reliable for the purposes of this report.
We conducted this performance audit from April 2015 to July 2017 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 we obtained provides a reasonable basis for our findings  and conclusions based on our audit objectives.
section_title: Appendix II: Percentage Change in the Average Administrative and Operating Subsidy, by Crop, 2011-2015
section_title: Appendix III: Percentage Change in the Average Administrative and Operating Subsidy, by State, 2011-2015
section_title: Appendix IV: Percentage Change in the Average Administrative and Operating Subsidy, by County, 2011-2015
section_title: Appendix V: Analysis of Reasonable Rate of Return
paragraphs: A 2009 study commissioned by the U.S. Department of Agriculture  (USDA) estimated a reasonable rate of return for crop insurance  providers for 1989 through 2008. This study used the opportunity cost of  capital as the definition of the reasonable rate of return for crop  insurance. In order to determine a reasonable rate of return for  companies participating in the federal crop insurance program, the 2009  study averaged the results obtained using two methods: the capital asset  pricing model and the discounted cash flow model.
subsections: section_title: Capital Asset Pricing Model
paragraphs: The capital asset pricing model uses the return on a risk-free asset,  usually a U.S. Treasury security, to estimate the additional return an  investor should expect as compensation for the additional risk associated  with alternative investments. The capital asset pricing model uses the  following equation to calculate the cost of capital:  K= 𝑟𝑟𝑓𝑓+𝛽𝛽∗ 𝑟𝑟𝑑𝑑  in which 𝑟𝑟𝑓𝑓 is the risk-free rate, 𝛽𝛽 is the beta coefficient, and 𝑟𝑟𝑑𝑑 is the  equity risk premium.
subsections: section_title: Risk-Free Interest Rate in the Capital Asset Pricing Model
paragraphs: According to a 2000 study, movements in the cost of capital for the  insurance industry closely follow movements in the risk-free rate of  return. The 2009 USDA-commissioned study used the 3-month Treasury  bill secondary markets, 5-year constant maturity Treasury bond, and the  20-year constant maturity Treasury bond as the risk-free interest rates to  estimate the short-, intermediate-, and long-term costs of capital. The  2009 study used interest rate data from the Federal Reserve for the  selected months of April, May, and June to estimate the cost of capital for  each year reviewed. We calculated the cost of capital using April, May,  and June interest rates in the same way as the USDA-commissioned  study. In addition, we calculated the cost of capital using the full 12-month  average risk-free rate for each year as a test for the robustness of our  results. Although our calculations begin with 2009 data, we note the  significant decrease in interest rates from 2008, the last year covered by  the USDA-commissioned study, to 2009, the first year for which we  updated the analysis included in the study, as context for the downward  trend in interest rates from 2009 through 2015. From 2008 to 2009, the  average risk-free interest rate—defined as the average of the rates on the  3-month, 5-year, and 20-year Treasury securities—decreased from 3.1  percent to 2.2 percent. Furthermore, from 2009 through 2015, the  average risk-free rate generally continued to decrease.
section_title: Relative Volatility Measure (Beta Coefficient) in the Capital Asset Pricing Model
paragraphs: The “beta coefficient” (β) is an estimate of the relative volatility of a  particular security compared with that of a proxy for the market, normally  the S&P 500 index. The USDA-commissioned study gathered estimates  of the beta coefficients for a sample of publicly traded property and  casualty insurance companies. According to the study, beta coefficients  should be adjusted to account for the long-run tendency of beta  coefficients to revert to the market mean value of “1”. We calculated the  cost of capital with both unadjusted and adjusted beta coefficients for  each year. The average unadjusted beta coefficient for property and  casualty insurance companies from 2009 through 2015 was 0.94. The  average adjusted beta coefficient for property and casualty insurance  from 2009 through 2015 was 0.98. These results indicate that the  property and casualty insurance industry has generally experienced  slightly less volatility, on average, than the market as a whole.
section_title: Equity Risk Premium in the Capital Asset Pricing Model
paragraphs: The equity risk premium” (“𝑟𝑟𝑑𝑑”) is the additional return expected by  investors for risk. That is, the equity risk premium is the average  difference between the return on the risk-free asset and the return on a  market portfolio, normally represented by the S&P 500 index. The equity  risk premium is an arithmetic mean of this difference for each year  beginning in 1926 through the year before which the cost of capital is  being estimated. The average equity risk premium fluctuated by no more  than 50 basis points from 2009 through 2015.
Our capital asset pricing model calculations estimate that the average  cost of capital from 2009 through 2015 was 9.7 percent when calculated  using an average of monthly interest rates for April, May, and June of  each year. The cost of capital or reasonable rate of return from 2009  through 2015 was 9.6 percent when calculated with a 12-month average  of the interest rates for each year.
section_title: Discounted Cash Flow Model
paragraphs: According to the 2009 USDA-commissioned study, the discounted cash  flow model is perhaps the most widely used method for estimating the  cost of capital, particularly in regulated industries, such as public utilities.  The discounted cash flow model is constructed on the assumption that  the cost of an investment (for instance, a stock) will equal the present  value of cash flows (such as future dividend payments or capital gains)  resulting from the investment. If the present value of cash flows resulting  from the investment does not equal the price, investors will bid on (or  against) the investment until the values are equal. The USDA- commissioned study collected data for a sample of publicly traded  property and casualty insurance companies from Value Line Investment  Survey.
The discounted cash flow model uses the following equation to calculate  the cost of capital:  K= 𝐷𝐷1𝑃𝑃0  + 𝑔𝑔  The first element, 𝐷𝐷1𝑃𝑃0  , is the dividend yield expected in the first year. The  dividend, 𝐷𝐷1, reported by Value Line Investment Survey, is the estimate of the cash dividends payable in the next 12 months. P is the price of the  The second element in the discounted cash flow model, 𝑔𝑔 , is an average stock at the beginning of the 12-month period.  of the growth forecast method and fundamental analysis. The growth  forecast method is an estimate of growth based on an equally weighted  average of 10-year historical earnings and dividends, 5-year historical  earnings and dividends, and a Value Line analyst’s forecasted dividends  and earnings. Sustainable (“fundamental”) growth is the rate at which  companies retain and reinvest earnings. Fundamental analysis assumes  that retained earnings can be reinvested and used to produce greater  earnings in the future—earnings that might produce higher dividends in  the future. Alternately, the company may grow by issuing stock above  book value, proceeds from which could finance new investments, thereby  generating higher dividends in the future.
The discounted cash flow model thus relies on numerous financial metrics  such as historical and forecasted earnings and dividends. However, the  property and casualty insurance companies that make up the dataset  may not report every figure. For instance, a company may not report  dividends in a given year. In these places, Value Line Investment Survey  may note the missing values. As a result, we performed two sets of  discounted cash flow calculations. One set of calculations only included  publicly traded property and casualty insurance companies that reported  complete historical and forecasted earnings and dividends. However, we  also calculated the reasonable rate of return for all publicly traded  property and casualty insurance companies covered by Value Line  Investment Survey; we imputed zeros for missing values. As a result, we  are reporting a range for the discounted cash flow results. Thus, the  average reasonable rate of return from 2009 through 2015 was 9.6  percent when calculated including only property and casualty insurance  companies that reported complete data and 8.4 percent when calculated  including all property and casualty insurance companies (imputing “0” for  missing values). However, out of concern that imputing zeroes could  skew the rate of return estimate downward, we used the higher rate of  return of 9.6 percent based on the companies that reported complete  data.
section_title: Results
paragraphs: To obtain the reasonable rate of return on equity from 2009 through 2015,  we averaged the results of the capital asset pricing model with the results  of the discounted cash flow model. According to our calculations, the  estimated reasonable rate of return on equity for 2015 was 8.8 percent.  The estimated average reasonable rate of return from 2009 through 2015  was 9.6 percent. According to the capital asset pricing model, the  average reasonable rate of return from 2009 through 2015 was 9.7  percent. According to the discounted cash flow model, the estimated  average reasonable rate of return from 2009 through 2015 was 9.6  percent. The estimated average reasonable rate of return from 1996  through 2015 was 11.0 percent. Estimates of the reasonable rate of  return by year for 1989 through 2015 are in table 5.
section_title: Appendix VI: Summary of Potential Actions and Estimated Savings for the Crop Insurance Program, 2012 through 2015
paragraphs: From 2012 through 2015, we issued four reports that identified potential  actions that could be taken by Congress or the Risk Management Agency  to reduce the cost of the crop insurance program and achieve budgetary  savings. Table 6 shows the reports, potential government actions we  reviewed, and estimated federal dollar savings associated with each  potential action, at the time we issued these reports.
section_title: Appendix VII: Participating Insurance Companies’ Retained Premiums and Underwriting Gains/Losses, 1996-2015
paragraphs: Table 7 shows, for 1996 through 2015, the premiums on which the  participating insurance companies retained risk and these companies’  underwriting gains or losses. It also shows the quota share amounts for  2005 through 2015, the years for which a quota share was in effect, and  how the quota share reduced the premiums retained by the companies,  thus reducing their underwriting gains or losses. For example, companies’  2010 underwriting gains before deduction of the quota share were $2.017  billion. This amount was multiplied by the agreed-upon quota share of 5  percent, which resulted in the quota share amount of $101 million. This  $101 million was deducted from the $2.017 billion, which resulted in  companies’ final underwriting gains of $1.916 billion. In each year  beginning with 2005, except 2012, the quota share reduced the  government’s program costs by reducing companies’ underwriting gains,  thereby increasing the government’s underwriting gains. For example, the  quota share reduced companies’ underwriting gains for 2009 by $121  million, thereby increasing the government’s underwriting gains by the  same amount. In 2012, a year of major drought, the quota share reduced  companies’ underwriting losses by $92 million, increasing the  government’s underwriting losses by that amount.
section_title: Appendix VIII: Comments from the U.S. Department of Agriculture
section_title: Appendix IX: GAO Contact and Staff Acknowledgments
subsections: section_title: GAO Contact
section_title: Staff Acknowledgments
paragraphs: In addition to the individual named above, Thomas M. Cook, Assistant  Director; Ron Aribo; Kevin S. Bray; Gary Brown; Serena Epstein; Farrah  Graham; Michael Kendix; Emei Li; Joshua Parr; Anne Rhodes-Kline; Dan  C. Royer; Kiki Theodoropoulos; and Frank Todisco made key  contributions to this report. In addition, Martin (Greg) Campbell, Diana C.  Goody, Michael Meleady, and Oliver Richard made important  contributions to this report.