Crop Insurance: USDA Needs to Improve Oversight of Insurance Companies and Develop a Policy to Address Any Future Insolvencies
Published: 2004-06-01T00:00:00

Fast Facts:

Highlights:
section_title: Why GAO Did This Study
paragraphs: U.S. Department of Agriculture's (USDA) Risk Management Agency (RMA) administers the federal crop insurance program in partnership with insurance companies who share in the risk of loss or gain. In 2002, American Growers Insurance Company (American Growers), at the time, the largest participant in the program, was placed under regulatory control by the state of Nebraska. To ensure that policyholders were protected and that farmers' claims were paid, RMA agreed to fund the dissolution of American Growers. To date, RMA has spent about $40 million. GAO was asked to determine (1) what factors led to the failure of American Growers, (2) whether RMA procedures were adequate to monitor companies' financial condition, and (3) how effectively and efficiently RMA handled the dissolution of American Growers.
section_title: What GAO Found
paragraphs: The failure of American Growers was caused by the cumulative effect of company decisions that reduced the company's surplus, making it vulnerable to collapse when widespread drought in 2002 erased anticipated profits. The company's decisions were part of an overall strategy to increase the scope and size of American Growers' crop insurance business. However, when anticipated profits did not cover the company's high operating expenses and dropped its surplus below statutory minimums, Nebraska's Department of Insurance (NDOI) declared the company to be in a hazardous financial condition prompting the state commissioner to take control of the company. In 2002, RMA's oversight was inadequate to evaluate the overall financial condition of companies selling federal crop insurance. Although RMA reviewed companies' plans for selling crop insurance and analyzed selected financial data, oversight procedures generally focused on financial data 6 to 18 months old and were insufficient to assess the overall financial health of the company. Additionally, RMA did not routinely share information or otherwise coordinate with state regulators on the financial condition of companies participating in the crop insurance program. For example, NDOI had identified financial and management weaknesses at American Growers. Since American Growers' failure, RMA has acted to strengthen its oversight procedures by requiring additional information on companies' planned financial operations. It is also working to improve its coordination with state insurance regulators. However, as we completed our review, neither of these initiatives had been included in written agency policies. When American Growers failed, RMA effectively protected the company's policyholders, but lacked a policy to ensure it handled the insolvency efficiently. RMA has spent over $40 million, working with the state of Nebraska, to protect policyholders by ensuring that policies were transferred to other companies and that farmers' claims were paid. NDOI accommodated RMA's interests by allowing RMA to fund the operation of the company long enough to pay farmers' claims. Prior to American Growers' failure, RMA did not have an agreement with the NDOI commissioner defining state and federal financial roles and responsibilities. If the NDOI commissioner had decided to liquidate the company, RMA may have incurred more costs and had less flexibility in protecting policyholders.

section_title: Letter
paragraphs: Federal crop insurance is part of an overall safety net of federal programs  for American farmers. Federal crop insurance provides protection for  participating farmers against the financial losses caused by droughts,  floods, or other natural disasters and against the risk of crop price  fluctuations. Participation in the program is voluntary; however,  participation is encouraged through federal premium subsidies. In 2003, the  program provided nearly $40 billion in risk protection for over 200 million  acres of farmland at a cost of over $3 billion to the federal government. The  U.S. Department of Agriculture’s  (USDA) Risk Management Agency (RMA)  has overall responsibility for the crop insurance program. RMA manages  the contracts with the companies that sell and service crop insurance,  oversees the development of new insurance products for farmers, and  monitors compliance with program provisions by both farmers and  insurance companies. RMA also acts as the ultimate guarantor for policy  losses, in the event companies are unable to fulfill their obligations under  the federal crop insurance program. RMA administers the program in  partnership with private insurance companies that share a percentage of  the risk of loss or gain associated with each insurance policy written. In  addition, RMA pays companies an expense reimbursement—a percentage  of premiums on policies sold—for the administrative costs of selling and  servicing federal crop insurance policies. Companies sell crop insurance to  farmers through agents, who are paid a commission by the companies on  the policies they sell.
American Growers Insurance Company (American Growers) failed in 2002;  at that time, it was the largest participant in the federal crop insurance  program, accounting for about 20 percent of the premiums written in 2002.  American Growers experienced a 50 percent decline in its surplus over a  9-month period, from January through September 2002. This decline in the  company’s surplus prompted the Nebraska Department of Insurance  (NDOI), the regulator for the state in which American Growers was  chartered, to take control of the company, due to its hazardous financial  condition. On November 22, 2002, NDOI issued a state order of supervision.  Under the order of supervision, American Growers could not sell any new  insurance policies or conduct other nonroutine business without the  approval of the supervisor appointed by NDOI. Rather than immediately  liquidating the company, NDOI decided with RMA to place the company in  rehabilitation—the process where the regulator, in this case NDOI, takes  control of the management of the company—and to operate the company  to settle remaining claims and transfer existing policies to other  companies. On December 20, 2002, NDOI obtained a court order that  placed American Growers into rehabilitation under the auspices of NDOI.  Under rehabilitation, NDOI appointed a rehabilitator who took control of  American Growers to oversee the orderly termination of the company’s  business and to allow for an orderly transfer of policies to other companies.  To ensure continued service to farmers who purchased crop insurance  through American Growers, RMA chose to pay costs associated with  managing the company while American Growers finished collecting and  processing premiums and settling claims. To date, RMA’s funding of  American Growers’ operations has cost taxpayers over $40 million to pay  agent commissions, staff salaries, and other operating expenses.
You asked us to determine (1) what key factors led to the failure of  American Growers, (2) whether RMA procedures were adequate for  monitoring crop insurance companies’ financial condition, and (3) how  effectively and efficiently RMA handled the dissolution of American  Growers. In addition, you asked us to determine the factors that led to RMA  determinations that affected a proposed sale of American Growers’ assets  to Rain and Hail LLC (Rain and Hail); and RMA’s decision to guarantee that  all American Growers’ agent commissions be paid. Information related to   Rain and Hail’s proposal is provided in appendix VII. Information on RMA’s  decision to pay agent commissions is provided in appendix VIII. To  determine the key factors that led to the failure of American Growers, we  examined company documents and financial statements, reviewed RMA  and NDOI files, conducted interviews with employees and company  personnel, and obtained statistical analyses of the crop insurance program  from RMA’s data mining center. We compared American Growers’ financial  information with that of other companies in the crop insurance program.  We also spoke with crop insurance companies to gain an industry  perspective on the failure of American Growers and RMA’s actions. To  evaluate RMA’s procedures for monitoring companies, we reviewed RMA’s  regulations and methods, interviewed RMA staff, and reviewed  documentation to verify that monitoring procedures were followed. To  determine the effectiveness of RMA’s handling of the dissolution of  American Growers, we examined RMA’s decision-making process,  reviewed financial and other documents, and interviewed RMA and  American Growers’ staff, National Association of Insurance  Commissioners (NAIC) officials, and industry groups. We also contacted  state insurance commissioners where crop insurance companies are  chartered to discuss oversight issues and coordination with RMA. We  performed our work between July 2003 and May 2004, in accordance with  generally accepted government auditing standards. 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 both production and price risks. Crop insurance is  one method farmers have of protecting themselves against these risks.  Over the years, 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.
Federal crop insurance began on an experimental basis in 1938, after  private insurance companies were unable to establish a financially viable  crop insurance business. The federal crop insurance program is designed  to protect farmers from financial losses caused by events such as droughts,  floods, hurricanes, and other natural disasters as well as losses resulting  from a drop in crop prices. The Federal Crop Insurance Corporation  (FCIC), an agency within USDA, was created to administer the federal crop  insurance program. Originally, crop insurance was offered to farmers  directly through FCIC. However, in 1980, Congress enacted legislation that  expanded the program and, for the first time, directed that crop  insurance—to the maximum extent possible—be offered through private  insurance companies, which would sell, service, and share in the risk of  federal crop insurance policies. In 1996, Congress created an independent  office called RMA to supervise FCIC operations and to administer and  oversee the federal crop insurance program.
Federal crop insurance offers farmers various types of insurance coverage  to protect against crop loss and revenue loss. Multiperil crop insurance is  designed to minimize risk against crop losses due to nature—such as hail,  drought, and insects—and to help protect farmers against loss of  production below a predetermined yield, which is calculated using the  farmer’s actual production history. Buy-up insurance, the predominant  form of coverage, provides protection at different levels, ranging from 50 to  85 percent of production. Catastrophic insurance provides farmers with  protection against extreme crop losses. Revenue insurance, a newer crop  insurance product, provides protection against losses in revenue  associated with low crop market prices in addition to protecting against  crop loss. RMA, through FCIC, pays a portion of farmers’ premiums for  multiperil and revenue insurance, and it pays the total premium for  catastrophic insurance. However, farmers still must pay an administrative  fee for catastrophic insurance. RMA determines the amount of premium  for each type of insurance policy by crop. RMA, through FCIC, contracts  with private insurance companies who then sell these policies to farmers.  Companies sell crop insurance to farmers through agents. An agent, a  person licensed by the state in which the agent does business to sell crop  insurance, is employed by or contracts with a company to sell and service  eligible crop insurance policies. While most companies pay their agents a  commission to sell and service crop insurance policies, some companies  pay agents a salary. American Growers paid its agents a commission.
RMA establishes the terms and conditions to be used by private insurance  companies selling and servicing crop insurance policies to farmers through  a contract made with the companies called the SRA. The SRA is a  cooperative financial assistance agreement between RMA, through FCIC,  and the private crop insurance companies to deliver federal crop insurance  under the authority of the Federal Crop Insurance Act. Under the SRA,  FCIC reinsures or subsidizes a portion of the losses and pays the insurance  companies an administrative fee or expense reimbursement—a  preestablished percentage of premiums—to reimburse the companies for  the administrative and operating expenses of selling and servicing crop  insurance policies, including the expenses associated with adjusting  claims. While the reimbursement rate is set at a level to cover the  companies’ costs of selling and servicing crop insurance policies, the  companies have no obligation to spend their payment on expenses related  to crop insurance, and they may spend more than they receive from FCIC.  The current reimbursement rates, set by statute, are based on  recommendations in our 1997 report of the costs associated with selling  and servicing crop insurance policies. However, RMA does not have a  process for regularly reviewing and updating these rates. RMA is currently  conducting a limited review of companies’ expenses to validate the costs of  selling and servicing federally reinsured crop insurance policies.
RMA, through FCIC, is the reinsurer for a portion of all policies covered by  the federal crop insurance program. Reinsurance is sometimes referred to  as insurance for insurance companies. It is a method of dividing the risk  among several insurance companies through cooperative arrangements  that specify ways in which the companies will share risks. Reinsurance  serves to limit liability on specific risks, increase the volume of insurance  policies that may be written, and help companies stabilize their business in  the face of wide market swings in the insurance industry. As the reinsurer,  RMA shares the risks associated with crop insurance policies with  companies that sell federal crop insurance. However, if a crop insurance  company is unable to fulfill its obligations to any federal crop insurance  policyholder, RMA, as the ultimate guarantor for losses, assumes all  obligations for unpaid losses on these policies. Reinsurance is also  available through private reinsurance companies. Crop insurance  companies must maintain certain surplus levels to issue crop insurance  policies. However, they may increase their capacity to write policies and  may further reduce their risk of losses by purchasing reinsurance from  private reinsurance companies on the risk not already covered by FCIC.
American Growers was originally established in 1946 as Old Homestead  Hail Insurance Company. The company went through several  reorganizations and name changes between 1946 and 1989. In 1989, the  company became American Growers Insurance Company, operating as a  subsidiary of the Redland Group, an Iowa-based insurance holding  company. Acceptance Insurance Companies Inc., (Acceptance)—a  publicly owned holding company that sold specialty property and casualty  insurance—acquired American Growers in 1993.
As a wholly owned subsidiary of Acceptance, American Growers was  primarily responsible for selling and servicing federal crop insurance  policies and shared the same general management as the parent  organization. Another wholly owned subsidiary of Acceptance, American  Agrisurance Inc., served as the marketing arm for American Growers.
section_title: Company Decisions Contributed to American Growers’ Failure
paragraphs: American Growers’ failure was the result of a series of company decisions  that reduced the company’s surplus, making it vulnerable to collapse when  widespread drought erased anticipated profits in 2002. The company’s  decisions were part of an overall management strategy to increase the  scope and size of American Growers’ crop insurance business. The  company’s surplus declined due to losses and other costs from mistakes  made when introducing a new crop insurance product, decisions to pay  higher than average agent commissions, and the purchase of a competitor’s  business. Additionally, the company’s operating expenses were about 1 1/3  times its reimbursement from RMA. In other words, American Growers  was spending $130 for every $100 it was receiving from RMA to pay for  selling and servicing crop insurance. American Growers planned to use  profits from policy premiums to pay for the expenses not covered by RMA’s  reimbursement. When these gains did not materialize due to widespread  drought, the company’s surplus dropped below statutory minimums,  prompting NDOI to take control of the company.
First, the company introduced a new crop insurance product, but mistakes  associated with the sale of this product resulted in significant losses in the  company’s surplus. In 1997, the company chose to market a new crop  insurance product, Crop Revenue Coverage Plus (CRC Plus), which was a  supplement to federal crop insurance, but which was not reinsured by  RMA. In 1999, American Growers expanded the sale of this product into  rice, a crop with which it had little experience. When the company realized  it had mis-priced the product for rice and withdrew the product, farmers  who had planned on using CRC Plus sued the company. Financial losses,  legal settlements, and other costs related to CRC Plus caused significant  losses in the company’s financial surplus. Appendix II provides further  details on the losses associated with CRC Plus.
Second, American Growers chose to spend more than RMA reimbursed it  for selling and servicing crop insurance, in part, because the company  chose to pay above-average agent commissions in order to attract more  agents to sell for the company. As part of its effort to expand operations,  the company in 2000 to 2002, paid agent commissions about 12 percent  higher, on average, than those offered by other crop insurance companies.  In addition to paying agent commission rates above the average of other  companies in the industry, American Growers offered agent sales  incentives, such as trips to resort locations, and funded other expenses not  required to sell and service federal crop insurance. These expenses, among  others, created operating costs that were 11 percent greater than the  average operating costs of other companies selling crop insurance, and  these expenses exceeded the reimbursement RMA provided companies.  Appendix III provides additional details of the high operating costs  associated with agent commissions and other expenses.
Third, the company purchased the crop business of a competitor, which  increased its expenses. In 2001, American Growers attempted to expand its  share of the crop insurance market by purchasing assets from another  company, including that company’s book of crop insurance business.  Because American Growers was unable to achieve the operational  efficiencies it had anticipated, this acquisition resulted in additional  operating costs and expenses that were higher than the reimbursement that  RMA provided companies to cover the sale and service of crop insurance.  Appendix IV provides additional details on the operating expenses incurred  from the purchase of a competitor’s crop insurance business.
Finally, the company relied on large underwriting gains to pay for its  expenses, rather than RMA’s reimbursement. When these gains did not  materialize due to widespread drought in 2002, the company’s surplus  dropped to a level that prompted NDOI to take control of the company. In  its 2002 operating budget, American Growers projected profits in excess of  its 10-year average and relied on these anticipated profits to cover the  company’s operating expenses and to further its growth. The company’s  profit projections were based, in part, on retaining a higher percentage of  the risk for the policies it sold than in past years. By retaining a higher  percentage of the risk on the policies, American Growers could increase its  profits if claims were low. Conversely, the company increased its exposure  to loss if claims were high.  However, profits did not materialize as the  result of widespread drought, which caused overall federal crop insurance  program losses to increase from $3 billion in 2001 to $4 billion in 2002.  When American Growers’ expenses and losses dropped the company’s  surplus below statutory minimums, NDOI declared the company to be in a  hazardous financial condition and took control of the company—first  placing the company under supervision in November 2002 and then in  rehabilitation in December 2002. Appendix V provides additional details on  the decline in American Growers’ surplus.
section_title: RMA Financial Oversight Was Inadequate to Identify American Growers’ Financial Weaknesses
paragraphs: At the time of American Growers’ failure, RMA’s financial oversight  processes were inadequate to identify the full extent of financial  weaknesses of insurance companies participating in the federal crop  insurance program. RMA’s actual oversight procedures focused primarily  on whether a company had sufficient surplus to pay claims based on its  past performance, rather than the overall financial health and outlook of  the company. In addition, RMA did not generally share information or  coordinate with state regulators on the financial condition of companies  participating in the federal crop insurance program. Although RMA  reviewed companies’ operational plans and selected financial data, such as  annual financial statements, in the case of American Growers, RMA was  unaware that the company was projecting underwriting gains in excess of  historic averages to pay for its operating expenses. The company’s failure  to achieve these gains resulted in a substantial reduction in its surplus and  its subsequent financial failure. In the case of American Growers, RMA and  NDOI did not begin cooperating on overseeing the company until it had  been placed into supervision in November 2002.
subsections: section_title: RMA’s Procedures Were Inadequate to Evaluate Companies’ Overall Financial Condition
paragraphs: In 2002, when American Growers failed, data provided to RMA by the  companies participating in the federal crop insurance program provided an  overall picture of company operations and complied with RMA’s  regulations. However, the information provided was typically 6 to 18  months old; and, according to an RMA official, the agency’s oversight  focused primarily on whether a company had financial resources to pay  claims on crop insurance policies and not on the overall financial health of  the company. RMA’s approach to financial oversight stemmed, in part,  from the fact that the companies participating in the program are private  and are licensed and regulated by state insurance departments. State  insurance departments are responsible for monitoring the overall financial  condition of companies chartered and licensed to operate in their state. In  addition, some of the companies selling crop insurance are affiliated with  holding companies or other related companies, which RMA does not  review for financial soundness. Since American Growers’ failure, RMA has  begun requiring federal crop insurance companies to provide additional  financial data to help the agency determine if companies are adequately  financed to perform their obligations under their SRAs.
One of RMA’s primary responsibilities is to ensure the integrity and stability  of the crop insurance program, in part, by monitoring insurance companies’  compliance with program criteria such as submitting statutory statements  required by state regulators and meeting certain financial ratios, as defined  in federal regulations. To ensure that the companies participating in the  federal crop insurance program sell and service insurance policies in a  sound and prudent manner, the Federal Crop Insurance Act requires crop  insurance companies to bear a sufficient share of any potential policy loss.  Title 7, Code of Federal Regulations, chapter IV, contains the general  regulations applicable to administering the federal crop insurance  program. The SRA between RMA and participating crop insurance  companies establishes the terms and conditions under which RMA will  provide subsidy and reinsurance on crop insurance policies sold or  reinsured by insurance companies. These terms and conditions state, in  part, that companies must provide RMA with accurate and detailed data,  including their (1) annual plan of operation, (2) financial statements filed  with the applicable state insurance regulator, and (3) any other information  determined necessary for RMA to evaluate the financial condition of the  company.
When approving a company to participate in the crop insurance program,  RMA analyzes it according to 16 financial ratios set forth in RMA  regulations. Combined, these 16 ratios are intended to provide RMA a  reasonable set of parameters for measuring insurance companies’ financial  health, albeit generally from a historical perspective. The 16 financial  ratios include such things as (1) change in net writings, (2) 2-year overall  operating ratio, (3) change in surplus, and (4) liabilities to liquid assets.  Ten of the 16 ratios specifically refer to changes related to companies’  surplus—the uncommitted funds used to cover policy claims. When a  company fails more than 4 of the 16 financial ratios, RMA requires the  company to submit an explanation for the deviation and its plans to correct  the situation. If the explanation appears reasonable, RMA approves the  company to sell and service crop insurance for the next crop year.
In August 2001, RMA notified American Growers that the company had 6  ratios, based on its December 2000 financial statement, that fell outside  acceptable ranges, including its 2-year overall operating ratio, change in  surplus, and 2-year change in surplus. Table 1 shows the 6 ratio  requirements and American Growers’ ratio for each of the 6 ratios it failed.
According to an RMA memorandum dated October 2001, American  Growers reported that most of its unacceptable ratios were due primarily  to underwriting losses related to its multiperil crop insurance that  produced unfavorable results due to drought conditions in 2000,  particularly in Nebraska and Iowa, and the impact of the federally  subsidized reimbursement not covering the company’s expenses.  Additionally, American Growers cited the cost of the class-action lawsuit  relating to its CRC Plus product as a contributing factor. Finally, American  Growers explained that the expansion of its crop operations through the  purchase of a competitor’s crop insurance business was expected to  provide efficiencies that would reduce expenses and help improve the  company’s profitability in the future.
Based on American Growers’ explanations, RMA determined that the  company’s 2002 SRA should be approved. RMA did not believe that the  adverse developments that American Growers had experienced were  significant enough to move the company close to insolvency. RMA’s  decision was partially based on anticipated improvements in overall  performance resulting from American Growers’ acquisition of another  company’s assets and the potential for achieving greater economies of  scale.
Furthermore, while American Growers failed more than 4 of the 16  financial ratios, it was not the only company with such results. Of the 18  companies participating in the federal crop insurance program in 2002,  other companies had a higher number of failed ratios than American  Growers, though most had fewer. Specifically, of the other 17 companies, 3  companies had 7 or more failed ratios, 1 had 6—the same number as  American Growers, and 13 companies had 4 or fewer failed ratios.
In March 2002, American Growers had 5 ratios, based on its December 2001  financial statement, that fell outside acceptable ranges, including change in  net writings, 2-year overall operating ratio, and liabilities to liquid assets.  Table 2 shows the 5 ratio requirements and American Growers’ ratio for  each of the 5 ratios it failed.
American Growers cited its acquisition of its competitor’s crop insurance  business, the adverse development of its CRC Plus settlement, and the  delay in its reinsurance payments due from RMA as the primary reasons for  failing these ratios. Based on the company’s explanation of why it had  failed the 5 ratios, in June 2002—5 months before American Growers’  financial failure—RMA determined that American Growers met the  standards for approval to sell and service crop insurance policies for 2003.
In 2002, as in 2001, although American Growers failed to meet more than 4  ratios, as required by the SRA, its performance was not unlike some other  companies. Of the 19 companies participating in the crop insurance  program in 2003, 2 companies had 8 or more failed ratios, 2 had 5—the  same number as American Growers, and 14 companies had 4 or fewer  failed ratios.
Although RMA routinely reviewed the financial documents required under  the SRA, we found the agency’s financial oversight procedures inadequate  to fully assess American Growers’ financial condition. RMA reviewed the  company’s surplus and reinsurance arrangements and approved the  company to write policies for the 2003 crop year, based on this analysis.  However, RMA was unaware that American Growers was projecting profits  in excess of historic averages to pay for its operating expenses and that its  failure to achieve these profits would mean that the company’s surplus  would be inadequate to absorb resulting operating losses and could result  in the financial failure of the company.
One reason RMA was unable to identify deficiencies in American Growers’  finances was because, following the agency’s emphasis on companies’  compliance with program criteria, RMA only reviewed a company’s  historical financial information and its ability to pay claims on the basis of  the company’s past surplus and its private reinsurance agreements. For  example, RMA’s decision to approve companies to participate in the federal  crop insurance program for 2002 (July 2001 – June 2002) was based on the  company’s financial information as of December 31, 2000. Further, while  RMA required companies to submit an operation plan showing projected  policy sales, RMA did not require a company to provide operating budget  projections for the upcoming year. As a result, RMA’s approval decisions  were generally based on a company’s past financial performance rather  than a forward-looking perspective of a company’s financial health.
Without knowing the details of a company’s projected operating budget  including its acquisition plans and the financial conditions of affiliated,  parent, or subsidiary companies, RMA did not have a complete picture of  the company’s financial condition. Thus, RMA was unable to adequately  identify or take action to lessen any risks that may have been developing in  companies with deteriorating profits, as was the case in American  Growers. We believe that this lack of information impaired RMA’s  decision-making process; therefore, the agency was forced to make  decisions based on incomplete, narrowly focused, and dated information.
Subsequent to the financial failure of American Growers, RMA took several  steps to improve its oversight and analysis of the financial condition of  companies currently participating in the federal crop insurance program.  For example, in 2003, RMA started requesting more comprehensive budget  and cash flow information from participating companies, which provides  the agency a more forward-looking perspective of the companies’ financial  health. Specifically, RMA will require insurance companies to provide their  estimated underwriting gains or losses for the coming year; copies of all  risk-based capital reports; and a signed statement identifying any  potential threats to the company’s ability to meet its obligations for current  and future reinsurance years, along with the possible financial ramification  of such obligations. In addition, RMA is revising the SRA in its efforts to  address some of the shortcomings of the current SRA. Although RMA  officials said the agency plans to continue requesting more comprehensive  information from crop insurance companies and had developed a financial  analysis plan, as we concluded our review, the agency did not have formal  written policies and procedures in place incorporating these changes.
In a November 2003 memorandum to RMA’s administrator, USDA’s Office of  Inspector General provided general comments and suggestions for RMA’s  consideration in its renegotiation of the current SRA. Some of the  suggestions to improve the SRA included requiring companies to provide  (1) “revenue and expense forecast budget data for the forthcoming year as  a part of the plan of operations approval process, including agents’  commission rates and salary and other compensation for top company  officials,” (2) “information relating to any planned acquisition of other crop  insurance companies,” and (3) “the financial roles that will be played by  parent/subsidiary companies in the crop insurance operations.”
section_title: RMA Did Not Coordinate Oversight with State Insurance Regulators
paragraphs: RMA did not routinely coordinate with state regulators regarding the  financial condition of companies participating in the federal crop insurance  program.  RMA’s contact with state regulators was ad hoc and primarily  limited to episodes during the introduction of new crop products or  company acquisitions. RMA did not discuss the financial status of  companies with regulators, but it would have been prevented from doing so  because it lacked an agreement with state insurance regulators regarding  the sharing of confidential financial and examination records.
Companies selling and servicing crop insurance under the federal crop  insurance program are subject to the regulations of the state where the  company is chartered as well as federal regulations. According to NAIC, a  state regulators’ primary responsibilities are to protect the public interest;  promote competitive markets; facilitate the fair and equitable treatment of  insurance consumers; promote the reliability, solvency, and financial  solidity of insurance institutions; and enforce state regulation of insurance.  State regulators, among other things, require companies to file periodic  information regarding their financial condition, including the adequacy of  their surplus to cover claim losses, and the solvency of the company.
Prior to the failure of American Growers, RMA did not routinely coordinate  with state regulators regarding companies’ financial condition. Also, RMA  did not have a written policy or information-sharing agreements that would  allow state insurance regulators to share sensitive financial information  about crop insurance companies with the agency. According to several  state regulators, RMA did not routinely share information or otherwise  coordinate with state regulators to determine the financial health of a  company. According to another state regulator, RMA and the state have  talked when a company was introducing a new crop insurance product;  however, the regulator could not remember sharing information with RMA  about the financial operations of companies participating in the federal  crop insurance program. Furthermore, the state regulators with whom we  spoke said that any policy promoting coordination would be of limited  value unless the states and RMA established a written agreement allowing  the state regulators to share confidential business information with RMA.
RMA’s lack of an agreement for sharing information with NDOI prevented  the state from disclosing sensitive business information on American  Growers. NDOI officials identified financial and management weaknesses  directly or indirectly affecting American Growers during its periodic  reviews as early as 2000. Beginning in 2001, and continuing through August  2002, NDOI was internally discussing the possibility of conducting a  targeted examination of Acceptance, including its subsidiary—American  Growers. However, in September 2002, due to other priorities and resource  constraints, NDOI decided to postpone an on-site examination of the  company until 2003. RMA called the state insurance regulator in May 2002,  and again in September 2002, asking whether there were any special  inquiries or actions pending by the state regarding American Growers and  whether American Growers was listed on the state’s list of companies at  risk. NDOI acknowledged to RMA that it had asked American Growers to  provide additional information regarding its first quarterly submission for  2002; however, NDOI explained that this was not unusual because a  number of other companies also had outstanding inquiries. NDOI explained  that most of its information is considered public and could be furnished to  RMA if requested. However, NDOI’s work products, including its list of  companies most at risk, company examination reports, and associated  work papers were considered confidential. As a result, NDOI required that  a confidentiality agreement be signed before they could share the  information. On September 20, 2002, NDOI began drafting a confidentiality  agreement so it could share information about American Growers with  RMA. However, this agreement was not completed before American  Growers’ failure.
Since the failure of American Growers, RMA has begun working with NAIC  on draft language for confidentiality agreements that would allow state  regulatory agencies to share confidential business information with RMA.  However, at the conclusion of our review, no written confidentiality  agreements had been formalized.
section_title: RMA Effectively Protected American Growers’ Policyholders but Lacked a Policy to Efficiently Address Insolvencies
paragraphs: RMA worked with NDOI to effectively manage the failure of American  Growers by ensuring that policyholder claims were paid and crop  insurance coverage was not disrupted. However, servicing the company’s  crop insurance policies cost RMA more than $40 million for such things as  paying agent commissions and staff salaries. Further, RMA lacked a written  policy that clearly defined its relationship to state actions in handling  company insolvencies. While NDOI accommodated RMA’s interests by not  immediately liquidating American Growers’ assets so that policyholders  could be served, without a written agreement in place, other actions such  as liquidation could have limited RMA’s flexibility to protect policyholders  and maintain stability in the federal crop insurance program.
subsections: section_title: RMA Effectively Protected American Growers’ Policyholders
paragraphs: RMA effectively protected American Growers’ policyholders after the  company’s failure by ensuring that farmers’ claims were paid and that their  crop insurance coverage was not disrupted. After NDOI obtained an order  of supervision, NDOI and RMA signed a memorandum of understanding  that specified that American Growers, under NDOI appointed management,  would pay claims and service policies with American Growers’ funds. RMA  signed an amendment to American Growers’ 1998 SRA and agreed to  reimburse the company for continued expenses associated with paying or  servicing crop insurance claims when American Growers’ available cash  accounts—about $35 million—dropped to $10 million or below. RMA began  day-to-day oversight of American Growers in conjunction with NDOI at the  company’s Council Bluffs, Iowa, offices on January 6, 2003. The purpose of  the oversight was, among other things, to ensure the timely payment of  claims, the timely collection of premiums, the efficient transfer of 2003  business to other insurance companies, and the review and approval of the  company’s employee retention plan and payments to creditors.
RMA worked with NDOI to keep American Growers in rehabilitation rather  than liquidate the company because RMA was concerned that if NDOI  chose to liquidate the company RMA may not have a mechanism to  expeditiously pay claims and transfer American Growers’ policies to other  insurance providers. Continuity of coverage is critical to policyholders  because they must provide proof of insurance coverage in order to secure  loans and obtain credit to plant the next year’s crops. Policyholders may  become ineligible for crop insurance for 1 year if their coverage is  terminated. RMA was concerned that if American Growers was liquidated,  policyholders would not be paid for their losses and their coverage would  lapse, making them ineligible for continued crop insurance coverage. While  the SRA provides that RMA could take control of American Growers’ crop  insurance policies, it did not have an effective way to service these policies.
On December 18, 2002, RMA issued procedures for transferring existing  policies written under American Growers to other insurance providers  approved under the federal crop insurance program. Under these  procedures, American Growers was to notify its agents that all of its  policies must be placed with another insurance provider. The agents had  the primary responsibility to transfer the policies. By April 2003, RMA  transferred or assigned a total of 349,185 policies—all which were  eligible—to other companies in the federal crop insurance program  reflecting about $576.4 million in premiums. Any American Growers’  policy that was not transferred voluntarily to a new insurance provider was  assigned by RMA on a random basis to a provider that was currently  writing insurance in the applicable state. Less than 8 percent of the policies  had to be assigned to other insurance providers because the policy or agent  had not acted on them, or because paperwork errors interfered with their  transfer. For the fall and spring crop seasons combined, agents or  policyholders transferred about 323,000 policies, and RMA assigned about  26,500 policies.
RMA worked in conjunction with NDOI and remaining American Growers’  staff to ensure that 52,681 claims totaling about $410 million were paid.  About $400 million of these claims were paid by March 2003. The claims  that were filed resulted from policyholder losses from the 1999 through  2003 crop seasons—primarily the 2002 crop season. A month-by-month  presentation of this information is presented in appendix VI.
section_title: Servicing American Growers’ Policies Cost RMA More Than $40 Million
paragraphs: The cost of servicing American Growers’ crop insurance policies, which  included the administrative and operating costs of paying claims and  transferring policies, totaled about $40.5 million as of March 2004 (see table  3). These costs included agent commissions, office space leases and rental  equipment, payroll for remaining American Growers’ staff, severance pay,  and other expenses. Six former American Growers’ employees remained  on-site to respond to information requests associated with paid claims and  transferred policies, to process remaining claims, and to produce  end-of-year financial statements.
RMA would like to recoup some of these costs by (1) obtaining revenues  that could be derived from the liquidation of American Growers’ assets by  NDOI, if that should occur, and (2) requesting that NDOI provide RMA with  any portion of the company’s cash reserves—totaling about $7 million as of  February 2004—that may remain before the company is liquidated.  However, according to NDOI, RMA’s standing as a creditor in the case of  liquidation is unclear, and RMA does not know to what extent, if any, it can  recoup its costs from these financial sources.
section_title: RMA Lacked a Written Policy to Efficiently Address Insurance Provider Insolvencies
paragraphs: At the time of American Growers’ failure, RMA did not have a written  policy defining its financial roles and responsibilities in relationship to  state actions in the event of an insurance provider insolvency. While the  SRA provides that RMA may take control of the policies of an insolvent  insurance company to maintain service to policyholders and ensure the  integrity of the federal crop insurance program, state regulators’ decisions  may constrain RMA’s ability to efficiently protect policyholders. In the case  of American Growers, an RMA official reported that NDOI made it clear  that it had no choice, given the weakened financial condition of the  company, but to liquidate American Growers unless RMA funded the company until all the policies had been serviced. If the state had liquidated  the company, it would have sold all the company’s property and assets,  creditors may have initiated legal actions over the existing assets  (including premiums owed by policyholders), and there was the possibility  of a freeze on the payment of any claims. Furthermore, liquidation would  have left RMA with a number of crop policies to service, with no way of  servicing them.
RMA decided that the best course of action was to reach an agreement with  NDOI to stave off liquidation by reimbursing NDOI for all costs associated  with the servicing of policies until all 2002 policies had been serviced and  until all producers had found new insurance providers for the 2003 crop  year. Fortunately, NDOI accommodated RMA’s interests by allowing RMA  to fund the operation of the company long enough to pay farmers’ claims  and transfer policies. However, other actions available to the state could  have increased RMA’s costs or limited RMA’s flexibility in protecting  policyholders.
When an insurance provider becomes insolvent, the SRA provides that  RMA will gain control of its federally funded crop insurance policies and  any premiums associated with those policies. However, as the case of  American Growers demonstrates, RMA is not prepared to assume such  responsibility. RMA was concerned, among other things, that it lacked  sufficient staff and other capabilities, such as data management systems, to  effectively service policyholders. RMA could have employed a contractor  to service policyholders, but doing so could have been costly and may not  have resulted in the timely payment of claims. Furthermore, according to  RMA, they were unable to identify a company to contract with to service  the policies and related claims. Thus, according to RMA, while RMA has the  authority in the event of insolvency to service policyholders by taking  control of companies’ policies, it is unprepared to act on this authority.  RMA is further dependent on state regulators to make decisions that will  allow the agency to act in the most efficient manner to protect  policyholders and maintain stability in the federal crop insurance program.
Prior to American Growers’ insolvency, RMA had not reached an  agreement with NDOI that addressed RMA’s interests in the case of  insolvency including the state’s financial responsibilities. RMA argues that  while it does not have a written policy to address insolvencies, it does have  flexibility to assess the situation when it occurs and use the most efficient  way to ensure that policyholders do not face a service disruption. While the  lack of a written policy and agreements may allow greater flexibility, the  absence of specific framework may also result in state regulator decisions  detrimental to RMA and the federal crop insurance program. A policy  describing state and RMA authorities and responsibilities when a state  decides to act against an insolvent company would provide RMA some  assurance that the federal government’s interests are protected.
section_title: Conclusions
paragraphs: The failure of American Growers, at the time, the largest participant in the  federal crop insurance program was caused by the cumulative effect of  company decisions over several years, and triggered by a drought that  forced the company to severely deplete its surplus to cover operating  expenses. Reviewing the causes underlying American Growers’ failure and  RMA’s actions provides a valuable opportunity to identify shortcomings in  the financial oversight of companies participating in the federal crop  insurance program and reforms necessary to strengthen RMA’s oversight  and RMA’s ability to respond to an insurance provider insolvency.
The failure of American Growers demonstrates that companies relying on  anticipated underwriting gains to cover operational expenses may face  financial difficulties similar to American Growers. More specifically, it  suggests that companies must find ways to achieve operating efficiencies  so that their expenses do not exceed the administrative and operational  expense reimbursement provided by RMA to cover expenses for the sale  and service of federal crop insurance policies. Further, the failure of  American Growers highlights the need to improve RMA’s financial  oversight of companies participating in the federal crop insurance  program. Clearly, RMA’s oversight procedures at the time of the failure  were inadequate to ensure that companies met applicable financial  requirements for participation in the program. Specifically, the failure of  American Growers highlights the need for improved financial and  operational reviews, and improved coordination with state insurance  regulators. If adequate financial oversight procedures had been in place  prior to the failure of American Growers, the company’s weakened  financial condition may have been detected in time to allow for corrective  actions and thereby reduced costs to taxpayers. While RMA has conducted  additional oversight of companies and has initiated greater contact with  state regulators after the failure of American Growers, RMA has not  formalized these procedures.
RMA responded to the failure of American Growers in an effective manner  that ensured continued coverage for farmers and stability in the crop  insurance program. Further, RMA demonstrated that the federal crop  insurance program functioned as intended by ensuring that policyholders  were protected. However, the failure of American Growers highlights the  need for RMA to consider developing written policies to ensure that it takes  the most effective and efficient actions in the event of future insolvencies  in the federal crop insurance program. As demonstrated by the failure of  American Growers, RMA is vulnerable to state insurance regulators’  actions when a company fails. State regulators are vested with the  authority to determine what supervisory action to take in response to the  financial failure of an insurance company. While NDOI accommodated  RMA’s interests by allowing RMA to fund the operation of the company long  enough to pay farmers’ claims, other actions available to the state,  including liquidation, could have increased RMA’s costs or limited RMA’s  flexibility in protecting policyholders. Better coordination with state  regulators, regarding respective authorities and responsibilities in the  event of future insurance provider insolvencies, is necessary to ensure that  RMA’s interests are protected.
section_title: Recommendations
paragraphs: To improve RMA’s financial oversight of companies participating in the  federal crop insurance program and its ability to effectively address future  insolvencies, we recommend that the Secretary of Agriculture direct RMA  to take the following three actions: (1) Develop written policies to improve financial and operational reviews  used to monitor the financial condition of companies to include analyses of  projected expenses, projected underwriting gains, relevant financial  operations of holding companies, and financial data on planned  acquisitions. (2) Develop written agreements with state insurance regulators to improve  coordination and cooperation in overseeing the financial condition of  companies selling crop insurance, including the sharing of examination  results and supporting work papers. (3) Develop a written policy clarifying RMA's authority as it relates to  federal/state actions and responsibilities when a state regulator decides to  place a company under supervision or rehabilitation, or to liquidate the  company.
section_title: Agency Comments and Our Evaluation
paragraphs: We provided USDA with a draft of this report for its review and comment.  We received written comments from the Administrator of USDA’s RMA.  RMA agreed with our recommendations and stated that it is (1) formalizing  the improvements in oversight that we recommended in the new SRA, (2)  developing written agreements with state insurance regulators and the  National Association of Insurance Commissioners (NAIC) to improve data  sharing and oversight, and (3) clarifying RMA’s authority as it relates to  federal/state actions when a state takes action against a crop insurance  company in its draft SRA and in discussions with state regulators and the  NAIC.
When completed, RMA’s initiatives to implement the recommendations in  this report will improve its ability to evaluate companies overall financial  health and to earlier detect weaknesses in companies’ financial condition.   However, to the extent that RMA cannot obtain enhanced disclosure and  accountability through proposed changes to the SRA, it should implement  our recommendation by modifying its regulations or other written policies.  Finally, RMA’s increased cooperation and coordination with state insurance  regulators will likely strengthen oversight by both federal and state  regulators and facilitate problem resolution should a company fail in the  future.
RMA also provided technical corrections, which we have incorporated into  the report as appropriate.  RMA's written comments are presented in  appendix IX.
As arranged with your office, unless you publicly announce its contents  earlier, we plan no further distribution of the 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.
section_title: Scope and Methodology
paragraphs: At the request of the Chairman and Ranking Minority Member of the House  Committee on Agriculture and the Chairman and Ranking Minority member  of the House Subcommittee on General Farm Commodities and Risk  Management, we reviewed USDA’s actions regarding American Growers  Insurance Company (American Growers) and their impact on the federal  crop insurance program. Specifically, we agreed to determine (1) what key  factors led to the failure of American Growers, (2) whether Risk  Management Agency (RMA) procedures were adequate for monitoring crop  insurance companies’ financial condition, and (3) how effectively and  efficientlyRMA handled the dissolution of American Growers. In addition,  we were asked to determine what factors led to RMA determinations  affecting a proposed sale of American Growers’ assets to Rain and Hail LLC  (Rain and Hail) and RMA’s decision to guarantee that all American  Growers’ agent commissions be paid. Information related to the Rain and  Hail proposal is provided in appendix VII. Information on USDA’s decisions  to guarantee agent commissions is provided in appendix VIII.
To determine the key factors leading to the failure of American Growers,  we analyzed company documents and financial statements, including  annual and quarterly statements for 1999 through 2002. We compared  American Growers’ expense data with expense data for other companies  participating in the program. For this analysis, we computed the average  expense ratios of companies participating in the crop insurance program,  excluding the expense data from American Growers. Due to the timing of  American Growers’ failure, it did not submit an expense report to RMA for  2002. To capture the extent of the financial problems that American  Growers experienced in 2002 in comparison with other companies, we  worked closely with staff who remained at American Growers while it was  in rehabilitation to create an expense report for 2002.  We also interviewed  American Growers’ management; the Nebraska Department of Insurance  (NDOI) appointed rehabilitator for American Growers and other key staff;  industry groups, such as the National Association of Insurance  Commissioners (NAIC); and representatives from other crop insurance  companies, including key Rain and Hail personnel, to gain an industry  perspective on the failure of American Growers’ and RMA’s actions. We  also contacted the National Association of Crop Insurance Agents;  however, they did not grant our requests for an interview. To adjust for the  general effects of inflation over time, we used the chain-weighted gross  domestic product price index to express dollar amounts in inflation- adjusted 2003 dollars.
To evaluate RMA’s oversight procedures we interviewed RMA staff in  Washington, D.C. and Kansas City, Missouri, offices. We reviewed the  guidance that RMA uses to monitor companies’ compliance with the  federal crop insurance program, including relevant laws; the Code of  Federal Regulations, title 7, part 400; and agency guidance, including RMA’s  Crop Insurance Handbook for 2002 and the current Standard Reinsurance  Agreement (SRA), to verify that monitoring procedures were met. We also  reviewed RMA’s files relating to the oversight of American Growers and  approval of its SRA.
To determine the effectiveness of RMA’s dissolution of American Growers,  we examined RMA’s decision-making process and the costs associated with  running American Growers’ operations after its failure to ensure that  federal crop insurance policies were serviced. We reviewed American  Growers’ financial statements and other documents. We used  semistructured interviews to obtain the views of the Nebraska state  commissioner; American Growers’ management; representatives from  other crop insurance companies, including key Rain and Hail personnel;  RMA staff; NAIC officials; and, industry groups on the failure of American  Growers and on issues related to RMA’s handling of the dissolution.  Specifically, we obtained our information from the officials by asking 10  structured questions in a uniform order within an interview that included  additional unstructured, probing follow-up questions that were interjected  at the discretion of the interviewer. We also used structured interviews to  obtain the views of insurance commissioners on the failure of American  Growers and on issues related to sharing confidential business information  with RMA. In this case, we asked an additional three structured questions  and followed up with additional unstructured questions as needed. We  selected insurance commissioners in 10 states where there was at least one  2004 SRA holder, according to RMA data. These states were Connecticut,  Indiana, Illinois, Iowa, Kansas, Minnesota, New York, Ohio, Pennsylvania,  and Texas. We met with RMA officials in February 2004 to discuss our  findings and tentative recommendations.
We conducted our review from July 2003 through May 2004 in accordance  with generally accepted government auditing standards.
section_title: Penalties and Financial Losses Associated with Marketing CRC Plus for Rice Reduced American Growers’ Surplus
paragraphs: As part of an overall strategy to increase the company’s market share of the  crop insurance industry, in 1997, American Growers developed and  marketed a crop insurance product—Crop Revenue Coverage Plus (CRC  Plus)—that was a supplement to federally reinsured crop insurance, but it  was not subsidized or reinsured by the federal government. The product  was a supplement to Crop Revenue Coverage (CRC), an insurance product  that protected farmers against crop loss and low crop prices in the event of  a low price, a low yield, or any combination of the two. CRC Plus allowed  farmers to obtain supplemental coverage for their crops, in essence  providing a higher level of coverage in the event of losses. American  Growers initially marketed CRC Plus in only two states and covered grain,  corn, sorghum, and soybean crops. In 1999, when the company extended  CRC Plus to rice, a crop with which American Growers had limited  actuarial experience, the company mistakenly priced the product too low.  It then promoted the product heavily and did not adequately anticipate the  demand for the product.
When it priced CRC Plus for rice, American Growers made a mathematical  error—caused by the misplacement of a decimal point—that resulted in the  insurance being sold for a lower price than it should have been. The low  price for the policy, coupled with uncertainty in the market price of rice  that year, resulted in a greater demand for the product than the company  had anticipated. When American Growers realized that the demand for the  product and associated losses would be greater than the company’s surplus  could handle, especially considering its low price, American Growers  announced it would no longer accept applications at the price originally  listed, effectively withdrawing the product from the market. However,  farmers had already made decisions about what crop insurance they would  purchase, based upon their belief that they could obtain the new product  offered by American Growers. The withdrawal of the product was untimely  and made it difficult for some farmers to find adequate insurance. As a  result, Congress acted to extend the filing deadline for other types of  federally reinsured crop insurance so that farmers adversely affected by  American Growers’ actions could obtain adequate insurance for their  crops.
Finally, some farmers sued American Growers, while RMA and six states  examined American Growers’ actions. The litigation by farmers and  regulatory actions resulted in more than $13 million in fines and  settlements levied against American Growers in addition to losses of $6  million. The fines, costs from litigation, and increased service costs  resulting from the new insurance product reduced American Growers’  surplus. As a result, American Growers’ surplus dropped from $76 million  in 1998, to $60 million in 2000, a 21 percent decline over 2 years. This  decline in American Growers’ surplus occurred at the same time the  company increased the amount of insurance premium it wrote, from $271  million in 1998 to $307 million in 2000, an increase of 13 percent. To lessen  the impact of losses associated with the CRC Plus policies, American  Growers accepted a $20 million loan in the form of a surplus note from an  affiliate company to strengthen its surplus. American Growers also  acquired commercial reinsurance coverage to pay for losses related to CRC  Plus. This reinsurance coverage committed the company to future  payments of more than $60 million through 2006.
section_title: Agent Commissions and Other Expenses Created High Operating Costs
paragraphs: American Growers’ reported that operating expenses were higher than the  average reported expenses of other companies participating in the federal  crop insurance program, primarily due to American Growers’ efforts to  attract agents by paying them higher than average commissions and other  actions designed to expand its business. From 2000 to 2002, average  commissions for American Growers’ agents were 12 percent higher than  commissions for agents working for other companies. American Growers  paid commissions that averaged about $17 for each $100 premium it sold  while other companies’ agent commissions averaged $15 for each $100 of  premium.
Agents are companies’ principal representatives to farmers. Farmers  purchase crop insurance through agents who can write premium for any  company selling crop insurance. Farmers generally develop relationships  with specific agents and rely on agents for advice and service. Successful  agents write more policies and may write policies with lower loss ratios.  Agents typically receive as a commission a percentage of every dollar of  premium in crop insurance sold to farmers. Some agents choose to write  policies for certain companies based on commissions paid them by the  company and on how well the company services the agents’ clients. Higher  commission rates are not the only factor attracting an agent to a company,  but rates do play an important role. In an effort to increase its market share  by recruiting more agents to sell crop insurance, American Growers paid  higher agent commissions than other companies participating in the  program.
American Growers also funded some expenses not directly related to the  sale and service of federally funded crop insurance, such as trips to resort  locations. These expenses, among others, created operating costs that  were greater than the average operating expenses of other companies in  the industry. Overall, American Growers’ expenses, as a percentage of  premium sold, were about 11 percent higher than the average expenses of  the other companies. In other words, American Growers had expenses of  about $30 for every $100 of premium it sold while other companies had  expenses of about $27 for every $100 of premium sold. Salaries at American  Growers averaged 15 percent higher than at other companies. In addition,  American Growers spent twice the rate as other companies on advertising;  and American Growers’ expenses for equipment, including computer  equipment, was twice that of other companies. In addition to the fact that  American Growers’ expenses, as a percent of premium sold, were higher  than those of other companies, American Growers’ expenses were also  higher than the amount of RMA’s reimbursement to the company.
RMA provides companies a reimbursement to cover their expenses related  to the sale and service of crop insurance. This reimbursement is a  preestablished percentage of premiums to reimburse companies for the  expenses associated with selling and servicing federal crop insurance. The  reimbursement rate is set at a level to cover the companies’ costs to sell  and service crop insurance policies. These costs include agent  commissions, staff and office expenses required to process policies and  claims, and loss adjusting expenses. In 1998, Congress reduced the amount  of reimbursement from a cap of 27 cents per dollar of premium a company  sells to 24.5 cents per dollar of premium. This reduction occurred after our  1997 report revealed that companies were basing their request for higher  reimbursement rates on numerous expenses that were not directly related  to the sale and service of crop insurance, such as trips to resorts,  noncompete clauses associated with company mergers, and company  profit-sharing arrangements. Under the current reimbursement  arrangement, companies have no obligation to spend their payment on  expenses related to crop insurance; they may spend the payment in any  way they choose. We found that American Growers spent more than its  reimbursement by paying above average-rates for agent commissions,  marketing efforts, and other items not directly related to the sale and  service of federal crop policies, such as tickets to sporting events and trips  to resorts for agents.
section_title: Purchase of Competitor’s Crop Insurance Business Created Additional Expenses
paragraphs: On June 6, 2001, Acceptance Insurance Companies Inc., (Acceptance) and  its subsidiaries, including American Growers, acquired the crop insurance  business of IGF Insurance Company (IGF) from Symons International  Group, Inc. Acceptance and its subsidiaries raised funds for this purchase  by selling most of its noncrop insurance subsidiaries between September  1999 and July 2001, as part of a larger business strategy to focus on and  expand American Growers’ crop insurance business.
American Growers, through its parent corporation Acceptance, acquired  most of IGF’s book of crop insurance policies, in addition to obtaining  leased office space, company cars, and related staff to service these  policies. A senior manager at American Growers said that the company’s  strategy was to achieve operational efficiencies by combining the  operations of the two companies. However, he said that this goal was not  achieved as quickly as the company had planned. For example, American  Growers had planned on combining the companies’ two computer systems;  but it was unable to successfully do so, requiring it to keep two staffs of  information technology specialists.
After the acquisition, American Growers grew from the company with the  third largest volume of premium sold to being the largest. However, this  growth also came with higher costs. American Growers’ expenses  increased 63 percent, from 2000 to 2001, the years before and after the  purchase of IGF. In 2000, American Growers had about $117 million in  expenses, but its expenses increased to $191 million in 2001. While the  amount of premium American Growers wrote increased, from about $291  million in 2000 to $450 million in 2001, a 54 percent increase, the amount of  surplus the company kept only increased from $57 million in 2000 to $75  million in 2001, a 31 percent increase. In 2002, American Growers wrote  nearly $632 million in premiums, but without adding to the $75 million  reserve.
section_title: American Growers’ Surplus Was Inadequate to Cover Expenses When Underwriting Gains Did Not Materialize
paragraphs: American Growers’ high expenses led them to spend more than RMA was  reimbursing it for the sale and service of crop insurance. In 2001, for every  $100 RMA provided American Growers to sell and service crop insurance,  the company was spending $130. To pay for its expenses in excess of RMA’s  reimbursement, American Growers planned on making underwriting  profits from the sale of crop insurance. When setting its budget for 2002,  American Growers predicted it would receive an 18 percent underwriting  gain from policies it serviced under the federally reinsured crop program.  However, American Growers’ 10-year history of underwriting gains in the  program was only 16 percent.
American Growers based its 2002 budget on achieving over $86 million in  underwriting gains that year. The company’s profit projections were based,  in part, on retaining a higher percentage of the risk for the policies it sold  than in past years. By retaining a higher percentage of the risk on policies,  American Growers could increase its profits if claims were low.  Conversely, the company increased its exposure to loss if claims were high.
However, widespread drought impacted the company’s ability to achieve  these gains. In June 2002, more than one-third of the contiguous U.S. was in  severe to extreme drought. Total losses for the crop insurance program  increased 33 percent from 2001. In 2001, total losses to the program were  over $3 billion. In 2002, total losses increased to over $4 billion. For the  category of policies for which American Growers retained a higher level of  risk, the loss ratio in 2002 was about 40 percent higher than in 2001,  resulting in the payment of $114 in claims for every $100 it received in  premiums for those policies.
When the underwriting gains American Growers had predicted did not  materialize, losses and expenses depleted the company’s surplus. As a  result, NDOI, which regulates insurance companies domiciled in that state,  declared that the company was operating in a hazardous financial  condition and placed the company in supervision, and later rehabilitation.  On November 22, 2002, NDOI took steps to protect American Growers’  policyholders by issuing a state order of supervision. NDOI ordered the  supervision because the company’s surplus declined from about $75 million  for the year ending December 31, 2001, to about $11 million as of  September 2002. According to the order, the decline in American Growers’  surplus—in excess of 50 percent within a 9-month period—rendered the  company financially hazardous to the public and its policyholders. Under  the order of supervision, American Growers could not sell any new  insurance policies or conduct business beyond those that are routine in the  day-to-day operations of its business, without the approval of the  supervisor appointed by NDOI.
On December 20, 2002, NDOI obtained a court order that placed American  Growers into rehabilitation under the auspices of NDOI. Under  rehabilitation, NDOI appointed a rehabilitator who took control of  American Growers to oversee the orderly termination of the company’s  business and to allow for an orderly transfer of policies to other  companies. The NDOI-appointed rehabilitator assumed the responsibilities  of the board of directors and officers and took control of the day-to-day  management of the company.
section_title: RMA Paid Policyholders’ Claims after American Growers’ Failure
paragraphs: RMA worked in conjunction with NDOI and remaining American Growers’  staff to ensure that claims were paid (see table 4). The claims that were  filed resulted from policyholder losses from the 1999 through 2003 crop  seasons—primarily the 2002 crop season.
After NDOI took control of American Growers, the company had about $35  million in cash. These funds were used, in part, to pay American Growers’  staff and support staff operating under the auspices of NDOI to pay  policyholder claims. When American Growers’ cash reserves were reduced  to $10 million, RMA reimbursed NDOI for additional costs of $40.5 million  to operate the company. When RMA began reimbursing NDOI in February  2003, the vast majority of policyholder claims had been paid (see Fig. 1).  About $317 million, or 77 percent, of the approximately $410 million in  claims were paid by the end of January 2003.
According to an RMA official, while the costs of reimbursing American  Growers’ operations may appear excessive, relative to the amount of  claims paid, the claims that had been paid before February 2003, were  those that could be expeditiously handled. The claims that remained to be  paid—beginning in February 2003—were those that required follow-up to  determine the accuracy of reported information, were difficult to process  due to missing information, or had other problems. Additionally, although  claims had been paid and policies transferred, staff were still needed to  process the transfer of policy-related paperwork to other companies and  resolve lingering issues, such as claims with missing information.
section_title: Rain and Hail’s Proposal to Purchase Selected Assets of American Growers
paragraphs: Prior to NDOI’s declaration of its hazardous financial condition, American  Growers was working to strengthen its financial condition by selling its  insurance business to another insurance provider. In September 2002, as  losses associated with that year’s extensive drought began to materialize,  American Growers realized that the company’s operating expenses and  crop losses were outpacing its income and surplus and advised NDOI and  RMA accordingly. To improve its financial condition, American Growers  attempted to sell its crop insurance business to another insurance  company. On November 18, 2002, American Growers’ parent company,  Acceptance, signed a nonbinding letter of intent setting forth preliminary  terms for the company to sell portions of its crop insurance business to  Rain and Hail LLC (Rain and Hail) for over $20 million pending regulatory  approval.
Rain and Hail asked RMA for authority to transfer American Growers’  policies without having to cancel each policy and rewrite them under its  own name—a concession that would have facilitated the bulk transfer of  the policies. In the past, RMA had allowed this type of transfer only if the  acquiring company agreed to (1) accept all the policies previously  underwritten by the company being purchased and (2) assume all past  liability for those policies. According to RMA, Rain and Hail did not want to  assume any past liabilities for the policies and wanted to retain the right to  select agents and policyholders with whom it wished to contract.  According to RMA, Rain and Hail’s intention was to not accept past  liabilities regarding disputed claims, compliance issues, litigation or  regulatory issues associated with American Growers’ policies and  ultimately to acquire only about one-third of American Growers’ business.
In a letter dated November 25, 2002, RMA rejected Rain and Hail’s request  for exemptions from RMA rules regarding the bulk transfer of policies. The  agency was concerned that waiving the existing rules regarding potential  liabilities and future policy placement would not protect the interests of  policyholders and taxpayers or the integrity of the federal crop insurance  program. RMA was concerned that if it approved the sale of American  Growers’ policies to Rain and Hail, it could have left a significant number of  policyholders without insurance. It also may have left a disproportionate  number of poor performing policies for other insurance providers to  assume. Since reinsured companies are required to accept all policyholders  that apply for insurance regardless of their loss history, RMA was  concerned that its decision would be unfair to other insurance providers  and that any future denial of similar exemptions to other companies would  be challenged as arbitrary and capricious. As a result, RMA informed Rain  and Hail that it could not grant the exemptions it requested.
Accordingly, Rain and Hail announced that it was withdrawing its offer to  purchase American Growers’ business. When we discussed this issue with  Rain and Hail, it concurred that its company was unwilling to accept the  past liabilities associated with American Growers’ policies, but denied it  was not willing to accept all of American Growers’ policyholders. Senior  managers at Rain and Hail said their company was unwilling to accept the  past liabilities associated with American Growers’ policies because they  did not have adequate time to assess the extent of any such liabilities and  the financial implications for Rain and Hail. However, these managers said  that Rain and Hail was willing to accept any farmer who wanted a policy  from the company, but they stated that the company wanted to retain the  right to select which agents it would use to sell and service crop insurance  policies.
Whether the sale of American Growers’ policies to Rain and Hail could  have saved taxpayers all or some of the costs of the dissolution if the  proposed sale had been completed is unclear. A Rain and Hail  representative stated that the sale would have provided a cash infusion that  could have prevented the failure of American Growers.  An Acceptance  representative stated that the sale might have allowed American Growers  to pay remaining claims without having to come under control of NDOI.  However, depending on the details, even with the cash infusion from the  sale of assets to Rain and Hail, the company may still have been found to be  in a financially hazardous condition.
section_title: RMA’s Decision to Pay American Growers’ Agent Commissions
paragraphs: After consultation with NDOI, RMA agreed to pay American Growers’  agent commissions in full, despite the fact that they were paid higher than  industry averages. RMA believed several factors, any one of which could  have resulted in the disruption of policyholders’ coverage, warranted  paying agent commissions in full. First, RMA agreed to pay agent  commissions in full, in part, because NDOI’s position was that as long as  American Growers was under the rehabilitation order instead of in  liquidation, the company’s contracts were valid, enforceable legal  obligations that had to be paid. Second, RMA was concerned that some  agents may have refused to continue to service policyholders if they knew  they would not get paid for their work, and RMA needed agents’  cooperation in ensuring the timely collection of premiums and transfer of  policies to other crop insurance companies. Third, RMA was concerned  that some agents, particularly small agents, could go out of business if not  paid their commissions and would therefore be unable to service claims or  transfer policies. Finally, RMA was concerned that some agents may have  deducted their commissions from policyholder premiums, which could  have made it more difficult for RMA to determine which policyholders had  paid the premiums on their policies.
While RMA could have potentially achieved cost savings of about $800,000  by not paying some of American Growers’ agents’ commissions—the  portion of their $7.6 million in commissions that exceeded industry  averages—agents’ response to such a decision could have also disrupted  service to policyholders and caused RMA to incur additional costs.
Industry opinion varied on whether RMA should have paid agent  commissions in full. According to the former chief executive officer of  American Growers, high commissions paid to agents contributed to  American Growers’ and other companies’ financial troubles. One company  executive expressed concerns that RMA’s actions might make it more  difficult for companies that are holding the line on agent commissions to  continue to hold commissions at a reasonable level. Another representative  was concerned that agents were going to work for the company that paid  the highest commissions, regardless of the company’s financial health,  because RMA had shown that agents would receive their commission  regardless of the company’s status. However, one crop insurance company  representative was concerned about the consequences of not paying agent  commissions, particularly since the agents were not directly responsible  for the company’s failure. Representatives also stated that RMA was  correct in paying agent commissions to ensure agent cooperation, to not  drive smaller agents into bankruptcy, and to maintain the integrity of the  federal crop insurance program.
Finally, RMA’s actions in paying full agent commissions could have  implications for the future of the federal crop insurance program, but it is  unclear how future company and agent practices may be affected by RMA’s  decisions. RMA’s actions could suggest that it might provide similar  financial support in the event of future insolvencies, regardless of company  and agent practices. For example, RMA’s actions could have set a precedent  for high agent commissions, a key factor in the failure of American  Growers, which could, in turn, be a factor in other insolvencies. However,  RMA has stated that it plans to consider each new situation on a case-by- case basis and that agents and companies should not expect the same  treatment as in the case of American Growers. RMA said that a managing  general agent had recently gone out of business and that RMA had not  stepped in to provide relief to agents.
section_title: Comments from RMA
paragraphs: The following are GAO’s comments on the Risk Management Agency’s  letter dated April 28, 2004.
subsections: section_title: GAO Comments
paragraphs: 1. Per RMA’s suggestion, we have provided additional details in this report  noting that NDOI placed American Growers under supervision on  November 22, 2002, and later placed the company under rehabilitation  on December 20, 2002. RMA suggests that the state’s initial action  impacted its flexibility in working with the state and the company. As  we note in our conclusions, better coordination with state regulators  regarding respective authorities and responsibilities in the event of  future insurance provider insolvencies is necessary to ensure that  RMA’s interests are protected. 2. We revised the report to note that some agents are paid a salary rather  than receiving commissions on the premiums from policies sold.  American Growers’ agents received commissions, as do most agents  who sell and service crop insurance.  3. At the time of our review, we noted written procedures based on  regulations for the yearly review and approval of SRA holders and  applicants. However, as noted in this report, these procedures were  insufficient to assess the overall financial health of a company. To the  extent that the final SRA does not fully address oversight weaknesses  identified in our report, RMA should take action to modify its  regulations or other written policies.   4. RMA on-site financial and operational reviews do not appear to focus  on the overall financial health of a company, but rather on internal  controls. However, as a minimum, RMA should coordinate these  reviews with state regulators who periodically review company  operations.
section_title: GAO Contacts and Staff Acknowledgments
subsections: section_title: GAO Contacts
section_title: Acknowledgments
paragraphs: In addition to the individuals named above, David W. Bennett, John W.  Delicath, Tyra DiPalma-Vigil, Jean McSween, and Bruce Skud made key  contributions to this report.
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