Second, a state excess load adds a provision for the excess indemnity excluded from the LCR in the unload rate calculation. It is equal to the state excess indemnity (i.e., the sum of the county excess indemnities at the state level) divided by the state adjusted liability (i.e., the sum of the county adjusted liability), with a minimum of 1% (cupping) and a maximum of 5% (capping). The excess indemnity for each county is thus pooled for the entire state and then spread back to each county. The capping process is actuarially justified by the fact that catastrophic events lack statistical credibility.

Third, a prevented planting load is added as a provision for losses due to crops never planted because of external factors which are not directly related to yield loss.

Finally, the rate loaded by the previous components is loaded by the unit division load, which takes into account that indemnity is not computed for an entire farm but rather for each division of farm.

# _Capping rate changes_

The implied base rate derived above is divided by the current base rate to produce a normalized loss ratio. This loss ratio is compared to a pre-determined schedule of rate changes centered at the mandated target loss ratio of 107.5%. The current base rate is then adjusted to meet this target loss ratio, if necessary. However, public policy considerations force the rate change to range between –5% and 10% of the current base rate. The imposition of such limits, based on political considerations, is to stabilize premiums paid by producers from year to year.

# _Update_

The rates developed to this point have used aggregate data. They are then adjusted to take into account individual characteristics: farming practices, coverage level and average yield. Studies have shown that producers with lower APH yields also have significantly higher variability of yields. For this reason, different Rate Classes are established for producers with different APH yields. Finally, other expenses and capital costs are added.

APH premium rates are calculated by multiplying the premium rate at 65 percent coverage level by a rate relativity factor that is the same for all crops and all regions. For example, to find a 75 percent APH rate, one multiplies the 65 percent premium rate by 1.53. Babcock, Hart and Hayes (2002) show that these constant rate relativities may be inconsistent with the underlying probability distribution of yields and therefore premium rates may not be actuarially sound. They show that farmers who plant crops in region where the 65 percent pure premium rate is above 3 percent face unsubsidized premiums that are too high at the 80 percent coverage level. This discrepancy may explain why 65 percent coverage was the most popular coverage level in higher-risk areas.

# **_5.2.  Rating a New Insurance Scheme_**

In the absence of historical indemnity data, indemnity payments of a new crop insurance scheme can be simulated from the yield data. As discussed in Section 3, the data generating process of yields can be estimated through parametric or non-parametric methods, depending on the data available and a priori beliefs. The distribution function of indemnity payments is thus derived from the distribution function of yields. However, this procedure does not capture the impact of insurance on farming practices, contrary to the ratemaking procedure described earlier. In other words, the yields observed are those 24