The objective of the ratemaking process is to derive the premium rate that is used in the above formula. Fundamentally, a premium rate is an estimate of the expected value of future costs. One of its largest components is typically the provision for losses. This component is derived from the expected loss component, which is represented by the loss cost ratio (LCR), i.e., indemnity divided by liability. The LCR is a measure of loss per unit of exposure. Because loss costs vary between crops and locations, the MPCI procedure establishes rates from each crop and each county. This empirical approach based on observed losses typically precludes from the use of individual data because it is rare that a single insured is sufficiently large to allow the insurer to derive the LCR solely from the insured’s loss history. Consequently, the aggregate experience of a group of similar risks is considered in developing premium rates. The main five steps of the MPCI procedure are detailed below (Josephson et al. 2000) _Adjusting loss and exposure to a common coverage level_ MPCI is offered at various coverage levels, generally from 50% to 85%. In order to use extensively the historical data, the first step in the ratemaking process is to adjust the data to a common coverage level (CCL) set at 65%.

The adjustment of the liability simply requires one to multiply the current liability by the ratio of the common coverage level to the CCL. For example, to adjust the liability from 75% to 65%, one multiplies the current liability by the ratio 0.65/0.75.

The adjustment of the indemnity is less simple and two cases need to be considered. For coverage levels higher than the CCL, the adjusted indemnity is equal to the unadjusted indemnity minus the reduction in liability, for all actual yields (in percentage of APH yield) lower than the CCL. The adjusted indemnity is zero for other actual yields. For coverage levels lower than the CCL, the adjustment procedure is more difficult because only the individual insured loss is known. For example, adjusting from a 50 percent coverage level to a 65 percent coverage level is problematic because actual yields higher than 50% of the AHP yields did not generate indemnity payments. RMA has developed an adjustment procedure based on an interpolation between minimum and maximum bounds.

An alternative adjustment process would be to treat each coverage level separately and to develop rates for each of them. While this segregation process may capture the differences in loss experience for producers selecting different coverage levels, it can result is less stability and predictability of expected losses due to the greater statistical variation. The adjustment process used by RMA is considered actuarially sound by several experts (see, for example, Josephson et al 2000).

_Derivation of county unloaded base rates_ The adjusted LCR is derived from the adjusted indemnity and the adjusted liability, for each year. It reflects the percentage of liability that would have been paid to producers if they had all purchased 65% coverage insurance.

The first issue is about the number of years to be used in the LCR projection. The year to year variability in loss costs and the long term trend have to be taken into account. The MPCI process uses years from 1975. The long-term average LCR is simply based on 22