The risks associated with natural disasters have always been a part of farming. Historically, farmers assumed these risks as part of the hazards of doing business. Since the 1930s, many farmers have been able to transfer part of the financial losses from these risks to the federal government through subsidized crop insurance. Before 1980, the crop insurance program was smaller, covering fewer crops and locations, and its premiums were generally adequate to pay the claims. Since the program was expanded in 1980 to cover more crops in more locations, it has not been financially stable, paying out more in claims in most years than the premiums the farmers and the government had paid in. To reduce the government’s cost for the crop insurance program, the Congress required that, by October 1, 1995, the U.S. Department of Agriculture (USDA) lower the program’s projected losses from over $1.40 in claims paid for every $1 of premiums taken in to $1.10 or less. In March 1994, USDA issued a plan explaining how it expected to achieve the desired improvement. Federal crop insurance is a program that is relatively simple in concept but highly complex in implementation. Farmers who buy crop insurance can file claims for part of the money that they would otherwise lose when droughts, floods, infestations of insects, or other natural disasters keep them from harvesting their normal expected crop. The size of the claim depends on the extent of the crop loss and the amount of insurance coverage the farmer has purchased. Two types of coverage—catastrophic and additional—are available for most major crops under changes made by the Congress in 1994. Under catastrophic coverage, the government provides a free minimum level of coverage to farmers for a small processing fee. The government pays the premium for this insurance. Farmers must sign up for this program if they sign up for the annual USDA commodity programs; obtain USDA farm ownership, operating, or emergency loans; or contract to place land in the Conservation Reserve Program. They can sign up through their local Consolidated Farm Service Agency office—the USDA agency responsible for administering the program—or obtain their policy from a participating private insurance agent. The free catastrophic program protects farmers against extreme losses. The program pays farmers only when they are able to harvest less than 50 percent of their normal crop. The normal crop is determined on the basis of a farmer’s past production history as reported to the USDA office or insurance agent. If a farmer does not report past production, that farmer’s normal crop is determined by using a modified average production level for the county, reduced by a discount, because of the uncertainty of the farmer’s expected production. For losses in production below the 50-percent level, farmers are paid 60 percent of USDA’s estimated market price. Farmers can purchase additional insurance from participating private insurance companies. As authorized by the 1980 act redesigning and expanding the program (P.L. 96-365, Sept. 26, 1980), the managers of USDA’s crop insurance program have entered into reinsurance agreements authorizing the participating insurance companies to sell the insurance and process the resulting claims. The government pays part of the farmers’ premium. Farmers who purchase this additional insurance must choose both the coverage level (the proportion of the crop to be insured) and the unit price (e.g., per bushel) at which any loss is calculated. With respect to level of production, farmers can choose to insure as much as 75 percent of normal production (25-percent deductible) or as little as 50 percent of normal production (50-percent deductible) at different price levels. With respect to the unit price, farmers choose whether to value their insured production at USDA’s full estimated market price or at a percentage of the full price. USDA sets the premium rates and assigns correspondingly higher premiums for higher production and price levels. The following example illustrates how a claims payment is determined. A farmer whose normal crop production averages 100 bushels of corn per acre and who chooses to buy insurance at the 75-percent coverage level will be guaranteed 75 percent of 100 bushels, or 75 bushels per acre. Assuming that the farmer had chosen the maximum price coverage and that USDA had estimated the market price for corn at $2 per bushel, the farmer would have total coverage of $150 per acre. Should something like drought cut the farmer’s actual harvest to 25 bushels, the farmer will be paid for the loss of 50 bushels per acre—the difference between the insured production level of 75 bushels and the actual production of 25 bushels. The insurance would pay the farmer’s claim at $2 x 50 bushels, or $100. In addition, the crop insurance program’s “prevented planting” provision pays farmers who have purchased insurance but never planted crops because of adverse weather conditions. These farmers are entitled to claims payments ranging from 35 to 50 percent of the coverage they purchased, depending on the crop. Critical to the success of the crop insurance program is aligning the premium rates with the risk each farmer represents. The riskiness of growing a particular crop varies from location to location, from farm to farm, and from farmer to farmer. If the rates are too high for the risk represented, farmers are less likely to purchase insurance, lowering the program’s income from premiums. Conversely, if the rates are too low, farmers are more likely to purchase crop insurance, but because the rates are too low, the income from premiums will be insufficient to cover the claims. To align crop insurance premium rates with the risk represented, USDA establishes rates that vary by crop, location (county), farm, and farmer. Because of all the combinations involved, literally hundreds of thousands of premium rates are in place. For this review, we examined crop insurance rates at the state level for six major crops: barley, corn, cotton, grain sorghum, soybeans, and wheat. For these crops, the average premium rates for crop insurance purchased at the 65-percent coverage level in 1994 varied widely among the states. As shown in figure 1.1, the average rates ranged from a low of $1.95 per $100 of insurance coverage for wheat in one state to a high of $32.94 per $100 of insurance coverage for soybeans in another state. To adjust the hundreds of thousands of rates it publishes each year, USDA goes through a multistep process involving considerable computer analysis and judgment. USDA’s objective is to set the rates that each farmer pays according to the risk associated with the farmer’s location, crop, past production, and past losses. For the six crops we reviewed, USDA begins its rate-setting process each year by looking at the crop insurance experience over the past 20 years for each county and state. On the basis of a county’s and state’s historical experience, USDA sets a basic rate for each crop in each county at the 65-percent coverage level for average production. Using this basic rate, USDA makes adjustments to establish rates for other coverage levels and for farmers whose production levels are higher or lower than the county’s average. This latter adjustment is based on USDA’s research showing that farmers with higher-than-average production levels are less likely to experience losses. USDA aligns rates with risk in several other ways as well. For example, it imposes an additional premium on those farmers who insure individual fields rather than all fields combined, purchase hail insurance, and are high risk as evidenced by frequent and high experience with claims. Moreover, for those farmers who have production records for fewer years than required to establish the amount of production that can be insured, USDA uses the modified average production level for their county, adjusting the production down according to the number of years for which the farmers have provided records. USDA’s rate-setting methodology is described in more detail in appendix I. Since 1980, when the Congress redesigned and expanded the crop insurance program to be the primary form of agricultural disaster assistance, the program has not been financially sound. USDA has regularly paid out more in claims than it received in premiums paid by farmers and the government. Two key requirements of the 1980 legislation were to (1) operate the program on a financially sound basis and (2) eliminate the need for government-funded disaster assistance by having most farmers buy crop insurance. The program has never met either requirement. First, to be financially sound, the program needed to realize more income from premiums, including the government’s subsidy, than it paid to settle farmers’ claims so that it could build up a cash reserve to pay farmers’ claims in years of catastrophic loss. As shown in figure 1.2, the claims paid per $1 of premium (including the government’s subsidy) for crop years 1981 through 1994 varied greatly from year to year, averaging $1.41. During this period, claims exceeded premiums by a total of $3.3 billion. The highest claims payments in relation to premiums were in 3 catastrophic years—resulting from severe droughts in 1983 and 1988 and excessive moisture and severe flooding in 1993. Excluding the 3 catastrophic years, the average claim per dollar in premiums was $1.22. Thus, even in years without catastrophic losses, the program consistently operated at a loss; catastrophic years just made the situation worse. Moreover, the Congress’s goal of having most farmers buy crop insurance to eliminate the need for direct government disaster payments was not reached. Farmers never insured more than 40 percent of their eligible acres, and the pressure for direct disaster assistance continued. In fact, the Congress passed emergency disaster legislation to cover several crop years in the 1980s and each crop year from 1988 through 1993. Over the period 1981-93, USDA paid farmers about $11 billion in disaster assistance payments. Adding this to the government’s $8 billion share of the cost of crop insurance, the government’s spending to assist farmers who lost crops exceeded $19 billion over the 13-year period.