Federal crop insurance protects participating farmers against crop losses caused by perils such as droughts, floods, hurricanes, and other natural disasters. The federal program—which began on an experimental basis in 1938 after private insurance companies were unable to establish a financially viable crop insurance business—was restructured and greatly expanded by key legislation in 1980 and 1994. A major component of the 1980 legislation was the enlistment, for the first time, of private insurance companies to sell, service, and share the risk on federal crop insurance policies. In 1994, the Congress further broadened the program by offering farmers catastrophic risk insurance. This coverage, established at a minimum level, incorporated elements of the former crop disaster assistance program into crop insurance provided jointly by the U.S. Department of Agriculture (USDA) and private insurance companies. USDA’s Risk Management Agency administers the federal crop insurance program through the Federal Crop Insurance Corporation (FCIC). FCIC pays the participating companies a fee, called an administrative expense reimbursement, that is intended to reimburse the companies for the reasonable expenses associated with selling and servicing crop insurance to farmers. The reimbursement is calculated as a percentage of the premiums paid, regardless of the expenses incurred by the companies. In addition to this reimbursement, participating insurance companies share with FCIC any gains or losses—known as underwriting gains and underwriting losses—that result from the insurance policies they sell. In 1994, 22 participating insurance companies received $395 million from the program—about $292 million in administrative expense reimbursements plus about $103 million in underwriting gains. In 1995, 19 participating insurance companies received $506 million from the program—about $373 million in administrative expense reimbursements plus about $133 million in underwriting gains. Expense reimbursements and underwriting gains varied by company according to the amount of premiums written, the amount of risk retained, and the management of the risk retained. Federal crop insurance offers farmers two primary types of insurance coverage—catastrophic and buyup. Both types of coverage are available for most major crops under the changes made by the Congress in the Federal Crop Insurance Reform and Department of Agriculture Reorganization Act of 1994 (P.L. 103-354, Oct. 13, 1994, title I). This act created catastrophic risk insurance as a replacement for expensive crop disaster assistance. Catastrophic insurance provides farmers with protection against extreme crop losses for a small processing fee. Buyup insurance provides protection against more typical and smaller crop losses in exchange for a farmer-paid premium. Participating insurance companies offer both types of insurance, whereas USDA’s Farm Service Agency (FSA), through its local offices, offers only catastrophic insurance. Under the terms of a negotiated agreement, participating insurance companies sell crop insurance and process any claims in exchange for an administrative expense reimbursement and for the opportunity to share in the potential for underwriting gains. The government pays the total premium for catastrophic insurance and a portion of the premium for buyup insurance. FCIC establishes the premiums, terms and conditions for both types of insurance. Under the 1994 reform act, farmers who had not previously purchased crop insurance were required to purchase at least catastrophic insurance coverage if they signed up for USDA’s annual commodity programs; obtained USDA’s farm ownership, operating, or emergency loans; or contracted to place land in the Conservation Reserve Program. Subsequently, the Federal Agriculture Improvement and Reform Act of 1996 (P.L. 104-127, Apr. 4, 1996) eliminated this mandatory linkage by permitting farmers, effective for crops harvested in 1996, to forgo crop insurance for any given crop without losing eligibility for other programs, provided they waive all rights to any possible crop disaster assistance in connection with the particular crop. Catastrophic insurance, which protects farmers against extreme losses, is often referred to as minimum coverage because it provides protection at the lowest production and price levels offered. Catastrophic insurance pays farmers only when they experience production losses greater than 50 percent of their normal crop. A normal crop is determined on the basis of a farmer’s production history as reported to USDA’s local office or to the insurance agent. For production losses greater than 50 percent, farmers are paid 60 percent of FCIC’s projected market price for the crop. Farmers desiring protection above the minimum price or production levels provided by catastrophic insurance can purchase buyup insurance. Unlike farmers who purchase catastrophic insurance, farmers purchasing buyup 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 the coverage level, 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 unit price, farmers choose whether to value their insured production at FCIC’s full projected market price or at a percentage of the full price. FCIC adjusts farmers’ premiums according to the production and price levels selected. The following example illustrates how a claim payment is determined under catastrophic insurance, which insures 50 percent of production and 60 percent of the price. A farmer whose normal crop production averages 100 bushels of corn per acre and who chooses catastrophic insurance will be guaranteed 50 percent of 100 bushels, or 50 bushels per acre. Assuming that FCIC had estimated the market price for corn at $3 per bushel, the farmer will be guaranteed a price of 60 percent of $3, or $1.80 per bushel. The farmer’s total coverage per acre will be $90 (50 bushels x $1.80 per bushel). This total amount will be paid in the event of a complete crop failure. Should an event like drought cut the farmer’s actual harvest from 100 to 60 bushels, the farmer will not receive a payment because, in this example, catastrophic insurance only pays if the yield drops below 50 bushels per acre. If a more severe problem caused the yield to fall to 25 bushels per acre, the farmer will be paid for the loss of 25 bushels per acre—the difference between the insured production level of 50 bushels and the actual production of 25 bushels. In this case, catastrophic insurance will pay the farmer’s claim at $1.80 x 25 bushels, or $45 per acre. If this same farmer chooses buyup insurance at the 75-percent coverage level, the farmer will be guaranteed 75 percent of 100 bushels, or 75 bushels per acre. Assuming that the farmer had chosen the maximum price coverage of 100 percent, and that FCIC had estimated the market price for corn at $3 per bushel, the farmer’s price coverage will be $3 per bushel. Accordingly, the farmer will have coverage in the event of a total crop loss of $225 per acre (75 bushels x $3 per bushel). Should drought or other perils cut the farmer’s actual harvest to 60 bushels, the farmer will be paid for the loss of 15 bushels per acre—the difference between the insured production level of 75 bushels and the actual production of 60 bushels. In this case, buyup insurance will pay the farmer’s claim at $3 x 15 bushels, or $45 per acre. In the event of a more severe loss that reduced production to a level of 25 bushels per acre, 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. In this case, buyup insurance will pay the farmer’s claim at $3 x 50 bushels, or $150 per acre. According to a written agreement between FCIC and participating insurance companies—called the standard reinsurance agreement—FCIC pays the participating companies a uniform reimbursement for administrative expenses at a preestablished percentage of total premiums to deliver—sell and service—catastrophic and buyup insurance. This base rate can be, and has been, supplemented to provide additional funding in years when administrative costs were high because of excess losses or when other factors require the companies to conduct additional work. Beginning in 1994, as part of the agreement, FCIC required each participating company to report its delivery expenses to FCIC for the prior year to help determine the long-term adequacy of the reimbursement rate. In addition to providing an administrative expense reimbursement, this agreement governs the participating companies’ share of any underwriting gains or losses resulting from the policies they sell. FCIC does not directly reimburse the participating companies for their actual costs of administering the program. Instead, FCIC pays all participating companies a uniform administrative expense reimbursement at a preestablished percentage of total premiums (including the farmer-paid premium, government premium subsidy for buyup insurance, and the imputed premium for catastrophic insurance). FCIC pays participating companies an administrative expense reimbursement that is intended to reimburse them for the expenses that can be reasonably associated with the sale and service of federal crop insurance, including the expenses associated with adjusting claims. Because the reimbursement is not tied to specific expenses, the companies are not obligated to spend the payment they receive on selling or servicing crop insurance policies; the payments can be used in any way the companies choose. Since 1980, in fact, the reimbursement rate has evolved as a result of negotiations between FCIC and the participating companies and budget concerns and has not been based on a systematic evaluation of companies’ expenses. For buyup insurance, the administrative expense reimbursement base rate under the standard reinsurance agreement has declined from a high of 34 percent of total premiums between 1988 and 1991 to 31 percent between 1994 and 1996. In 1995, the administrative expense reimbursement for buyup insurance totaled 32.6 percent of buyup premiums.