Whose Line is it Anyway?

1. Whose Line is it Anyway? Federal Crop Insurance Ratemaking and Profitability Projections Casualty Actuarial Society Seminar on Ratemaking San Antonio Marriott Rivercenter San Antonio, Texas March 27-28, 2003 COM-7 Richard Bill, FCAS Country Insurance & Financial Services

2. Overview • Perils Insured • Coverage • Federal/Private Partnership • Ratemaking Considerations • Profitability Considerations • Standard Reinsurance Contract (SRA) • Projected Profitability

4. Perils Insured • Too Dry (Large Area) • Too Wet • Hail • Insects • Prevented Planting • All other Risks except poor farming practices • Price (Revenue products only)

5. Seven Prerequisites of Insurable Risk#7-”Unlikely to produce loss to a great many insured units at the same time”Mehr & Cammack; Principles of Insurance; 1972

6. Coverage Provided • The policy Guarantees the yield of the crop or the revenue from the crop • Loss is not one event but is based on crop production (and price for Revenue Ins) at the end of the season

7. Yield Product Guarantee • Yield Guarantee=Actual Production History (APH) X Coverage Level • Example - 100 Bushels per acre X 75% Coverage Level = 75 Bushels per acre

8. Revenue product Guarantee • Revenue Guarantee=APH X Anticipated Price Per Bushel X Coverage Level • Example - 100 Bushels per acre X $2 per Bushel X 75% = $150 per acre

9. Coverage Level • Generally from 50% to 85% • Acts like a deductible • Example – 75% coverage level is really a 25% Deductible. • A 25% loss is needed before any payment is made

10. Federal/Private Partnership • Began strictly as a Govt Program in 30’s • Small program until Private Industry began participating in the early 80’s • Private Companies took over all delivery in the 90’s • Safety Net for Nation’s Farmers • Intended to replace Free Ad Hoc Disaster Payments

11. Size of Industry • Almost 80% of US cropland Insured • $37 Billion of Liability • $2.9 Billion of Premium • Less than 20 companies participating

12. Federal Government Role • Programs and Policy language • Rates (All companies charge same rates) • Expense reimbursement to the companies (Expenses are not built into the rate) • Premium subsidies to the Farmers (about 60% in 2002) • Oversight • Provides Reinsurance to Private Companies

13. Private Industry Role • Provides distribution system through their agents • Issues policies on their paper • Adjusts Claims • Retains risk after Government Reinsurance

14. Unique Ratemaking Considerations • Paper in the Winter 2000 Forum by Schnapp, Driscoll, Zacharias, and Josephson which describes ratemaking in detail • Loss is not one event but is based on crop production at the end of the season • Long Experience Period Needed • Variability of Loss Ratio • Cyclical Weather patterns

15. Ratemaking (Cont.) • Losses and Liability are converted to common coverage level • Basic ratemaking unit is County. A Loss Cost per $100 of Liability is Calculated for each County by year • Catastrophe procedure

16. Ratemaking (Cont.) • A maximum of 60% credibility is assigned to the County Loss Cost • The remainder of the credibility is assigned to “Simple circle Loss Cost “ which is a weighted average of the surrounding Counties Loss Cost • Loading for Unforeseen Losses

17. Profitability Considerations

19. Aggregate Loss Ratio, 1981 - 2002 Source: Joe Glauber’s Presentation

20. A&O per dollar written premium Joe Glauber’s Presentation

21. Projected Loss Ratios • 1980-2002 Average Loss Ratio was 127% • Loss Ratio in the Federal Budget is 107.5% for 2003 Fiscal Year • Little if any investment income • How do Companies Make Money???

22. Standard Reinsurance Contract (SRA) • Combination of Stop Loss and Quota Share • Each State stands on its own • Three Categories of Funds with each having three different product types for a total of 9 separate funds • Each of the 9 funds have different reinsurance terms for Stop Loss and Quota Share

23. 3 Categories of Funds (Companies choose)

24. 3 Types of Policies

25. Commercial Fund Stop Loss Cover-All Other Policies (101.6% Max loss Retention)

26. Stop Loss Premium (Max Profit Ret. 48.9%)

27. Modeling Profitability • I used Lognormal Distribution for illustration purposes • Most states appear to have Lognormal Distribution with Original Coefficient of Variation of between 50% and 125%

31. Final Considerations • Profitability varies considerably from state to state • Complex models are available to help decide which funds each policy should be assigned to • Underwriting Gain is reduced because expense reimbursement is inadequate to cover actual expenses

32. Future-Random Thoughts • Revenue policies may become, by far, the predominate coverage sold • Should a different procedure be used to weight County loss cost with surrounding Counties (see Christopherson and Werland, “Using a Geographic Information System to Identify Territory Boundaries”, 1996 Winter Forum)

33. Future (Cont.) • Federal Money is tight and perception is that companies are making too much money • Federal Govt. will renegotiate a new Standard Reinsurance Agreement (SRA) next year • The federal budget includes a provision to reduce industry expense reimbursement by 2 points in spite of the current shortfall • Will there be an impact on the number of companies participating