Ratemaking for Multi-Peril Crop Insurance

1. Ratemaking for Multi-Peril Crop Insurance CAS Seminar on Ratemaking Thomas Worth, Ph.D. Concurrent Session COM-7 Senior Actuary Philadelphia, PA Research and Development March 21-22, 2004 Risk Management Agency U.S. Dept. of Agriculture

2. Mission of the Federal Crop Insurance Program • “to promote the national welfare... through a sound system of crop insurance” • “provide the means for the research and experience helpful in devising and establishing such insurance.” • FCIC Act, section 502(a), Feb. 16, 1938

3. Industry Structure • A Public-Private Partnership • Federal Government (RMA) • Determines or approves policy terms and premium rates • Subsidizes premium for growers • Provides Program Oversight • Reinsures approved insurance providers (AIP’s) • Reimburses AIP’s administrative and operating expenses

4. Industry Structure • Approved Insurance Providers (AIP’s) • Market and issue policies • Policyholder underwriting • Adjust claims • Retain a portion of underwriting risk

5. Industry Liability

6. Industry Liability

7. Industry Liability

8. Insured Perils

9. Crop Insurance Indemnity

10. Crop Insurance Indemnity Source: US Drought Monitor http://drought.unl.edu/dm Map issued July 23, 2002

11. Crop Insurance IndemnityGross Loss Ratios for the Crop Insurance Program

12. Insurance GuaranteeYield Insurance • Yield Guarantee = Actual Production History (APH) x Coverage Level • Indemnity = Max[Yield Guarantee – Realized Production, 0] x Established Price Per Unit • APH based on historical average yield • Coverage Level varies from 50% to 85% • Deductible = 1- Coverage Level

13. Insurance GuaranteeYield Insurance • Example • Yield Guarantee = 100 bushels per acre x 65% or 65 bushels per acre • Assume realized production is 50 bushels per acre and the establish price is $2.00 per bushel. • Indemnity = (65 – 50) x $2.00 or $30 per acre

14. Insurance GuaranteeRevenue Insurance • Revenue Guarantee = Actual Production History (APH) x Expected Price x Coverage Level • Indemnity = Max[Revenue Guarantee – (Realized Yield x Realized Price), 0] • Expected and Realized Prices are determined by futures contracts on a commodities exchange.

15. Insurance GuaranteeRevenue Insurance • Example • Revenue Guarantee = 100 bushels per acre x $2.00 per bushel x 65% or $130 per acre • Assume realized production is 50 bushels per acre and the Realized Price is $2.50 per bushel. • Indemnity = ($130 – $125) or $5 per acre

16. Ratemaking Method • Pure Premium (Loss Cost) Method • Average loss per unit of exposure • Premium is not loaded for program expenses. • AIP administrative and operating costs are paid for separately

17. Assumptions • The average loss cost is a reasonable estimate of future losses • Historic series covers a reasonable length of time • Data is comparable over time • Data can be adjusted to a common unit of measure

18. Rate Basis • County/Crop • Annual loss-cost ratios (LCR’s) from 1975 to present.

19. Rating ProcessAdjusting Loss and Exposure to a Common Unit • Historic data is adjusted to a common coverage level -- 65%. • Most business is around this coverage level. • The liability and indemnity of all growers in a county are adjusted to reflect the values that would have been reported had the coverage been purchased at the 65% level. • Adjusting lower coverage levels up to 65% requires estimation.

20. Rating ProcessDevelop Unloaded County Base Rates • Adjusted data is used to derive historic annual LCR’s for each crop and county. • Each county’s LCR is capped at the 80th percentile. • Losses above the cap are pooled at the state level • Each county’s capped LCR is averaged with those of surrounding counties. • The amount of weight given to surrounding county LCR’s is determined by a credibility measure

21. Rating ProcessDevelop Loaded County Base Rate • Several loads are applied to the unloaded county base rate. • Disaster Reserve Factor • State Excess Load • Prevented Planting Load • Unit Division Factor

22. Rating ProcessCalculate Individual Rate – Relative Yield • The county rate reflects rates for growers whose average yield is at the county average yield. • Probability of loss is correlated with grower’s average yield relative to the county average yield. • The probability of loss is lower for growers with an average yield that is above the county average. • Vice-versa. • [Grower Yield/County Avg Yield]Exponent

23. Rating ProcessCalculate Individual Rate – Relative Yield

24. Rating ProcessCalculate Individual Rate – Coverage Level • County base rate is for the 65% coverage level. • Rate is adjusted by a coverage level differential (factor) to derive a rate for other coverage levels. • The differential varies by county base rate.

25. Rating ProcessCalculate Individual Rate – Coverage Level

26. Rating ProcessSummary • The final rate is the county base rate with cumulative adjustments. • Relative Yield • Coverage Level • Unit Division Factor • Type Practice Factors

27. Standard Reinsurance Agreement • Reimbursement for Administrative and Operating expenses. • 22% of premium on average. • Risk sharing with AIP’s • AIP’s must accept all eligible producers. • Large systemic risk. • AIP’s may place policies in one of 3 reinsurance funds. • Commercial (greatest risk/gain), Assigned Risk (least risk/gain), or Developmental (in between) funds

28. Standard Reinsurance Agreement

29. Standard Reinsurance Agreement

30. Standard Reinsurance Agreement

31. Standard Reinsurance Agreement • Agricultural Risk Protection Act of 2000: • Government “may renegotiate the Standard Reinsurance Agreement once during the 2001 through 2005 reinsurance years.” • Negotiations are under way. • An initial draft of the new SRA is available on RMA’s website.

32. Thank You • Visit the RMA website for more information: www.rma.usda.gov