GAO recommends lowering expected rate of return for crop insurance

The U.S. Government Accountability Office (GAO) is recommending that Congress consider legislation to reduce the expected rate of return for companies that sell federal crop insurance.

To implement the federal crop insurance program, the U.S. Department of Agriculture (USDA) partners with private insurance companies, which sell and service policies. In 2010, USDA negotiated a set rate of return with these companies—that is, how much companies can profit from these insurance policies. However, GAO found that this expected rate of return was too high compared with market conditions. Reducing it could save the federal crop insurance program hundreds of millions of dollars a year.

Thus, GAO states that Congress should consider repealing the Agricultural Act of 2014 provision that says any revision to the agreement with insurance companies not reduce their expected underwriting gains. Further, legislators should direct the USDA’s Risk Management Agency (RMA) to adjust companies’ target rate of return to reflect market conditions and assess the portion of premiums that companies retain and adjust it, if warranted.

The RMA makes payments to insurance companies to cover the cost of selling and servicing federal crop insurance policies. A cap on these payments stabilized them at about $1.4 billion per year from 2011 to 2015. In capping the annual payment to companies, RMA sought to make these payments more stable and dependable for companies and agents, but payments have fluctuated widely by crop, state, and county because the method RMA uses for calculating payments has allowed large fluctuations at the policy level.

Specifically, RMA calculates payments based on such factors as crop price, and a price change can cause a change in the payments. For example, the average payment for almonds decreased by 42 percent from 2010 to 2011 but increased by 75 percent from 2013 to 2014. RMA could reduce such fluctuations by considering adjustments to how the payments are calculated when it negotiates a new agreement with companies.

The crop insurance program’s target rate of return—the annual rate of return that insurance companies are expected to earn—does not reflect market conditions. A 2009 USDA-commissioned study found that a 12.8 percent return was reasonable for 1989 through 2008 based on economic factors, such as interest rates. RMA used this study in 2010 negotiations with insurance companies to set a 14.5 percent target rate. According to GAO’s analysis, which updated information in the study for 2009 through 2015, the reasonable rate of return declined, averaging 9.6 percent.

At the 2015 premium level, if the target rate were reduced by 4.9 percentage points, from the current rate of 14.5 percent to 9.6 percent, the companies’ expected annual underwriting gains would decrease by $364 million.

Also, the portion of premiums retained by companies could be reduced so that they would earn a rate of return on a smaller premium base. The portion of premiums retained by companies has changed little, averaging 77 percent since 2000, while USDA has retained the rest. Reducing the premiums that companies retain by 5 percentage points could reduce companies’ annual underwriting gains by up to $100 million.

However, a provision in the Agricultural Act of 2014 requires any such changes would require congressional action to repeal this provision. If Congress were to direct RMA to adjust the target rate in future negotiations or assess the portion of premiums companies retain, the agency could generate significant cost savings for the program.