A Lottery That’s a Sure Bet
Crop Insurance Lottery: Crop "Insurance" is a Misnomer
The commercial insurance industry is one of the largest sectors of the U.S. economy. In 2013 it directly employed about 2.3 million people and collected $1.1 trillion in premiums, approximately 7.7 percent of the national gross domestic product. Insurance companies earn revenue from premiums and from the returns on the investments they maintain as a capital reserve. Their expenses include the cost of claims adjustments, the cost of marketing the policies, the cost of paying off claims and other overhead. When revenue exceeds these expenses, the company makes a profit. State insurance commissions regulate the industry to ensure that companies have the financial resources to pay off claims and that the policies are fairly written.
Because a portion of premiums is used to pay the non-claim expenses of operating an insurance company, customers do not expect to regularly get back more in claims than they pay in premiums. If they did, the company could not remain in business.
The Federal Crop Insurance Program, however, operates nothing like private commercial insurance. Instead, the government pays a large share of the farmers’ premiums and covers the expenses incurred by the companies to sell and service the policies. Moreover, what crop insurance considers a “loss” that triggers a payout bears little resemblance to the actual financial losses a farm family has experienced.
It is, in fact, a misnomer to apply the word “insurance” to the heavily subsidized program. The subsidies provided to the farmers and companies are so large and "losses" so frequntthat many growers can expect to receive much more in claims than they pay in premiums year after year.
Data on premiums versus claims show that the gains can be both frequent and large. The program operates more like a lottery than an insurance plan. For farmers, buying a subsidized federal crop insurance policy turns out to be a very good bet.
Farmers Make Money on Crop Insurance
There are two ways of measuring a farmer’s gains from purchasing a subsidized crop insurance policy:
- calculating the rate of return on the premium (the amount of net claim payouts expressed as a percent of the premium paid); and
- estimating net returns (the amount of claim payouts minus the premium paid).
When farmers get more back in payouts than they paid in premiums, both measures are positive. Conversely, if a farmer pays more in premium than he or she gets back in payouts, both the rate of return and net return are negative.
The rate of return when there has been no payout is negative 100 percent, and the net return equals the negative value of the premium paid. Similarly, a 100 percent rate of return means the farmer got a payout that was twice the size of the premium paid. The largest loss a farmer can experience from investing in a crop insurance policy comes when he or she gets no payout at all.
Figure 1 shows both rates of return and net returns for all insured farmers from 2001 to 2014. During this period, farmers in aggregate achieved a positive rate of return on their premium dollars every single year, which means that claims payouts exceeded premiums paid for 15 years in a row.
Figure 1. Aggregate Farmer Returns on Crop Insurance: 2001 – 2014
Source: Calculated from USDA-RMA Summary of Business Reports.
Growers’ aggregate rate of return from buying a crop insurance policies ranged from a “low” of 29 percent in 2007 to a high of 324 percent in 2012. That means that in 2007 farmers, in aggregate, got back what they paid in premiums plus 29 percent of that amount. The 324 percent rate of return for 2012 means that farmers got back more than four times what they paid in premiums.
The sharp growth in net returns since 2011 reflects both higher crop values as well as higher claims rates. From 2000 to 2014, the average rate of return from crop insurance was 120 percent per year. In contrast, even risky private-sector investments yield expected returns of around 15 to 25 percent. And as we all know, the return on the lowest-risk investments has been practically zero since 2009.
Farmers’ Gains Are Not Guaranteed
The data clearly demonstrate that in aggregate, crop insurance has been quite a good bet for U.S. farmers. But not every farmer in every state has enjoyed such favorable returns. Most do not receive a claim check every year. An individual farmer’s rate of return will be much more variable than shown in Figure 1, which also masks the large variability in the average rate of return between different crops and regions.
Figure 2 shows the annual rate of return on crop insurance for three state-crop combinations over the 26 years from 1989 to 2014.
Figure 2. Annual Rate of return on Crop Insurance for Three State/Crop Combinations
Source: Calculated from USDA-RMA Summary of Business Reports
At one extreme, Arkansas corn growers in aggregate enjoyed a 900 percent rate of return on crop insurance in 1998. And in 2011 Texas cotton farmers achieved almost a 700 percent return. In contrast, Illinois soybean farmers in aggregate experienced a negative return on crop insurance in 18 out of the 26 years shown. Their maximum return was just under 200 percent in 2012. The average annual rate of return on crop insurance over this period was minus 7 percent for Illinois soybean farmers, 247 percent for Arkansas corn farmers and 203 percent for Texas cotton farmers.
In three states – Arkansas, Florida and Mississippi – claims payouts exceeded premiums paid every year. In contrast, in four Corn Belt states – Minnesota, Iowa, Illinois and Indiana – claims payouts exceeded premiums in fewer than half the years.
 “Annual report on the insurance industry.” Federal Insurance Office of the US Treasury, June 2013.