Federal Crop Insurance Ratemaking and Profitability Projections
Casualty Actuarial Society Seminar on Ratemaking San Antonio Marriott RivercenterSan Antonio, TexasMarch 27-28, 2003COM-7
Richard Bill, FCAS Country Insurance & Financial Services
Whose Line is it Anyway?
Overview• Perils Insured• Coverage• Federal/Private Partnership• Ratemaking Considerations• Profitability Considerations• Standard Reinsurance Contract
(SRA)• Projected Profitability
Perils Insured• Too Dry (Large Area)• Too Wet• Hail• Insects• Prevented Planting• All other Risks except poor farming
practices• Price (Revenue products only)
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
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
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
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
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
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
Size of Industry• Almost 80% of US cropland Insured
• $37 Billion of Liability
• $2.9 Billion of Premium
• Less than 20 companies participating
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
Private Industry Role• Provides distribution system
through their agents• Issues policies on their paper• Adjusts Claims• Retains risk after Government
Reinsurance
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
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
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
Profitability Considerations
Federal CropCW Gross
Loss Ratios
0%50%
100%150%200%250%300%
1981 1984 1987 1989 1992 1995 1998 2001
Loss Ratios 100%
Less than 11 - 1.5Greater than 1.5
Aggregate Loss Ratio, 1981 - 2002
Source: Joe Glauber’s Presentation
A&O per dollar written premium
$0.00$0.05$0.10$0.15$0.20$0.25$0.30$0.35
Joe Glauber’s Presentation
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???
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
3 Categories of Funds (Companies choose)
Assigned Risk
Developmental
Commercial
Policies that are significantly under priced with the risk being primarily born by the Federal Govt.
Policies that are better, but not good enough for the companies to take full risk
Policies that the companies chose to take the maximum amount of risk
3 Types of PoliciesCat Revenue All Other
Low level of coverage, fully subsidized (except small policy fee)
Guarantee based on anticipated Price X Yield Per Acre X Coverage Level
All other including Yield guarantee
Commercial Fund Stop Loss Cover-All Other Policies (101.6% Max loss Retention)
Retention:
100% LR
Layer Ceded toGovt
Points Retained
1st Layer 60 Pts 50% 30 pts
2nd Layer 60 Pts 60% 24 pts
3rd Layer 280 Pts 83% 47.6 pts
4th Layer Above 500%
100% 0 pts
Stop Loss Premium (Max Profit Ret. 48.9%)
Below 100% LR
Layer Charge Pts Retained
.1st Layer 35 Pts 6% 32.9 Pts
2nd Layer 15 Pts 30% 10.5 Pts
3rd Layer 50 Pts 87% 5.5 Pts
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%
State XYZLognormal Loss Ratio Distribution
Mean = 107.5% Coefficient of Variation = 100%
0% 50% 100% 150% 200%
Loss RatioProbabilityMedianMean
Calculation Of Expected ProfitabilityState XYZ-Commercial Fund-All other
Loss Ratio = 107.5%; COV = 100%
(1) (2) (3) (4) (5)Cumulative Company
Loss Distribution Incremental Avg Loss RetainedRatio F(x) Area Ratio Gain*
From To 0% 50% 30.7% 30.7% 31.8% 45.4%50% 65% 42.5% 11.8% 57.3% 38.3%65% 100% 62.9% 20.4% 81.1% 17.7%100% 160% 81.4% 18.5% 126.0% -13.0%160% 220% 89.9% 8.5% 186.4% -40.5%220% 500% 98.8% 8.9% 304.4% -68.3%500% Plus 100.0% 1.2% 693.8% -101.6%
Weighted Average of Col (3) and Col (5) = Expected Gain = 9.0%
*Based on Reinsurance Contract (SRA)
Expected Profit -Commercial FundBased on Lognormal Distribution
ExpectedLoss Ratio Coefficient of Variation*
0% 50% 75% 100% 125%
92.5% 7.1% 12.0% 13.7% 15.3% 16.8%100.0% 0.0% 7.5% 10.0% 12.1% 13.9%107.5% -3.8% 3.2% 6.4% 9.0% 11.2%115.0% -7.5% -0.9% 2.9% 5.9% 8.5%122.5% -11.3% -4.8% -0.5% 3.0% 5.9%130.0% -15.0% -8.6% -3.8% 0.2% 3.4%137.5% -18.8% -12.2% -6.9% -2.5% 1.0%145.0% -22.5% -15.6% -9.9% -5.2% -1.3%
* Coefficient of Variation for Original Distribution
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
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)
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