Is Congress sure a $40,000 limit will only affect “big” farms?

Agri-Pulse just published the comments made during the House hearings on the Farm Bill (Volume 8, No. 21, May 23, 2012). During the hearings, policymakers continue to propose payment limits and the latest is a proposal to limit the subsidy in crop insurance to $40,000. The average farmer is paying $18.28 per acre for buy-up coverage (Table 1). That means the  average subsidy per acre for all levels of buy-up coverage is $29.06. These dollar amounts were based on the actual coverage purchased in 2011 and if famers were to maintain their current level of coverage, on average it would only require 1,377 acres of owned and cash rented acres to hit the limit. The average subsidy for CAT insured farmers is $15.04 per acre, so they will hit the limit with 2,660 acres based on 2011 premium costs set by the Risk Management Agency (RMA). If they are cash renting, which is very common in the Corn Belt, then all of the subsidy will count in the farmer's limit. Because cash rented land is treated the same as owned land, these limits are more likely to hurt young farmers who probably cash rent more land than they own. Clearly, lenders have encouraged crop insurance coverage to protect their collateral, so payment limits will affect the available credit.

These are average premiums reported in Table 1 based on the national aggregate book of business. The 1,377 acres to hit the limit is an average and the national insurance book is dominated by corn and soybeans. However, even on a corn-soybean farm the maximum acres could be less than 600 acres as cited by Ruth Gerdes, Auburn, Nebraska in her House testimony. Dan Carothers, Bakersfield, California, testified that as little as 50 acres would put some specialty crop producers over this proposed limit. Because the 1,377 acres is an average for the 2011 year, some farmers will need more acres while others will need less, depending on the year (premium cost change based on strike price and option premiums), type of coverage, level of coverage, crop, and location. Farmers with annual paid premiums on buy-up coverage between $9,000 and $17,000 will start to hit the proposed $40,000 subsidy limit, depending on the type and level of coverage. Farmers can talk to their agent to see if they would be over the limit. Because of premium cost changes between years, one should look at more than one year when checking for the effect of a subsidy limit.

Payment limits have many unintended consequences, especially with a proposed national farm policy based on risk management rather than transfer payments under the Direct Payment (DP) program. DP paid up to $40,000 every year, while a risk management policy will pay nothing in most years but limits payments in the catastrophic years when farmers really need the cash because of an arbitrary payment limit.

In the past crop insurance subsidies were much lower but Congress continued to provide free "crop insurance" but renamed it as; CAT coverage with 100% subsidy, ad hoc disaster aid, ACRE, SURE, Zero/92, Counter Cyclical, Direct Payments, Marketing Loans, and the new proposed ARC program. It is difficult to get farmers to pay higher premiums if there are free government provided program alternatives, either through the RMA or the Farm Service Agency (FSA). This was the very argument used to increase crop subsidies in the 2000 Agricultural Risk Protection Act (ARPA) Law. The objective of the 2000 ARPA Law was to increase crop insurance participation and at higher coverage levels so there would be no need for ad hoc disaster aid. The Law worked better than even the Authors expected. It moved 74.6 million acres to buy-up! About 21 million of those acres came from a reduction in CAT acres with a 100% subsidy. Some CAT insured farmers may have become self insured but most of those acres likely moved to buy-up coverage with farmers paying a share of the premium.

In 1996, during Crop Revenue Coverage's (CRC) pilot year, the average premium subsidy for CRC revenue insurance was less than 30% vs. 62.3% today for nearly the same coverage. After 2000, those subsides were increased and revenue insurance expanded to more crops. The theory was if more farmers were insured there would be less "need" for free coverage via ad hoc disaster aid, CAT, SURE, ACRE, ARC, etc. The ARPA Law increased the number of insured acres by 74.6 million acres (Table 1). If those acres had not been added to the insurance rolls, it would have saved over $2 billion in subsidies in 2011.

If Congress were to cut the subsidy to the 1996 level, the result would be fewer insured farmers and lower coverage levels purchased. Therefore the subsidy savings would be even greater than $3.5 billion. If Congress were willing to do the second part and eliminate all of the free coverages, then this will work because some farmers will be self insured. This does shift the pain of higher premiums to farmers but without the "free" alternatives many would continue to buy coverage. There would also be unintended consequences from a lower subsidy rate because crop insurance is often part of a much larger marketing and finance plan. Changing public ag policy effects ag lenders, rural commodity brokers, contracts offered by processors, crop insurance agents, crop insurance companies, and USDA employees. Libertarians would argue Congress could even close down USDA and eliminate all commodity programs and crop insurance subsidies, and Iowa will still be planted to corn. So what do policy makers want; more insured farmers or less subsidy dollars?

The other problem is the savings from a $40,000 crop insurance subsidy limit will be smaller than the estimates because farmers will form new entities to avoid the limits. Some growers have already formed new entities so they could insure dryland and irrigated crops separately under a separate enterprise unit. The Senate Bill will allow irrigated and non-irrigated crops to be "separate crops" without creating a new entity. When Congress puts payment/subsidy limits on these programs it just creates inefficiencies and full employment for accountants and lawyers to create new entities. These limits are always sold as a way to target payments to "family farmers" that no one can define. When new combines with headers cost a half of a million dollars, it will require more than a 320 acre small farm; those small farmers are either in poverty or "professors who inherited the family farm".

There are other ways to reduce subsides based on the data in table 1. It contains the results after the 2000 ARPA Law was passed. First, the actual premium subsidy spent is less than the dollar amount reported because RMA has received a share of the underwriting gain. When RMA returns money to the U.S. Treasury there is no credit given to the program for the reduction in spending. From 2001 to 2010 RMA had a net underwriting gain of nearly $4 billion returned to the U.S. Treasury based on published work by Keith Collins and Frank Schnapp in Crop Insurance Today, February 2012.

Most of the new proposals to replace the FSA commodity programs are effectively revenue insurance with the government providing a 100% premium subsidy. If this free coverage were eliminated, it would save the current budget about $5 billion and reduced the administrative cost of the Farm Service Agency (FSA). This would not eliminate FSA because they administer the Conservation Reserve Program (CRP) and other programs but likely it would reduce the replacement of employees as they retire, but this option is not under consideration.

Another alternative is to reduce the 100 percent subsidy on the CAT contract. Currently farmers pay no premium for CAT but the amount of coverage nearly equals buy-up coverage. The average CAT contract provides $391.30 per acre free coverage. Buy-up coverage with an average farmer paid premium cost of $18.28 provides $432.40 per acre purchased coverage and net coverage of $414.12 vs. $391.30 for the free CAT. How can the free coverage and buy-up coverage provide almost the same amount of coverage? The average CAT insured farmer has an expected crop value of $1,304 per acre vs. about $575 to $625 for buy-up insured farmers. In addition there is no payment limit on the free CAT coverage. With this amount of crop value many policy makers would argue these CAT insured farmers with high value crops could pay some of their premium.

Policy makers could reduce the CAT subsidy from 100% to the same subsidy rate as the other 50% coverage insurance contracts (currently at 67% subsidy). Changing CAT subsidy from 100% to 67% would save $95 million.

One of the unintended consequences of limiting the subsidy to $40,000 is it is likely to move many farmers to lower coverage levels, including CAT. So if the subsidy remains at 100% on CAT that will limit the savings from a subsidy limit.

If policy makers want to cut a $billion then an across the board cut in subsidy will provide the savings. Cutting all of the current subsidy rates by 10 points will save at least $1.188 billion on buy-up and $123.6 million on CAT assuming CAT subsidies are changed to the same subsidy rate that is paid on all of the other 50% coverage level contracts.

A reduction in subsidy rates will affect all farmers and create no incentive for farmers to create new entities. The CAT with a 100% subsidy and FSA free coverage must be eliminated first otherwise many farmers will switch from purchased coverage with a reduced subsidy rate to the free government provided alternatives.

Farmers made it clear in the Senate hearing in Wichita, they did not want any more cuts in crop insurance. It is fair to say most of the farmers at the Wichita hearing would prefer to take any additional cuts in some of the other programs discussed above, if Congress were to force more budget cuts on agriculture. A reduction in the 100% premium subsidy for CAT coverage would have little effect in Kansas, but would be an issue in fruit and vegetable growing regions.

Some policy makers want to target payments to "small family" farmers that cannot be defined. These are either rural home sites with off farm income, or they are under the poverty line with a lack of resources, i.e. land and livestock to reach efficient economies of scale. Many would argue the first group needs no government help and the second group is not helped with traditional farm programs. The best alternative for the second group would be to increase the teaching function at the Land Grant Universities and encourage the next generation living on small farms to leave production agriculture.

Payment and subsidy limits make good politics but poor economics. These limits never save the money expected and cause farmers to create new entities to avoid the limits. The limits will also shift more farmers to crop share rents that create inefficiencies for farmers who are doing no till and crop rotations that often work better when the farmer has total control under cash rent leases. These payment limits often impact the full time efficient farmers and hurt the very group they are suppose to help. It would be more economically efficient to reduce the subsidy rate that will provide a real budget reduction. However, that will cause farmers to reduce their coverage and more to self insure. Can Congress then say no to ad hoc disaster aid and other forms of "free crop insurance"?

Is Congress sure a $40,000 limit will only affect

Source:G. A. (Art) Barnaby, Jr., Professor, Department of Agricultural Economics, K-State Research and Extension, Kansas State University, Manhattan, KS 66506, May 24, 2012, Phone 785-532-1515, e-mail – [email protected].

This web page is designed to aid farmers with their marketing and risk management decisions. The risk of loss in trading futures, options, forward contracts, and hedge-to-arrive can be substantial and no warranty is given or implied by the author or any other party. Each farmer must consider whether such marketing strategies are appropriate for his or her situation. This web page does not represent the views of Kansas State University.

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