No-Fault Auto Insurance

Auto Insurance No-Fault

THE TOPIC

The term "no-fault" auto insurance is often used loosely to denote any auto insurance program that allows policyholders to recover financial losses from their own insurance company, regardless of fault. But in its strictest form no-fault applies only to state laws that both provide for the payment of no-fault first-party benefits and restrict the right to sue, the so-called “limited tort” option. The first party (policyholder) benefit coverage is known as personal injury protection (PIP).

Under current no-fault laws, motorists may sue for severe injuries and for pain and suffering only if the case meets certain conditions. These conditions, known as a threshold, relate to the severity of injury. They may be expressed in verbal terms (a descriptive or verbal threshold) or in dollar amounts of medical bills, a monetary threshold. Some laws also include minimum requirements for the days of disability incurred as a result of the accident. Because high threshold no-fault systems restrict litigation, they tend to reduce costs and delays in paying claims. Verbal thresholds eliminate the incentive to inflate claims that may exist when there is a dollar "target" for medical expenses. However, in some states the verbal threshold has been eroded over time by broad judicial interpretation of the verbal threshold language, and PIP coverage has become the target of abuse and fraud by dishonest doctors and clinics that bill for unnecessary and expensive medical procedures, pushing up costs.

Currently 12 states and Puerto Rico have no-fault auto insurance laws. Florida, Michigan, New Jersey, New York and Pennsylvania have verbal thresholds. The other seven states—Hawaii, Kansas, Kentucky, Massachusetts, Minnesota, North Dakota and Utah—use a monetary threshold. Three states have a "choice" no-fault law. In New Jersey, Pennsylvania and Kentucky, motorists may reject the lawsuit threshold and retain the right to sue for any auto-related injury.

RECENT DEVELOPMENTS

States

• Minnesota: A study by the Insurance Research Council (IRC) of the state’s no-fault system, using data from 500 personal injury protection (PIP) insurance claims settled in 2007, found that 58 percent of all medical care provider charges for treatment of no-fault auto insurance claimants were from chiropractors, compared with 11 percent for physical therapists and 19 percent for physicians (general practitioners, ER physicians and orthopedists combined). The 22 auto insurance companies participating in the study represented 61 percent of the Minnesota auto insurance market.
  
  
• The growing cost is mostly due to the rapid rise in fees. While the number of auto insurance claimants obtaining chiropractic treatment increased 5 percent over the five year period 2002 to 2007, the average charge rose 30 percent from $122 to $158 per visit. Minnesota had the third-highest chiropractor utilization rate (42 percent) among the 17 states in the study, those with either with a true no-fault or the add-on system, see chart below for a list of states in these categories. Only Washington (add-on) and Florida had higher rates. Utilization of and charges for MRIs also grew during the period.
  
  
• Colorado: Colorado repealed its no-fault law in 2003, but critics of the repeal have been working to reinstate some form of first-party medical coverage ever since. Legislation was signed into law in June 2008, which would add an optional $5,000 in coverage to auto insurance policies for medical payments. Critics argued that emergency care providers, such as trauma centers, are suffering financially under the current tort-based system, under which medical bills are paid by health insurers. In September 2008 there was an attempt to reinstate no-fault but it failed to garner support in committee.
  
  
• The root of the problem lies in the difference between reimbursement rates set by the no-fault auto insurance law and those negotiated by health insurers. No-fault insurers paid the bills in full whereas health insurers, which deal with a much larger volume of cases, not just auto injury cases, can negotiate a significantly lower rate. Under S.B. 11, for the first 30 days emergency care providers are paid under a priority of payment schedule. Policyholders who do not want the coverage may reject it when they purchase auto insurance or when they renew their policy.
  
  
• An independent research group has found that Colorado drivers pay 35 percent less for auto insurance than they did before the state changed its auto insurance system nearly five years ago. Hospital reimbursements were down by $85 million, in part because they are treating fewer auto accident victims. In 2002 acute care hospitals admitted almost 6,000 people after auto accidents, compared with close to 4,500 in 2006, a drop of almost 1,500 people. In two-thirds of crashes there are no injuries and the majority of injuries that do occur are minor strains and sprains, according to insurance data.
  
  
• Florida: The state’s no-fault law expired on October 1, 2007 after lawmakers had failed to agree on how to reform the law. However, shortly after the expiration date, under pressure from the Governor, lawmakers reenacted the no-fault law which became effective in January 2008, with significant reforms designed to curb fraud. One provision limits the type of health care providers that can be reimbursed to help eliminate claims from fraudulent medical clinics. Payments for medical care under the personal injury protection (PIP) part of the policy can only be made when provided, ordered or prescribed by authorized medical care providers. The legislation also sets limits on fees for medical care provided under the law. Hospitals feared that unreimbursed costs would soar under a tort system. About 40 percent of the patients treated at hospitals and trauma centers for injuries related to auto accidents rely on PIP because they have no health insurance, hospitals say. Under the old system, the state’s no-fault PIP benefits had been subject to fraud and abuse.
  
  
• New Jersey: New Jersey is one of the five states with a verbal threshold and one of three with a law that allows people to choose a no-fault or tort-based liability policy. The key to the success of a verbal threshold is to preserve the strict limit on filing of lawsuits. Since the law was rewritten in 1998, the state Supreme Court has ruled on several verbal threshold cases. The most recent involves emotional distress, which is not specifically mentioned in the law as an injury that meets the threshold. In June 2008, in Jablonowska v. Suther, the New Jersey Supreme Court ruled in a 4-3 decision that a plaintiff may recover claims for severe emotional harm that may be expected from having perceived the death of or serious injury to a spouse or an intimate family relative. Jablonowska was driving with her mother when her car was hit in the rear, causing it to crash into the concrete divider. When she regained consciousness, she saw that her mother was seriously injured. At the hospital she was pronounced dead. Voting against recovery of damages for emotional distress, dissenting justices said that the decision opened the way for distinctions regarding the severity of accidents that the legislature never considered when they adopted the verbal threshold in 1998.
  
  
• Insurers have been monitoring case filings to determine whether a June 2005 New Jersey Supreme Court ruling in what is known as the DiProspero case has had a significant effect on the number of court filings. Initially, it was feared that the decision would allow many more people to sue for pain and suffering, effectively negating the cost advantages of choosing no-fault coverage. However, so far, there has been no appreciable change. The DiProspero ruling weakened the verbal threshold that is designed to keep all but the most seriously injured drivers from suing for noneconomic damages.
  
  
• The language defining the threshold was modified by the legislature in 1998 when the state auto insurance law was completely revamped. In the DiProspero case the high court said that if the legislature had intended to make it more difficult for accident victims to obtain an award through the courts, then it should have written the new statute accordingly.
  
  
• A lawsuit has been filed by the state’s Medical Society and others seeking to modify a PIP medical fee schedule. The fee schedule, which was to take effect in October 2007, is a list of maximum charges for certain common treatments and procedures. It was adopted by the state’s Insurance Department in an attempt to control soaring medical care fees paid by insurers for treatment related to auto accidents. The Insurance Department said that it will consider at a later time whether a fee schedule for hospitals is needed. A ruling by the court is expected soon.

STATE AUTO INSURANCE LAWS GOVERNING LIABILITY COVERAGE First-party benefits (PIP) Restrictions on lawsuits Thresholds for lawsuits “True” no-fault Compulsory Optional Yes No Monetary Verbal Florida X X X Hawaii X X X Kansas X X X Kentucky X X X (1) X (1) Massachusetts X X X Michigan X X X Minnesota X X X New Jersey X X X (1) X (1), (2) New York X X X North Dakota X X X Pennsylvania X X X (1) X (1) Puerto Rico X X X Utah X X X Add-on Arkansas X X Delaware X X D.C. X X (3) X (3) Maryland X X New Hampshire X X Oregon X X South Dakota X X Texas X X Virginia X X Washington X X Wisconsin X X (1) “Choice” no-fault state. Policyholder can choose a policy based on the no-fault system or traditional tort liability. (2) Verbal threshold for the Basic Liability Policy, the Special Policy and the Standard Policy where the policyholder chooses no-fault. The Basic and Special Policies contain lower amounts of coverage. (3) The District of Columbia is neither a true no-fault nor add-on state. Drivers are offered the option of no-fault or fault-based coverage, but in the event of an accident a driver who originally chose no-fault benefits has 60 days to decide whether to receive those benefits or file a claim against the other party. PIP=Personal injury protection. Source: American Insurance Association.

In the following 28 states auto liability is based on the traditional tort liability system. In these states, there are no restrictions on lawsuits: Alabama Alaska Arizona California Colorado Connecticut Georgia Idaho Illinois Indiana Iowa Louisiana Maine Mississippi Missouri Montana Nebraska Nevada New Mexico North Carolina Ohio Oklahoma Rhode Island South Carolina Tennessee Vermont West Virginia Wyoming

BACKGROUND

Currently, state auto liability insurance laws fall into four broad categories: no-fault, choice no-fault, tort liability and add-on. The major differences are whether there are restrictions on the right to sue and whether the policyholder’s own insurer pays first-party benefits, up to the state maximum amount, regardless of who is at fault in the accident. These alternative systems have evolved over time as consumers, regulators and insurers have sought ways to lower the cost and speed up the delivery of compensation for auto accidents.

The Different Auto Insurance Systems

No-fault: The no-fault system is intended to lower the cost of auto insurance by taking small claims out of the courts. Each insurance company compensates its own policyholders for the cost of minor injuries, regardless of who was at fault in the accident.

Crop Insurance

THE TOPIC
As its proponents hoped, crop insurance has become the largest single source of financial protection to farmers. From insuring 182.2 million acres in 1997, the program has grown to cover more than 271.7 million acres in crop year 2007, an increase of almost 12 percent, or about 30 million acres, over the 2006 crop year. According to National Crop Insurance Services, the program is meeting the Congressional mandate of insuring 80 percent of insurable farmland.

There are two kinds of crop insurance: crop-hail, which is provided by the private sector, and multiple peril, an all-risk coverage underwritten by the private sector and the federal government and serviced mostly by the private sector. Crop-hail insures against loss of the value of a crop as a result of damage by hail. Multiple peril insurance covers loss of crop value as a result of all types of natural disasters, including drought, excessive moisture and unusually hot weather.

There have been sweeping changes in the federal multiple peril crop insurance program in recent years. Up to 1995, only about one-third of farmers bought federal multiple peril crop insurance because, in the event of a disaster, they could generally rely on Congress to bail them out with disaster assistance and emergency loans. With the passage of reforms in 1995, Congress made it harder to justify legislation granting disaster. It also took other steps to encourage farmers to buy insurance against loss of income due to natural disasters, requiring new types of products, such as revenue protection, to make crop insurance more attractive and subsidizing a portion of the basic traditional coverage that protects against loss of yield.

RECENT DEVELOPMENTS

• Recent flooding in the Midwest has severely damaged crops. Iowa has been particularly hard hit. Flooding has affected crops already in the ground and will delay the planting of other crops. Estimates of losses to crops in Iowa alone run as high as $3 billion. It is too early to determine the extent of losses to crop insurers, reinsurers and the federal government.
  
  
• Premiums and Losses: As of the beginning of June 2008, total premiums for crop year 2008 (catastrophic and additional business combined) were well ahead of last year, due in part to rising commodity prices. The tally for 2007 multiple peril crop insurance business was $6.6 billion, an increase of 43 percent over the previous 12 months, according to data from the Federal Crop Insurance Corporation.
  
  
• Data from the Department of Agriculture’s Risk Management Agency (RMA) provide state rankings. Illinois, the leading state in 2007 and 2006, reported a 47.99 percent rise in premiums, a result that is similar to last year. Iowa, North Dakota, Minnesota and Texas were the other states in the top five, with Texas dropping to fifth from second in 2006. Iowa saw the largest increase from 2006 among the top five with a 63.73 percent jump. Premiums in Florida, 15th on the list, grew 64.50 percent. Premiums dropped in only four states, Arizona, Alaska, Nevada and California, compared with 10 in 2006. The drop in premiums was greatest in Arizona, with a decrease of 17.82 percent, but minimal in the other three states. In 2006 premiums dropped almost 34 percent in Alaska.
  
  
• The crop insurance business is subject to great variability in results, both across time and by state. For example, the combined ratio for multiple peril crop insurance (MPCI) was 77.9 in 2006 but 91.3 in 2005, the year that hurricanes Katrina and Rita struck the Gulf coast, and 76.1 in 2004. In 2002, when the Midwest suffered a widespread drought, the MPCI combined ratio was 124.4 and in the following year it was 109.8. The combined ratio is a measure of profitability; it represents the percentage of the premium dollar spent on claims and expenses. According to the National Crop Insurance Services, which collects data for the private crop insurance business, only one state, Oklahoma, suffered high crop-hail losses in 2007 with a loss ratio of 127. The loss ratio is the percentage of each premium dollar spent on claims. In 2006, the loss ratio was 174 in Pennsylvania, meaning that $174 were spent on claims for every $100 collected in premiums; 144 in Wisconsin; 131 in Washington; and 105 in Virginia.
  
  
• Legislation: The 2007 farm bill was finally passed in 2008. Among the major provisions affecting crop insurers is a decrease of $5.6 billion in the federal crop insurance program, $800 million of which is related to the government’s reimbursement of crop insurers’ administrative and operating costs. Reimbursements represent a percentage of premiums which have risen substantially as crop prices have surged, somewhat offsetting the cuts.
  
  
• The “Combo” Crop Insurance Policy: The Federal Crop Insurance Program is proposing a new combination crop insurance policy for certain kinds of crops, including rice, cotton, canola and rapeseed, which will provide both revenue and yield protection. The ”Combo” policy would replace crop revenue coverage, income protection and several other coverages, the goal being to reduce paperwork and simplify risk management decisions. If approved, the changes would be effective for the 2009 crop year.
  
  
• Fraud: In 2005 the U.S. Government Accountability Office (GAO) published a report on fraud waste and abuse in the crop insurance program. In 2007 the GAO found that the Department of Agriculture’s Risk Management Agency (RMA) was not using all the tools available and some farmers continued to abuse the program. In the past it has recommended reducing premium subsidies to those who repeatedly file questionable claims, improving the effectiveness of growing season inspections and strengthening oversight of insurance companies’ use of quality controls. Government investigators are increasingly using satellite images to match actual crop planting and growing practices in suspicious cases with information submitted in claims.
  
  
• New Programs: Livestock insurance is now available in at least 20 states. Livestock insurance, which just a few years ago was only a pilot project, allows the policyholder to lock in prices for animals to be sold for slaughter. If prices subsequently fall, the policy compensates for a portion of the loss.
  
  
• In a related move that will also help livestock producers, the RMA has developed pilot programs for pasture, rangeland, forage and hay to provide a safety net for farmers who face drought conditions There are two programs: the Rainfall Index program and the Vegetation Index -- both use indexes and grids that are smaller than counties to determine expected losses. The Rainfall program is based on accumulated rainfall and the Vegetation program relies on satellite images to measure departures from expected losses in a given grid area. One or both programs are available in certain counties in nine states. So far they have been highly successful, with participation levels in excess of expectations. Some 28 million acres are insured, mostly in Texas. Together, these pilot programs ultimately will be available in about 25 percent of the nation’s grazing and hay land. The RMA’s long-range goals call for some kind of crop insurance product to be available to cover 98 percent of the value of U.S. commercial crops by crop year 2012. The development of a livestock program will help expand the program since more than half of all farms are livestock farms.
  
  
• In 2004, 15 states deemed historically underserved by the crop insurance program were targeted for $4.5 million in educational programs under the Agricultural Risk Protection Act of 2000. These states are mostly in the Northeast. The northeastern parts of the country have a disproportionate share of small farms. This program is continuing along with an outreach program to specialty crop producers, few of whom are insured, and ranchers. One answer to the problems of small farms may be what has become known as an adjusted gross revenue “lite” insurance program which covers the whole farm under one policy. The policy provides a maximum protection of $100,000 and can cover all crops and animal production including milk. Approved as a pilot program in some parts of Pennsylvania in 2003, it was expanded to cover five more states for the 2005 crop year. The program is now available in 28 states.

MULTIPLE PERIL CROP INSURANCE, 1999-2007 ($000) Year Annual point change (3) 1999 NA 2000 -7.8 pts. 2001 5.6 2002 28.4 2003 -14.6 2004 -33.8 2005 15.2 2006 -13.4 2007 -2.6 (1) After reinsurance transactions, excluding state funds. (2) After dividends to policyholders. A drop in the combined ratio represents an improvement; an increase represents a deterioration. (3) Calculated from unrounded data. NA=Data not available. Source: National Association of Insurance Commissioners (NAIC) Annual Statement Database, via Highline Data, LLC. Copyrighted information. No portion of this work may be copied or redistributed without the express written permission of Highline Data, LLC.

MULTIPLE PERIL CROP INSURANCE, 1999-2007

($000)

Year	Net premiums written (1)	Annual percent change	Combined ratio (2)	Annual point change (3)
1999	$725,821	1.8%	98.2	NA
2000	938,840	29.3	90.4	-7.8 pts.
2001	1,321,820	40.8	96.0	5.6
2002	2,003,443	51.6	124.4	28.4
2003	1,702,862	-15.0	109.8	-14.6
2004	2,203,143	29.4	76.1	-33.8
2005	2,234,630	1.4	91.3	15.2
2006	2,824,769	26.4	77.9	-13.4
2007	3,736,658	32.3	75.3	-2.6
(1) After reinsurance transactions, excluding state funds. (2) After dividends to policyholders. A drop in the combined ratio represents an improvement; an increase represents a deterioration. (3) Calculated from unrounded data. NA=Data not available. Source: National Association of Insurance Commissioners (NAIC) Annual Statement Database, via Highline Data, LLC. Copyrighted information. No portion of this work may be copied or redistributed without the express written permission of Highline Data, LLC.

BACKGROUND

Insurance works best when everyone exposed to a certain kind of risk, such as fire, buys a policy, but only a limited number of policyholders suffer losses (and therefore file claims) in any given year. Where all policyholders in a geographical area are likely to file claims, as farmers would in the event of a drought, and where the people mostly likely to purchase insurance are those most vulnerable to loss, such as farmers in flood plains, insurers cannot spread the risk of loss broadly enough and over a sufficient length of time to make insurance affordable. This fundamental principle of insurance is critical to an understanding of the history of crop insurance.

Agricultural production is subject to many uncertainties, including natural disasters. Adverse weather, insect infestations and plant diseases can severely reduce the yield or quality of a crop, wiping out a farmer's profits for the whole year in a bad season.

The most important consideration, as far as insurers are concerned, is the potential for catastrophic losses resulting in widespread and severe damage claims. Many "perils," or causes of loss, to which farmers are exposed, such as heat and drought, freezing temperatures and excessive moisture, can affect whole regions. Droughts may also persist for extended periods so that farmers may suffer successive losses.

But there is one common weather-related disaster that generally impacts a more limited area, and that is hail. Hail strikes randomly and erratically. Crops growing in one part of a field may be completely ruined while the remainder is unscathed. In addition, damage from hail can be easily identified and assessed separately from other adverse conditions that can lead to yield losses.

The catastrophic nature of many crop-related perils led to the development of two types of crop insurance: crop-hail insurance, which is provided by the private marketplace, and the multiple peril crop insurance program, which is overseen and subsidized by the federal government and sold and serviced by private insurers. Multiple peril insurance covers most causes of loss, as its name suggests.

The History of the Federal Crop Insurance Program: Hail insurance has been in existence in some form since the early part of the twentieth century and it has been a thriving segment of the insurance industry since the 1920s. Insurers also tried to develop a multirisk crop insurance business. But the attempt failed because they had insufficient data to set adequate rates to cover the kind of widespread catastrophic losses that long periods of drought, for example, produced.

In 1933 at the height of the Great Depression, Congress passed major legislation aimed at protecting the family farm. By restricting domestic production, it hoped to raise prices for agricultural products and this, together with subsidies to keep acreage unplanted, would restore farmers' standard of living to pre-World War I levels. Five years later in 1938 after the U.S. Supreme Court declared the law unconstitutional, a new piece of legislation was enacted with similar goals, authorizing the Secretary of Agriculture to set acreage and marketing quotas for staple and export crops and to pay cash subsidies for planting soil conserving crops. (It was not until the 1990s that Congress began to seriously question the wisdom of protecting farmers from market forces, especially since the family farms that such programs were designed to protect now account for only a small portion of agricultural production.)

In the same year that price support legislation was passed, Congress approved the Federal Crop Insurance Act, thereby creating the first federal crop insurance program. Backed by the resources of the U.S. Treasury Department, lawmakers expected the federal program to avoid the problems that had thwarted the formation of a private multirisk insurance industry. However, it was plagued by high costs, low participation on the part of farmers and an inability to accumulate sufficient reserves to pay for catastrophic losses.

In an effort to make the program more financially viable, lawmakers limited coverage to crops and geographic areas that would be least likely to require government subsidies and to protect farmers who were not insured. Congress began to provide disaster assistance and emergency loans. As federal expenditures under these programs grew, not surprisingly, farmers had little incentive to purchase crop insurance and consequently the program remained limited in scope.

In 1980, frustrated by the program's continuing deficiencies, Congress passed legislation designed to make crop insurance the preeminent vehicle for helping farmers survive major agricultural disasters. Its goals were to increase participation in the program to the point where government-funded disaster assistance programs could be abolished; raise the level of efficiency by joining with the private sector to sell, service and bear some of the risk of providing coverage (until then crop insurance was provided solely by the U.S. Department of Agriculture); and create an actuarially sound program that would reduce federal outlays while keeping coverage affordable through subsidies.

The private sector would be involved in two ways: as master marketers and reinsured companies. Master marketers were insurers paid by the federal government to sell crop insurance policies but who did not assume liability on policies they serviced. (This arrangement was phased out by 1994, see below). Now private insurers bear the underwriting risk and the policies they write are reinsured by the federal government. Farmers’ premiums cover a portion of the risk of loss. Reinsured companies are reimbursed by the federal government for administrative and operating expenses and they share the risk of loss.

A decade later the program was still experiencing problems. Because so many farmers lacked coverage, Congress found it difficult to resist political pressures to provide ad hoc disaster assistance and emergency loans, further undermining the crop insurance program. The devastating Midwest floods of 1993 further highlighted the costs and inefficiencies of the federal government supporting two separate and competing programs to deal with crop disasters. By 1994 the federal program was approaching a crisis. Despite the involvement of the private sector, the participation rate in any given year rarely exceeded 33 percent and the federal annual price tag for crop insurance was close to $900 million. Disaster relief expenditures, which were “off-budget”(not counted towards budget limits), were out of control, with payments over the six-year period 1988-1994 averaging $1.5 billion per year.

Market-oriented Reforms: The Federal Crop Insurance Reform Act of 1994 was passed at a time when the costs of all agricultural programs were under intense scrutiny as part of efforts to balance the federal budget. With little hope of bringing expenditures under control unless it made sweeping changes in the program, Congress decided to mesh crop insurance and disaster assistance into one program, radically restructuring the agricultural community's safety net.

Lawmakers took a multipronged approach. First, if disaster payments were to be severely curtailed or abolished, farmers would need some measure of economic security. A key element of the legislation, therefore, was the provision of basically free "CAT" coverage—insurance against catastrophic losses. All producers of insurable crops would be able to purchase CAT coverage for a nominal processing fee. Crops not covered by the federal crop insurance program would be eligible for a special disaster assistance program with payments triggered by area-wide losses. The level of payment would be similar to that of the CAT insurance plan.

Second, as an added incentive for growers to invest in a comprehensive multiple peril crop insurance program, the federal government would subsidize the premium for additional insurance coverage, see below.

Third, the "emergency" designation status for crop loss legislation, which allowed undisciplined off-budget borrowing to pay for disaster relief, would be repealed. Any future disaster assistance would be considered part of the budget and therefore could not be approved without an offsetting reduction in spending for other programs. Fourth, all farm programs, including crop insurance, would be handled by a single agency to improve service and program coordination.

One key provision of the 1994 legislation, which was later modified as part of a massive reform of farm policy, was mandatory catastrophe coverage. To encourage farmers to buy insurance, and thus further minimize the potential need for disaster aid, crop insurance had been tied to agricultural price support and loan programs. Under the 1994 legislation, farmers would not be eligible for these farm program benefits unless they had obtained at least the basic catastrophic level of crop insurance protection. By encouraging farmers to obtain CAT insurance, the program widened the pool of policyholders beyond those most exposed to risk.

But when Congress began to review the nation's farm programs, which were due for reauthorization in September 1995 (agricultural policy is reviewed by Congress every five years), lawmakers examined all aspects of farm policy, including insurance, and decided to make some changes. As part of the sweeping farm policy reform legislation that was passed early in 1996, farmers are no longer required to have a minimum level of insurance as long as they waive in writing eligibility for any future disaster payments. Farmers who fail to sign waivers must carry CAT coverage to maintain their eligibility for disaster aid.

In addition, the sale and servicing of policies would be shifted to the private sector. The Federal Crop Insurance Corporation would manage crop insurance, establishing insurance policy terms and conditions, setting rates and generating the payment of claims through its Risk Management Agency (RMA). The exception to this is the noninsured crop disaster assistance program, which remains with the Farm Service Agency.

Congressional deliberations about farm subsidy costs ultimately resulted in one of the biggest shifts in agricultural policy since the 1930s. Part of the impetus for change was the movement to reduce the federal deficit. But it was also an acknowledgement that farming had changed over the past six decades. Most of the subsidies were now going to large agricultural corporations that today grow most of the nation's food crops and to absentee owners of farmland living outside the agricultural community. In 1940, according to Congressional testimony, there were 6.1 million farms. In 1996 there were only 2.1 million. Many of these no longer rely on farming for the major portion of their income. Only 348,000 are considered “commercial” farms with annual sales in excess of $100,000.

The New Deal price support program had allowed farmers to sell their crops to the federal government for a fixed price when market prices fell below a government-set target price. Now that the subsidy program was about to end, there was a need to fill this gap.

Many farmers use the Chicago Board of Trade (CBOT) commodities futures market to protect against falling prices. Most use the futures market indirectly through cash-forward contracts with grain elevators, large farm product merchandisers who distribute agricultural products and who in turn hedge their exposure with the CBOT. But in either case, they have not been able to lock in prices for their entire crop because of uncertainties about the yield. Insurance programs reduce the risk of a poor yield but until recently did not respond to price declines.

The 1996 Agricultural Market Transition Act addressed the need for "revenue" protection—the product of yield and price. Provisions in the bill set up various pilot programs that respond to fluctuating price levels as well as yield variability using the CBOT commodity prices.

In addition, the CBOT itself has developed a new crop yield insurance product that allows grain elevators to offer farmers over-the-counter revenue insurance contracts in much the same way as they now offer cash-forward contracts. The major difference between CBOT and insurance products is in the underlying standard on which the contract is based. Insurance products are tailored to an individual farmer's historic yield, or in some cases to the yield of the county, see Revenue Insurance section, whereas the CBOT contracts are based on much broader aggregates, such as the state average yield.

Congress approved another major piece of legislation, the Agricultural Risk Protection Act (ARPA) in May 2000. The Act made it easier for farmers to buy different types of multiple peril crop insurance, including revenue insurance, by increasing government subsidies. Over the five years following the passage of the bill, $8.2 billion is to be spent on the Federal Crop Insurance Program and 80 percent of these funds is to be set aside to reduce farmers' premium expenses.

The measure also addressed the problem of farmers who face lower than average yields in their production history following multiple years of natural disasters. A succession of bad harvests lowers farmers’ insurance payments since compensation for low yields is based on actual production history. Under the law, farmers may include a yield equal to 60 percent of the long-term county average for any year in which their yield falls below that amount. In addition, the legislation focused on eliminating waste, fraud and abuses of the program; expanded pilot programs to include coverage for livestock; and extended risk management activities to underserved areas. Farmers with a good record may receive a performance-based discount on premiums.

Crop-hail Insurance: Insurance coverage for hail damage is provided by both the private sector, with crop-hail insurance, and under federally subsidized multiple peril insurance policies. Farmers who purchase crop-hail coverage can choose to drop coverage for hail under the multiple peril policy, in exchange for a reduction in premium, or keep it for additional protection.

A basic crop-hail policy covers losses due to hail and generally also fire, which is characterized by the same randomness as hail. The policy also covers damage caused by lightning and transit after harvest to storage. Coverage for additional causes of loss, such as vandalism, may be available as well as coverage for replanting costs when hailstorms early in the growing season damage a crop so severely that it has to be replanted. When the destroyed crop is replanted, the farmer also receives compensation for the reduction in expected yield due to the later planting date. Most insurers offer policies for the major grain and hay crops but the availability of coverage for specialty and vegetable crops is more limited.

A policy can be purchased at any stage during the growing season from the time when 50 percent of the crop is clearly visible to the anticipated harvest date, as long as the crop has not already been damaged by hail. To prevent growers from closely tracking weather patterns and waiting until a storm with the potential for hail is imminent before buying insurance, the policy does not take effect until one minute after midnight on the second day after the signing of the application. Farmers can insure all crops in which they have a financial interest (where land is leased, the landowner as well as the farmer have financial interests in the crop yield) or just a portion of their acreage.

The amount of coverage, which is purchased on a per-acre basis, is limited to the expected value of the crop, including anticipated profit. Coverage amount is the harvest price per bushel (or pound) forecast for the crop at the time the insurance policy is sold, times the number of bushels or pounds each acre is expected to produce. Premiums vary according to the susceptibility of the crop to hail damage and the location of the crop. Since hail losses have been tracked for more than 40 years, certain townships are known to be more prone to hail damage than others.

After a report of loss, the adjuster estimates the percentage reduction in yield due to hail damage by taking samples and sometimes actually counting the plants damaged in a representative area. The loss calculation takes into account the fact that the expected value of the crop at the time the loss occurs may be higher than the value (yield times market price) forecast at the time the policy was written. However, the claim payment or "cash value" cannot exceed the original underwriting limit or the policyholder's financial interest in the crop. Where there is the possibility of a bumper crop, the farmer may increase coverage mid-season.

Multiple Peril Crop Insurance: Multiple peril, or all risk crop insurance, protects against low yield and crop quality losses due to adverse weather (including hail) and unavoidable damage from insects and disease. While multiple peril insurance covers most economically significant agricultural crops grown in the United States—more than 100 crops—insurance for a specific crop may not be available in every state or in every county within a state. Most crops for which there is not yet coverage are eligible for the limited protection offered by the Noninsured Crop Disaster Assistance Program.

A farmer purchasing multiple peril crop insurance has a number of coverage options. The first is a CAT (catastrophe) policy, the lowest amount of protection available. This coverage, which pays 55 percent of a crop's established price on crop losses in excess of 50 percent, provides a basic safety net. To encourage proper record keeping, reduce overpayments and deter fraud, payments may be reduced by up to 50 percent where farmers lack certified historical yield records, known as actual production history (APH). The federal government subsidizes the entire cost of the CAT coverage. Farmers pay only an administrative fee. In addition, farmers can buy additional insurance, known as "private supplemental," under a "buy up" program designed to encourage purchase of higher, more adequate levels of coverage.

Under the buy-up program, the federal government subsidizes a portion of the premium. Currently, the subsidy decreases as the amount of coverage rises. However, while the government’s share of the premium shrinks with each step up in coverage, the total dollar amount that the farmer receives in subsidy increases. In addition, there are more complex supplemental coverages that protect farmers who, for example, commit their entire crop to food processing plants in advance of harvest or need it to feed livestock and therefore must be able to replace lost crops at market prices. There are also supplemental programs to increase the loss payment amount and to increase payments in catastrophic situations.

Producers of some crops may be eligible for a multiple peril coverage known as "group risk" crop insurance, which may cost less than other options. It differs from the basic coverage in that yield guarantees are based on the county average yield rather than that of the individual farmer and is suitable for farmers whose yields tends to follow countywide yields. Policyholders automatically receive an insurance payment in any year that the county average yield falls below the yield guarantee. Group risk income protection adds a price protection feature to this coverage.

Differences Between Crop-hail and Multiple Peril Insurance: There are several key differences between multiple peril and crop-hail insurance programs. First, farmers purchasing multiple peril insurance choose coverage levels by "unit" rather than by acre as with crop-hail. A unit is the entire acreage of the crop planted in the county by the farmer. Farmers can also break down coverage by "sections"—one square mile—or by irrigated and dryland practices. This difference is most evident when a loss occurs, because in the multiple peril program the amount of the loss—the reduced yield—is averaged out over all the fields in the unit rather than over the affected acre or acres insured.

Second, a farmer cannot suddenly decide to buy a multiple peril policy. Unlike crop-hail, multiple peril coverage must be purchased prior to certain dates set by the federal government, which vary according to the county and the crop. These sign-up deadlines are set early in the planting season before long-range weather forecasts can influence purchase decisions. Coverage takes effect once the crop is planted, but the crop must be planted before the last government established planting date by crop and by county. Coverage may not be added during the growing season.

In addition, crop-hail coverage generally provides coverage from the first dollar of loss, although deductibles are offered, whereas multiple peril coverage includes what amounts to a deductible, guaranteeing up to 100 percent of expected market price but never 100 percent of yield.

Standard Reinsurance Agreement: From a private reinsured company financial perspective, the federal crop insurance program is unique in many ways. The first is the Standard Reinsurance Agreement. This sets out the relationship between private insurance companies and the federal government concerning the risk each will bear. There are three risk pools in each state—the commercial, developmental and assigned risk funds—and the amount of risk the insurer retains varies according to the pool and by state. Those policies covering acreage in counties known for low yields, for example, will be placed in the assigned risk fund, where the federal government bears most of the risk, and those where the risk of low yields is lowest in the commercial pool. Insurers may also reinsure a portion of their business in the private reinsurance market. Second, all administrative and operating costs are reimbursed by the federal government on a percentage-of-premium basis. This percentage is steadily being cut largely because farmers are purchasing higher amounts of insurance and administrative costs do not necessarily increase proportionately with each additional dollar of coverage.

In addition, crop insurers have less investment income than insurers in other segments of the industry because they receive payment for coverage after it has been provided, rather than in advance as with other types of insurance. Premiums, for example, are not due until the end of the insurance period and are not paid on policies under which claims have been filed, the premium is deducted from amounts owed, and administrative expenses are not reimbursed until the actual acreage planted is reported, often as much as five months after the insurance sales closing date. Moreover, premiums fluctuate widely because they are tied to the market value of the crop and the acreage planted.

Revenue Insurance: Farmers face three major risks: low crop prices, poor quality and low yields. Under the standard multiple peril policy, farmers are compensated for losses in crop yield. The market price paid for each bushel is fixed at a level set by the government in advance of the growing season, regardless of the actual price at harvest time, which could be lower or higher than the government forecast. The policy is triggered when the yield is less than the level of protection selected. Coverage can be between 50 and 75 percent of what their acreage typically produces and from 60 percent to 100 percent of the projected market price. The uninsured portion of the yield and anything below the full market price is essentially a deductible.

Revenue insurance, which was first introduced in the mid-1990s, goes a step beyond standard multiple peril coverage. It guarantees farmers a certain income, allowing them to manage both yield and price risk. It recognizes that farmers’ income is the product of the price they receive for what they have grown, as well as the number of bushels or pounds their acreage yields. With a revenue insurance policy in hand, farmers can borrow against and market their crops in advance, knowing they will have set revenues regardless of market conditions at harvest time. Several broad types of revenue insurance programs have been developed.

One program, Income Protection (IP), was created by the Federal Crop Insurance Corporation (FCIC) itself as a pilot program beginning with the 1996 crop year. Under an IP crop insurance policy, the farmer receives a payment when any combination of low harvest prices and low yield push gross income below the guaranteed income level selected. The income guarantee is based on early board of trade commodity prices for the insured crop.

A second program, developed by the Iowa Farm Bureau and approved as a pilot program beginning in crop year 1997, is Revenue Assurance (RA). RA is similar to IP in most respects except that commodity prices are adjusted to reflect average prices in the county to make them more representative of local market conditions. Premiums for RA tend to be lower than for IP, which is based on prices across a broad geographical production area, because the likelihood of income loss in Iowa counties is lower than average. In Iowa, yields tend to be more uniform across counties and prices therefore tend to move in opposite directions to a greater extent than elsewhere. When yields are low, rising prices typically compensate for a reduction in production and vice versa. In other states, yields across counties tend to vary to a greater extent under similar growing conditions. Low production in one county may be offset by higher production in another, thus stabilizing market prices and increasing the likelihood that a farmer with low yields will have a reduced income.

A third program, Crop Revenue Coverage (CRC), was developed by American Agrisurance, a private insurance company participating in the federal crop insurance program. The coverage was approved as a pilot program beginning in the 1996 crop year. CRC provides more comprehensive protection than the other two programs in that its revenue guarantee, which is based on the higher of two prices: the early market price and the harvest market price, covers fluctuations in market price both up and down. Although the upward movement in harvest price is capped above the historic maximum price increase, CRC allows the farmer to capture some of the benefit or rising prices when yields drop.

Revenue coverage is also available based on the county average revenue rather than the historical average of the individual farmer. Another option, particularly for small farms, is adjusted gross revenue coverage which insures the revenue of the entire farm, including some livestock rather than a single crop.