What is in this article?:
- Initial Perspectives of Crop Insurance Underwriting Losses due to 2012 Drought
- Risk Sharing Between Private Crop Insurance Companies and the Federal Government
- Predicting 2012 Underwriting Losses
Risk Sharing Between Private Crop Insurance Companies and the Federal Government
Risk sharing between private companies and the Federal government is determined largely by the decisions made by private insurance companies under the terms of the Standard Reinsurance Agreement between the insurance companies and the Federal government. This agreement describes how losses are shared between the companies and the government depending on fund assignment and the state in which the policy is originated. Private insurance companies can assign polices into either the Assigned Risk Fund or the Commercial Fund.
1. Assigned Risk Fund.Private crop insurance companies bear less risk in the assigned risk fund. Private insurance companies cede 75% of gross premium to the federal government, meaning that 75% of the premiums and associated gains or losses are born by the federal government. Private companies’ shares of gains or losses on the remaining 25% vary with the final loss ratio. The loss ratio simply equals indemnities divided by premium. A loss ratio of 1.5, for example, indicates that there were $1.50 indemnities for each dollar of retained premium, yielding an underwriting loss of 50¢. For policies in the assigned risk fund, a private company would bear 4¢ of the underwriting loss while the FCIC would stand for 46¢ of the loss (see Table 2 below). Companies’ losses per dollar of retained premium are 8¢ for a 2.5 loss ratio, 11¢ for a 3.5 loss ratio, 14¢ for a 4.5 loss ratio and 15¢ for a 5.5 loss ratio (see Table 1). When loss ratios exceed f.0, the Federal government bears all of the losses in excess of the maximum 15¢ insurance companies bear.
2. Commercial Fund.There are two separate schedules for loss sharing in the commercial fund depending on which group the state is in where the policy was written. Crop insurance companies decide how much of premium and losses in the commercial fund to retain with the remainder ceded to the federal government. Private companies must retain at least 35% of premium, but can retain more in five percent increments up to 100%. When losses occur, risk sharing differs by state. Insurance companies stand for a higher percentage of the losses in group 1 states (Illinois, Indiana, Iowa, Minnesota and Nebraska) than in other states. In a group 1 state, insurance companies will bear 30¢ of losses for each $1 of retained premium if the loss ratio is 1.5, 65¢ for a 2.5 loss ratio, 74¢ for a 3.5 loss ratio, 83¢ for a 4.5 loss ratio, and 88¢ for 5.0 and higher loss ratios (see Table 2). In compensation for this higher risk, insurance companies receive more of the gain when underwriting gains occur.
In both funds, the companies’ share of losses decreases as loss ratio increases. This declining risk feature as losses increase is meant to buffer companies from extreme loss years as is likely to occur in 2012. Besides insuring with the Federal government, private crop insurance also will insure underwriting losses with other private companies providing reinsurance. Hence, the losses that are likely to be incurred by private crop insurance companies in 2012 likely will be shared with private reinsurance companies.
Fund allocations results for 2012 have not yet been released, but it is likely that they will be similar to those from 2011. In 2011, 18% of all gross premiums in the United States were placed in the assigned fund, while the remaining 82% was in the commercial fund. In Illinois, 3% of premiums were placed in the assigned fund while 97% was in the commercial fund. Large losses in Illinois seem likely, meaning that crop insurance companies will bear large losses in Illinois and other Midwestern states. Hence, the large allocation of premium to the commercial fund in Illinois will exacerbate losses in this drought year.