Whose Line is it Anyway?

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Whose Line is it Anyway?
Federal Crop Insurance Ratemaking and
Profitability Projections
Casualty Actuarial Society Seminar on Ratemaking
The Tampa Marriott Waterside Tampa,
Florida March 7-8, 2002 COM-24
Richard Bill, FCAS Country Insurance
Financial Services
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Overview

• Perils Insured
• Coverage
• Federal/Private Partnership
• Ratemaking Considerations
• Profitability Considerations
• Standard Reinsurance Contract (SRA)
• Projected Profitability

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Perils Insured

• Too Dry (Large Area)
• Too Wet
• Hail
• Insects
• Prevented Planting
• All other Risks except poor farming practices
• Price (Revenue products only)

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Seven Prerequisites of Insurable
Risk7-Unlikely to produce loss to a great
many insured units at the same timeMehr
Cammack Principles of Insurance 1972
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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

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Yield Product Guarantee

• Yield GuaranteeActual Production History (APH) X
  Coverage Level
• Example - 100 Bushels per acre X 75 Coverage
  Level 75 Bushels per acre

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Revenue product Guarantee

• Revenue GuaranteeAPH X Anticipated Price Per
  Bushel X Coverage Level
• Example - 100 Bushels per acre X 2 per Bushel X
  75 150 per acre

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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

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Federal/Private Partnership

• Began strictly as a Govt Program in 30s
• Small program until Private Industry began
  participating in the early 80s
• Private Companies took over all delivery in the
  90s
• Safety Net for Nations Farmers
• Intended to replace Free Ad Hoc Disaster Payments

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Size of Industry

• About 70 of US cropland Insured
• 37 Billion of Liability
• 3 Billion of Premium
• Less than 20 companies participating

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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
  2001)
• Oversight
• Provides Reinsurance to Private Companies

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Private Industry Role

• Provides distribution system through their agents
• Issues policies on their paper
• Adjusts Claims
• Retains risk after Government Reinsurance

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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

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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

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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

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Profitability Considerations
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Projected Loss Ratios

• 1980-2000 Average Loss Ratio was 128
• Loss Ratio in the Federal Budget is 107.5 for
  2003 Fiscal Year
• Little if any investment income
• How do Companies Make Money???

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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

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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
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3 Types of Policies
Cat 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
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Commercial Fund Stop Loss Cover-All Other
Policies (101.6 Max loss Retention)
Retention 100 LR
Layer Ceded to Govt 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
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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
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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

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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

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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)

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Future (Cont.)

• The federal budget includes a provision to cap
  industry underwriting gains at 12.5 without
  considering the shortfall in expense
  reimbursement-Would there be an impact on the
  number of companies participating
• Federal Govt. may require that a new SRA be
  negotiated next year