Commentary

Agricultural Risk Management or Income Enhancement?

By Jerry R. Skees
August 26, 1999
Crop insurance reform is again on the agenda of agricultural policymakers. Some in Congress want to add at least $1 billion in subsidies to a program that is currently budgeted at $1.7 billion annually. Others want to introduce subsidized livestock insurance for the first time. Even President Clinton called for crop insurance reform in his 1999 State of the Union Address. Everyone is talking about shoring up the safety net with more subsidized insurance.

Before Congress moves forward with more subsidies under the rubric of risk management, it is important to take stock of existing programs and subsidies. When farmers must pay for risk protection at least what they expect to get back over the long term, the risks become internalized into their decisions. When farmers pay less than they will get back in indemnities resulting from insurance subsidies, society pays them to take on additional risk. The resources used in taking on those risks cost the economy much more than just the income transfer imbedded in the subsidy. There is the additional cost of inefficiency created by the subsidy.

As potential owners of farmland recognize the value of the subsidies, they will bid more for farmland, bidding up land prices and creating barriers to entry by new farmers. Under such conditions one must ask who is being helped. About half America’s farmland is farmed by a nonowner. If agricultural subsidies were more properly characterized as transfers from taxpayers to landowners (many of whom are not farmers), raising land prices and making entry into farming more difficult for the small farmer, political support might diminish.

Farmers whose risks are subsidized will push harder and faster and take on more risk. They will borrow at higher rates. The likely result is the same failure rate as before subsidies existed. For example, when farmers have access to subsidized crop insurance, their bankers will lend them more money. Lending more reduces farmers’ access to credit when there are temporary shocks. Subsidized crop insurance reduces farmers’ incentives to manage risk.

Farmers paid $930 million in premiums in 1998, or about 35 percent of the expected total cost of the program. When free disaster aid is added to taxpayer contributions, farmers paid about 20 percent of the cost. For 1999, premiums will be reduced another 30 percent (an additional $400 million in subsidies). With the same participation rate as in 1998, the total cost of the crop insurance program will exceed $2.5 billion in 1999. Farmers will pay about $650 million, 25 cents on the dollar.

Despite the small share of the costs that are borne by farmers, members of Congress and others are calling for still more subsidies, arguing that with higher subsidies, more farmers will ‘buy’ crop insurance, reducing the likelihood that free disaster aid will be needed. However, the more than doubling of subsidies that came with the 1994 reform did not prevent disaster aid in 1998. Are we destined simply to make our insurance programs into something like a multi-billion-dollar standing disaster assistance program for which farmers pay ever fewer pennies on the dollar? Although there are several unintended consequences that are common with agriculture subsidies, there are more serious unintended consequences when subsidies are tied to farm-level yield risk. Subsidies that are a direct function of premiums will transfer relatively more money to high-risk farmers and high-risk regions. Furthermore, the subsidies have caused more total acreage and lower prices. The price declines hurt the most productive regions and the risk transfers help the most risky regions. Is that the reward structure we want for U.S. agriculture? Everyone thinks we can fix the problems in agriculture with risk-management instruments like crop and revenue insurance. But to the extent that agricultural insurance markets are built with heavy subsidies, we will be no better off, and possibly worse off, than we were before the reform in the 1996 Farm Bill.

Like other subsidies, insurance subsidies will have limited success in doing what they are supposed to do - save the family farm. The beneficiaries are, agricultural lenders, insurance companies and those who sell the insurance, and landowners, who are in many cases not family farmers. Recognizing that farmers respond to subsidized insurance by taking on more risk and returning to pre-subsidy levels of risk is important. Try as they might, Congress cannot take the risk out of U.S. agriculture.

Jerry R. Skees is professor of agricultural economics at the University of Kentucky. This article is excerpted from Regulation, Vol. 22, No. 1, published by the Cato Institute.