Economic Analysis of Supplemental Deductible Coverage as Recommended in the USDA's 2007 Farm Bill Proposal

Article excerpt

A primary change to crop insurance contained in the USDA's Farm Bill proposal is supplemental deductible coverage (SDC). SDC would allow farmers who purchase individual crop insurance coverage to purchase area-wide coverage in the amount of the individual policy deductible. This supplemental area-wide coverage would be similar to the existing Group Risk Plan policy, but with an accelerated indemnity schedule. Analysis indicates that SDC increases farmer certainty equivalents. The largest benefits are realized by farmers with high yield potential in counties with greater systemic risk. In general, optimal individual policy coverage levels modestly decrease when SDC is taken.

Key Words: crop insurance, area-wide coverage, actual production history (APH), group risk plan (GRP), yield distribution

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The Administration released the USDA 2007 Farm Bill proposal in early 2007 (USDA 2007a). Among its recommendations were several proposed modifications of current crop insurance programs under Title X (USDA 2007b). The first of these recommended offering supplemental deductible coverage (SDC). This proposed SDC would "Allow farmers to purchase supplemental insurance that would cover all or part of their individual policy deductible in the event of a county or area wide loss" (USDA 2007b, p. 151). Additional discussion indicates that the intent of this provision was to improve the safety net for crop producers by offering full coverage (100 percent of the value of expected yield).

The current federal crop insurance program offers two types of yield insurance for farmers-individual coverage and area-wide coverage. The individual coverage pays indemnities when a farmer's harvested yield falls below a chosen percentage of the farmer's individual average yield. This individual average yield is calculated based on a farmer's actual production history (APH); hence the name of the policy is APH.1 Area-wide coverage as provided by the current program pays indemnities when the actual county average yield officially reported by the USDA falls below a chosen percentage of the expected county yield. This policy is called the Group Risk Plan (GRP). As proposed in the USDA 2007 Farm Bill proposal, SDC would allow farmers to combine a modified form of area-wide GRP coverage with individual APH coverage. This layered coverage would offer producers a higher level of yield risk protection while avoiding excessive government exposure to adverse selection and moral hazard that could result if such high levels of individual coverage were offered.

The SDC concept raises interesting policy questions, a few of which we examine here. Specifically, for a variety of empirically based assumptions regarding farm and county yields, we estimate changes in farmer welfare when moving from the current program of using either APH or GRP alone to a combination of APH and areabased coverage under SDC. This analysis identifies the types of farmers who would find SDC most beneficial-in particular, indicating how much SDC benefits farmers in high-risk areas relative to those in low-risk areas. The analysis also identifies the preferred APH coverage level under the current program and when SDC is available, thus determining how farmers would likely adjust individual APH coverage levels if SDC became available. Thus, the analysis identifies the characteristics of farmers who would find SDC most useful, provides monetary estimates of its farm-level benefits, and indicates how farmers would likely use SDC to manage their risk.

Proposed SDC Program Structure

The description of the proposed SDC program structure (USDA 2007b) indicates that SDC would be an option farmers could add to their existing APH yield insurance, with additional indemnity payments handled similarly to the current GRP policy. Hence, before explaining SDC, we first describe APH and GRP. With APH, farmers choose an APH coverage level as a percentage of their historical average yield. …