Updated forecast: Crop insurance industry losses due to 2012 drought

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By Carl X. Ashenbrenner | 28 September 2012

On July 18, 2012, Milliman issued estimated losses using crop conditions and yields forecasted by NASS for the 12 major corn/soybean producing states as well as current commodity future prices. Since that article was published, the drought worsened and crop futures prices increased, causing an increase in the estimated losses.

The table in Figure 1 displays the changes to Milliman’s estimates.

 

Two major factors changed, which caused the estimated underwriting losses to increase: the forecasted NASS yields decreased in the 12 states and the futures prices increased. The table in Figure 2 shows the changes in the national NASS yield forecasts.

 

Previously in our study, we estimated the yields by state using the current crop conditions report issued by NASS. Beginning in August, NASS issued forecasted yields by state (and by agricultural district for some states). The charts in Figures 3 and 4 display the changes in forecasted yields by state. Note that we use planted yield, rather than harvested yield, in our loss forecasting model to better account for fields that were not harvested because of the drought.

 

As we discussed in the previous article, the Revenue Protection insurance plan uses the greater of the spring or harvest price to establish a guarantee. Therefore, all things equal, a higher harvest price will produce more losses for the Revenue Protection policy, which covers 90% of the corn and soybean liabilities in the 12 states. Based on current commodity futures used in the MPCI policy, the prices for both crops increased as well since our initial study, as the chart in Figure 5 displays.

 

For this analysis, we use the current forecasted corn yield as a percentage of the previous 10-year average. On average, the current year’s yield is approximately 11% greater than the previous 10 years, which is due to improvements in farming techniques and higher-yielding varieties. Figure 6 shows this ratio by year for the 12 major corn-producing states. The 2012 corn yield is 20% lower than the previous 10-year average and is the lowest in terms of percentage since the 24% decrease in 1988.

 

The chart in Figure 7 shows the same graph for soybeans. It shows an 18% decrease in 2012 from the 10-year average, which is the lowest since 1988 (20% decrease).

 

Using the forecasted NASS yields, current futures prices, and previous loss ratios by state, we estimated the loss ratios for 2012 by state and crop. The overall forecasted loss ratio for corn and soybeans for the 12 states is 226% as shown in Figure 8.

 

In our previous study, we estimated premiums using 2011 premiums because the 2012 premium was not fully reported. In this study, we used the 2012 premium as reported by the U.S. Department of Agriculture Risk Management Agency (USDA-RMA). Using the estimated 226% loss ratio, the indemnity is forecasted to be about $12.9 billion for an underwriting loss of $7.2 billion. This underwriting loss excludes both the private insurance companies’ expenses and the administrative and operating (A&O) subsidy provided to the private insurers by the Federal Crop Insurance Commission (FCIC). While the $12.9 billion in indemnity is a large amount, this compares to the reported insured liabilities of $70 billion for corn and soybeans for the 12 states. Therefore, if actual yields decrease more than forecasted, a larger amount of indemnity is possible.

As discussed in the previous article, the private insurers will not accrue all of the losses, which is due to the Standard Reinsurance Agreement (SRA) the private insurers have with the FCIC. The SRA reduces the underwriting loss (or gain) that a private insurer has by state and fund. The private insurers may also purchase additional reinsurance from third-party reinsurers.

It should be noted there is a considerable amount of uncertainty to these projected underwriting losses. The actual insurance payments are based on the yields from an insurance unit. Therefore, the more volatile the yields are by unit, the greater the total insurance payments will be. There may also be significant differences in results by insurance companies. Other states and crops could provide offsetting underwriting gains and losses. The futures’ prices could change significantly and the actual yields could differ from NASS-forecasted yields.