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Friday 9 December 2016

Are US-style insurance schemes the way to go for CAP?

Can the EU's Common Agricultural Policy do more to help farmers manage income volatility

Alan Matthews

Published 06/11/2016 | 15:00

Insuring farmers against market price risk would be a challenge for insurance providers
Insuring farmers against market price risk would be a challenge for insurance providers

EU farm prices are more volatile now than ever before because Europe can no longer use border or trade measures to stabilise the market.

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Decoupled direct payments, which substituted for the high market price support, do not vary in response to farm income conditions.

They are the most stable part of any farm income. However, they are not particularly well targeted for this purpose in that farm sectors, such as horticulture, which are more exposed to instabilitym do not receive higher direct payments as a result.

In its most recent farm bill, the US eliminated its decoupled payments, in part because it was hard to justify making income support payments to farmers at a time when farm incomes were booming due to favourable prices.

They substituted instead a range of counter-cyclical payments which together make up the US farm safety net (see info box on the right).

Similar proposals have been circulating in Europe. In the 2008 CAP Health Check, member states could use up to 10pc of their direct payment ceilings to support crop and livestock insurances, although there was little interest in this facility.

The 2013 CAP reform moved support for insurance products into the revamped rural development regulation. It also extended the toolbox to include support for mutual funds which set up income stabilisation insurance for their members.

Again, the uptake of this measure in the rural development programmes submitted by member states was very limited.

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The Commission in its recent proposal to revise the CAP basic acts has suggested that the rules on operating conditions for these income stabilisation funds could be relaxed in an effort to stimulate their uptake.

Which system is better?

Most people insure against the very occasional risk of an emergency and are willing to pay a small premium to cover this eventuality. Insuring farmers against market price risk would be a challenge for insurance providers.

Market price variability could mean much more frequent pay-outs and thus correspondingly much larger premiums. Administrative costs could be high.

The cost efficiency of the US insurance programme is poor. It has been estimated that every time an American farmer receives $1 through the insurance system, it costs the American taxpayer $2.

US farm insurance policies

The US farm safety net has three pillars: federal crop insurance, farm commodity programmes, and disaster assistance. Under the 2014 farm bill, the projected cost of these three pillars is $8.8bn, $4.2bn, and $0.5bn, respectively. Actual costs will differ because these are counter-cyclical programmes which cost more in bad years for farming than in good years.

Federal crop insurance

Federal crop insurance is the centrepiece of the US farm safety net. It makes available subsidised crop insurance to producers who purchase a policy to protect against losses in yield, crop revenue, or whole farm revenue (including livestock producers to a limited extent).

The producer selects a coverage level and absorbs the initial loss themselves. For example, a coverage level of 70pc has a 30pc deductible initial loss (for a total equal to the expected value prior to planting the crop). Policies pay out for an individual farm loss in yield or revenue.

Policies are sold to producers by private insurance companies. Producers pay a portion of the premium which increases as the level of coverage rises. The federal government pays the rest of the premium (62pc, on average, in 2014) and covers the cost to insurance companies of selling and servicing the policies. The government also absorbs some of the losses of insurance companies in years when payouts to farmers are particularly high.

Around 1.2m policies are purchased annually, providing nearly $110bn in insurance coverage. More than 120 commodities are insurable. For major crops, more than three-quarters of the US planted area is insured under this programme.

Supplementary cover option

The 2014 Farm Act authorised a new Supplementary Coverage Option (SCO) to help producers to cover the deductible loss on farm crop insurance policies. Farmers can now purchase a second policy on the same acreage, with the amount of coverage related to the liability level and approved yield for the underlying policy.

Unlike the underlying policy, which is triggered where there is an individual farm loss in either yield or revenue, the SCO is triggered when there is a county-level loss in yield or revenue (not an individual farm loss). So it is possible for a farmer to receive an SCO payment even where he or she has not made a claim under the underlying policy, and vice versa.

For example, for a revenue insurance policy, the SCO option begins to pay when county average revenue falls below 86pc of its expected level.

The full amount of the SCO coverage is paid out when the county average revenue falls to the coverage level of the underlying policy (assume this is 70pc). This supplementary option therefore provides protection for up to 16pc of the value of the crop. The premium for this policy is covered by a 65pc subsidy.

Dairy Margin Protection Programme

This new insurance programme introduced in the 2014 farm bill makes payments to participating milk producers when the national margin (average farm price of milk minus an average feed cost ration) falls below a producer-selected margin. Producers elect how much of their historic production will be covered and at what margin, between $4 and $8 per hundredweight.

Insuring the milk margin at the lowest level only requires payment of a nominal administrative fee. Elections above $4 per hundredweight require payment of an additional premium above the nominal base fee. To date, only dairy producers who enrolled at the $6 through $8 margin trigger coverage level have received payments.

Alan Matthews is Professor Emeritus of European Agricultural Policy at Trinity College Dublin

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