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C.A.R.D. Report: "Should Area Revenue Coverage Be Offered through the Farm Bill or as a Crop Insurance Program?"

I. C.A.R.D. Report
II. Ethanol

I. C.A.R.D. Report

The Center for Agricultural and Rural Development at Iowa State University recently released a report entitled, “Get a GRIP: Should Area Revenue Coverage Be Offered through the Farm Bill or as a Crop Insurance Program?” which was written by Nicholas Paulson and Bruce A. Babcock.

In the report’s abstract, the authors indicated that, “The successful expansion of the U.S. crop insurance program has not eliminated ad hoc disaster assistance. An alternative currently being explored by members of Congress and others in preparation of the 2007 farm bill is to simply remove the ‘ad hoc’ part of disaster assistance programs by creating a standing program that would automatically funnel aid to hard-hit regions and crops. One form [of] such a program [c]an be found in the area yield and area revenue insurance programs currently offered by the U.S. crop insurance program. The Group Risk Plan (GRP) and Group Risk Income Protection (GRIP) programs automatically trigger payments when county yields or revenues, respectively, fall below a producer-elected coverage level. The per-acre taxpayer costs of offering GRIP in Indiana, Illinois, and Iowa for corn and soybeans through the crop insurance program are estimated. These results are used to determine the amount of area revenue coverage that could be offered to farmers as part of a standing farm bill disaster program. Approximately 55% of taxpayer support for GRIP flows to the crop insurance industry. A significant portion of this support comes in the form of net underwriting gains. The expected rate of return on money put at risk by private crop insurance companies under the current Standard Reinsurance Agreement is approximately 100%. Taking this industry support and adding in the taxpayer support for GRIP that flows to producers would fund a county target revenue program at the 93% coverage level.”

Although droughts do not have the visual impact of other natural disasters, the damage they cause is devastating (Photo B.B.C.).

The report noted that, “By almost any measure, the drive to induce farmers to increase their purchase of crop insurance through increased premium subsidies and support for the crop insurance industry has been a resounding success. Over 80% of insurable crop acreage was enrolled in the program in 2005, and more than half of those acres were insured at coverage levels of 70% or higher. Total liability for the 2006 crop year was approximately $50 billion. Despite this success, Congress once again seems poised to pass another disaster assistance program in 2007” (page one).

As to the focus of the paper, Paulson and Babcock indicated that, “In this paper we examine how provision of an area revenue program could be implemented as the basis for a safety net for agriculture. We use the Group Risk Income Protection (GRIP) program as the area revenue insurance that would be provided to farmers. We compare two different delivery mechanisms for GRIP. The first is delivery as a crop insurance product in the current crop insurance program. The second is as a program in the commodity title of the farm bill that would replace marketing loan and countercyclical programs. We compare program costs under the two approaches and discuss the advantages and disadvantages of each delivery approach” (page three).

On page six of the C.A.R.D. report, the authors explained that, “Farm bill commodity programs and crop insurance commodity programs share the objective of giving financial support to farmers. However, Congress has mandated different mechanisms for accomplishing this objective. Farm bill commodity programs are administered through the Farm Service Agency, and they are made available to farmers at minimal administrative cost. Crop insurance commodity programs are administered through a public-private partnership between the Risk Management Agency, crop insurance companies, and crop insurance agents. Farmers must pay a portion of program costs.

“Interest is growing in adopting a Miranda-Glauber style of area revenue plan as the basis for farm bill commodity programs [Miranda, M. J., and J. W. Glauber. 1991. “Providing Crop Disaster Assistance through a Modified Deficiency Payment Program.” American Journal of Agricultural Economics 73: 1233-1243.]. For example, Babcock and Hart (2005) showed how an area revenue plan can be designed to help the United States achieve proposed limits on commodity support as part of the Doha Round negotiations in the World Trade Organization. American Farmland Trust (2006) has proposed moving to an area revenue program as part of an overhaul of U.S. farm bill programs. Additionally, the National Corn Growers Association is working with an area revenue plan as the basis for their 2007 farm bill proposal.

“One consideration in choosing whether to run GRIP as a farm bill program or a crop insurance program is the cost and effectiveness of meeting program objectives. Expected program costs for GRIP in the crop insurance program include easily calculated A&O [administrative and operating] reimbursements and premium subsidies and the more difficult to calculate expected underwriting gains and expected indemnities, which require stochastic models for analysis. Expected program costs of GRIP as a farm bill program equal expected payments. In this paper, we estimate these costs for GRIP for corn and soybeans in the three states where GRIP was first introduced: Illinois, Indiana, and Iowa. To estimate these costs, we document and use the rating procedures that were used to originally rate GRIP. These procedures are directly conducive to estimating expected underwriting gains under the current Standard Reinsurance Agreement (SRA). We find that, on average, the per-acre taxpayer cost of supporting GRIP in its current form as a crop insurance product is equivalent to the expected payments that would be generated by a Miranda-Glauber area revenue farm bill program that guarantees county revenue at a coverage level of at least 93%” (page six -seven).

At the end of the report, the authors noted that, “As noted by many, a Miranda-Glauber type of farm program, of which GRIP is simply an example, offers farmers significant risk management benefits because it triggers payments when systemic risk strikes a crop or a region, and it provides a transparent and automatic disaster aid mechanism. Because the program targets revenue rather than price, it would cover risks not currently covered by current marketing loan and countercyclical programs, as well as risks currently covered by crop insurance. Therefore, it could be financed from savings from current farm programs and the current crop insurance program. These cost savings perhaps create a large obstacle to adoption of such an approach. The large and growing tax support of the crop insurance industry has created strong vested interests of some political constituencies who will act to protect these interests” (page 27).


Ron Smith, writing on Thursday at the Southwest Farm Press webpage, reported that, “One probable change in the next farm bill is that it will be funded less generously than the current one.

“The cut could be as much as $30 billion over the next 10 years, about $74 billion instead of the March 2006, Congressional Budget Office baseline score of $104 billion for continuing the current farm bill. Projected stronger grain prices for the next 10 years reduce expenditures for CCPs and LDPs due to the counter-cyclical nature of these programs.

“An estimate of what CBO’s baseline would be, given current projected crop prices, puts farm bill spending at the $74 billion figure. ‘That’s $30 billion off the table to write the next farm bill,’ says James Richardson, co-director, Texas A&M Agriculture and Food Policy Center.”

Mr. Smith added that, “Richardson said other factors including increased emphasis on conservation, renewable energy and fruits and vegetables in the 2007 farm bill could affect the amount of funds devoted to the commodity title. ‘Money for these will come out of the commodity title,’ he said.”

And with respect to revenue insurance, the article noted that, “Richardson also anticipates tighter payment limits in the next farm law. He said revenue insurance proposals discussed at Senate and House Ag Committee hearings and the Secretary of Agriculture’s ‘listening sessions,’ have gained little traction with the Ag Committee.

“‘We’re not seeing any indication that Congress is giving (those proposals) serious consideration,’ he said.”

II. Ethanol

Yesterday, The Federal Reserve Bank of Kansas City released the latest issue of the Main Street Economist, entitled, “Can Ethanol Power the Rural Economy?”

According to the Bank’s summary of the report, “Nancy Novack and Jason Henderson discuss how ethanol has created a buzz in rural America and on Wall Street with its recent success. Profits, however, can swing wildly because of forces beyond the industry’s control. The article delves into what ethanol profits may look like in the future, as well as the risks for the industry.”

The report rhetorically asked, “Can ethanol be counted on to help power the stalled economies of rural America? This article looks at the economics of ethanol and discusses some of the factors that may endanger the stability of this hot industry” (page one).

As part of the background setup, the report reminded readers that, “While profits have fueled the recent ethanol expansion, environmental policy has been the industry’s foundation. The Clean Air Act Amendments of 1990 required that reformulated gasoline be sold in areas where ozone requirements were not being met. Reformulated gasoline contains an oxygenate, typically ethanol or MTBE (methyl tertiary butyl ether). Until the early 2000s, refiners preferred MTBE over ethanol because it cost less and was more chemically stable. But when studies showed that MTBE contaminated ground water supplies, the chemical was banned in 25 states, including California, the largest consumer of reformulated gasoline. Many refiners switched to ethanol to meet the reformulated gasoline requirement.

“The Energy Policy Act of 2005 eliminated the reformulated gasoline requirement. But the new law still required refiners to blend gasoline to keep emissions low. Thus, while the law did not specifically require oxygenated gasoline, the demand for ethanol remained” (page one, two).

And with respect to the “Renewable Fuels Standard” (R.R. F.S.), which has garnered increased attention since the President’s speech earlier this week, the report explained that, “The Energy Policy Act further underpinned ethanol’s demand by establishing the Renewable Fuels Standard. The RFS required that 4 billion gallons of renewable fules be blended into the nation’s fuels supply in 2006 and 7.5 billion gallons by 2012. These requirements ensured demand for ethanol and other renewable fuels, such as biodiesel produced from soybeans” (page two).

(Recall in the President’s speech that he proposed a mandatory fuels standard to require 35 billion gallons of renewable and alternative fuels in 2017 – nearly five times the 2012 target now in law.)

As interest in ethanol investment has soared, the Kansas City Fed noted that, “From 1999 to 2005, about 70 percent of the ethanol plants under construction were farmer-owned. In 2006, farmers owned just 10 percent” (page three).

The authors conducted a series of economic simulations with respect to the price of oil and the price of corn. The report noted that, “The simulations revealed that ethanol profits are highly variable with the potential for losses under high corn prices and low crude oil prices. Currently, crude oil prices are fluctuating around $60 per barrel, which would historically translate into ethanol prices reaching $2.13 per gallon. As [a chart included the report notes] at these prices ethanol production would be profitable in all cases where corn fluctuated between $1.50 and $3.50 per bushel. When crude oil prices were assumed to be $80 per barrel and ethanol prices to be $2.71 per gallon, ethanol profits rose under all corn prices scenarios. When crude oil prices were lowered to $40 per barrel and ethanol prices fell to $1.55 per gallon, ethanol profits also fell. In fact, ethanol profits turned negative when crude oil and ethanol prices were low and corn prices were high, $3.50 per bushel. In this scenario, losses were estimated at 9 cents per gallon” (page four).

On page five, the authors noted that, “A final issue facing the ethanol industry is the impact of new technologies. If refiners can meet clean air requirements and octane needs with a lower cost input, they will most certainly do so. Some refiners claim that cleaner gasoline can already be achieved without oxygenates, although these technologies are more expensive (Yacobucci). If such technologies were to become cost competitive, refiners could choose the cheaper option.”

In conclusion, the report stated that, “Ethanol production may offer some bright opportunities for rural America. In reality, though, ethanol profits in the future will be highly variable, given the volatility of prices for corn, ethanol, and other energy products. At the same time, its opportunities could quickly fade with changing markets, environmental policies, and technological advances” (page five).

-Keith Good