before the
Senate Committee on Agriculture, Nutrition, and Forestry

March 10, 1998

  Good morning, Mr. Chairman, I am Rawle King, Insurance Analyst at the Congressional Research Service, the Library of Congress.  I am grateful to you for providing me the opportunity to appear before this committee to discuss reforms to the Federal Crop Insurance Program.

 Mr. Chairman, you requested that I provide this committee with information about how other federal insurance programs operate and how States regulate private insurance.  As background, I have served in my current position since 1987, and I have briefed Members of Congress and congressional staffers from offices of Members and committees of Congress, and I have prepared analytical reports, memoranda, and other written responses on significant insurance-related issues of legislative concern to Congress.  Prior to my tenure at CRS, I worked several years as an insurance account executive with responsibility for marketing various types of insurance products in the New York-New Jersey area.

 In recent years, crop insurance reform efforts were aimed at making crop insurance -- and not federal disaster assistance -- the primary form of disaster aid to farmers.  The Federal Crop Insurance Reform Act of 1994 (Public Law 103-354), for example, streamlined the past dual system of crop insurance and ad hoc disaster assistance by providing basically free catastrophic coverage for insurable crops, allowing participating producers to purchase coverage at a subsidized rate, and offering a permanent disaster payment program to growers of crops that are ineligible for insurance.  The Crop Insurance Reform Act of 1998 proposes to go a step further by implementing market-oriented reforms designed to encourage insurance price and policy coverage competition among insurers that participate in the federal multi-peril crop insurance program.

 In eleven years at CRS, I have assisted Members in analyzing various Natural Disaster legislative proposals.  This included work with the Senate Bipartisan Task Force on Funding Disaster Relief in 1994.  This Task Force was established by Public Law 103-211 in February 1994 in the aftermath of a major earthquake in Northridge, California.  In establishing the Task Force, the Senate noted that the unprecedented growth in the costs of disaster assistance needed to be reconciled with the restraints imposed on discretionary spending and with the deficit reduction goals of the Budget Enforcement Act of 1990 and the Omnibus Budget Reconciliation Act of 1993.

 The mission of the Task Force was to compile information on the history of federal funding for disaster relief and recovery assistance, evaluate the types and amounts of federal disaster assistance provided to individuals and state and local governments, and consider the relationship between funding relief from disasters and complying with requirements for controlling the deficit.  To achieve this mission, the Task Force brought together representatives from the Congressional Research Service, the Congressional Budget Office, and the U.S. General Accounting Office.

 A key issue examined in the Task Force report that has relevance to the crop insurance reform agenda was the need to require the purchase of private insurance for catastrophic events.  As with the crop insurance program where farmers' participation has historically been low, in the range of 30-40 percent of eligible acreage, most homeowners in disaster-prone regions simply do not purchase insurance.  There are essentially two reasons why individuals -- homeowners or farm owners -- do not purchase insurance .  First, individuals may not have an accurate perception of the risk of natural hazards.  While they may be in a unique position to evaluate how much they value living or  farming in a particular place, individuals often are not fully aware of their exposure to loss from flood, drought, etc.  Consequently, some may underestimate the chance that they will sustain damage.

 Second is the existence of disaster relief.  To the extent that the government provides aid to ameliorate losses from a hazard, it replicates the function of insurance.  In doing so, it decreases the incentive to buy insurance.  Not only are people given coverage without buying a policy, but they find that they are paying for that protection (through taxes) whether they choose to or not.  From this perspective, buying insurance is like paying twice for the same thing.  Moreover, disaster relief lacks many of the functions of insurance in that it generally lacks a mechanism to encourage individuals to engage in loss mitigation .

 Without an insurance purchase requirement for farmers, policymakers risk supply side market failure in four critical areas: (1) adverse selection (i.e., selection against the insurer) which occurs when property owners most likely to purchase disaster insurance are the ones who have the greater-than-average likelihood of loss and therefore are most likely to need it; (2) moral hazard which is the tendency of insurance protection to alter an individual's motive to prevent loss; (3) high transaction costs which occur in developing customized rates for property owners in hazard-prone areas; and (4) difficulties in predicting and pricing of insurancefor disaster loss which are inherent due to the low-frequency, high-impact nature of floods, droughts, hurricanes, earthquakes, and other soil movements.

 Together, these challenges raise specific concerns for crop insurers that may include rate inadequacy due to regulatory suppression of rates and incorrect catastrophe loading calculations, a tight reinsurance market, overexposure/concentration of risk in hazard-prone areas, and depletion of policyholders surplus.  Ideally, insurers want sufficient data on past losses to estimate the likelihood of future loss and to identify and classify the potential degree of risk, or the probability of loss of each potential applicant.  They will then develop rate structures that spread their risks broadly among policyholders in order to offer a price low enough to attract many potential customers into the market.  When insurers perceive some difficulty in assembling a pool of uncorrelated risks for which they have limited data, they will not offer coverage or they will become very selective in their underwriting practices.  This is the case with seismic, wind, and flood hazards  -- events that occur infrequently and typically result in catastrophic losses.

 In conclusion, I have tried to identify some issues that might arise as this committee considers market-oriented crop insurance reforms.  Federal policymakers face a difficult task in determining the appropriate role of the federal government and the private sector in funding disaster assistance for catastrophic crop losses.  The difficulty is complicated by the fact that rate setting, solvency, and market conduct practices of private insurance companies are regulated by the states.