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The Challenge of Setting Crop Insurance Rates

The rate you pay for your car insurance depends on how risky you appear to your insurance company. They estimate this risk not only on your driving record, but by looking at the categories you fit into--your age, your sex, your marital status.

Federal crop insurance programs also attempt to estimate risks when insuring farmers, but this is a significantly more challenging exercise. "One of the more difficult problems facing crop insurance is estimating premiums," says Alan Ker, an AREC faculty member researching the methodology used to set crop insurance rates.

"In car insurance they have not only your driving record, but also the driving records of thousands of people with similar characteristics," Ker explains. "This is not true for farmers. Farmer A is very different from Farmer B and there is relatively little historical data on any farmer."

Some operations have data going back for only three or four years, Ker notes. "One major line of my research is focused on how to best estimate premiums in light of a scarcity of data," he says.

The difficulty in setting premiums pertains to the new insurance products introduced over the last couple of years, as well as traditional crop insurance products. Using econometrics and different statistical methods, Ker's research aims to make the premiums for these products more accurate.

Ker is on the advisory board of the Risk Management Agency (RMA), a division of USDA that sets premiums for federal crop insurance programs. Some of the methodologies Ker has developed have been implemented into the agency's rate setting process.

A second line of Ker's research is focused on the role of the private insurance companies. Although the RMA sets the premium rates, insurance companies sell the policies to farmers. Profits and losses from the policies are shared between the government and these private companies.

"The arrangement by which profits and losses are shared is extremely complicated," Ker explains. "Given the increased prominence of crop insurance in the U.S. agricultural policy agenda, a thorough understanding of this arrangement is critical."

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