...channels and/or the revelation of private information. We find empirical evidence suggesting that private information is revealed by insurance companies via their reinsurance decisions. However, it is unlikely that such information will be incorporated into subsequent premium rates by the government.

INTRODUCTION

Federally regulated crop insurance programs have been a prominent part of U.S. agricultural policy since the 1930s. In 2004, the estimated number of crop insurance policies exceeded 1.24 million with total liabilities exceeding $45 billion. Traditional crop insurance schemes offer farmers the opportunity to insure against yield losses resulting from nearly all risks, including such things as drought, fire, flood, hail, and pests. A variety of crop insurance plans and a number of new pilot programs are currently under development.

In the crop insurance program three economic interests are served: the federal government through the United States Department of Agriculture's Risk Management Agency (RMA), the producers or farmers, and the private insurance companies. In 1980, insurance companies were solicited by the federal government to increase farmer participation. Intermediaries are often used in public policy if efficiency gains are expected. In the crop insurance program, efficiency gains could be expected through two avenues. First, the better established delivery channels of insurance companies could reach a greater number of producers at a given cost. Second, the exploitation of private information (if it exists with the insurance companies) can increase the accuracy of premium rates, thereby decreasing adverse selection losses. (1) In this article, we empirically test if insurance companies reveal private information about risk profiles to the RMA via their reinsurance decisions. Not only is this of economic interest, it is a timely empirical question given the sizeable public funds needed to operate the crop insurance program and that a significant share of those funds--rivaling that of producers--resides with the insurance companies (see Figure 1).

[FIGURE 1 OMITTED]

We use semiparametric as well as parametric methods to determine whether a set of policies returns a profit or not using a data set aggregated to the crop--county--year combination. We consider models with and without explanatory variables depicting the allocation decisions of insurance companies. The use of semiparametric methods, which avoid strong distributional assumptions, proves useful as we reject the parametric method.

The remainder of the article proceeds as follows. The second section "Insurance Companies and the Standard Reinsurance Agreement" provides a terse review of the involvement of insurance companies in the U.S. crop insurance program. The third section "Data and Methodology" discusses the data and outlines the econometric methods. The fourth section "Estimation Results" presents the results, while the final section focuses on the corresponding policy implications.

INSURANCE COMPANIES AND THE STANDARD REINSURANCE AGREEMENT

There is a surprisingly small literature on the role of insurance companies in the U.S. crop insurance program (see Miranda and Glauber, 1997; Ker, 2001). Figure I illustrates the breakdown of government program outlays into producer subsidies, indemnities less premiums, administrative and operating reimbursement for insurance companies, and underwriting gains/losses accrued by insurance companies. (2) There are a number of interesting features: (1) producer subsidies increased dramatically in 1995 (a result of the 1994 Federal Crop Insurance Act) and again in 2001 (a result of the 2000 Agricultural Risk Protection Act (ARPA)), (2) indemnities less premiums are quite volatile, (3) insurance companies' administrative and operating expenses have risen with increases in total premiums, and (4) underwriting gains accruing to insurance companies have increased dramatically since 1994. Given the significant underwriting gains realized by insurance companies, it is of economic interest to determine if they reveal private information through their reinsurance decisions.

The involvement of insurance companies in the U.S. crop insurance program is defined by the Standard Reinsurance Agreement (SRA). Insurance companies sell policies and conduct claim adjustments. In return, the RMA compensates them for the corresponding administrative and operating expenses. The underwriting gains/losses are shared asymmetrically, between the insurance companies and the RMA. Both the provisions by which the underwriting gains and losses are shared and the reimbursement for administrative and operating expenses are set out in the SRA.

Section II.A.2 of the 2005 SRA states that an insurance company "... must offer and market all plans of insurance for all crops in any State where actuarial documents are available in which it writes an eligible crop insurance contract and must accept and approve all applications from all eligible producers." An eligible farmer will not be denied access to an available, federally subsidized, crop insurance product. Therefore, an insurance company conducting business in a state cannot discriminate among farmers, crops, or insurance products in that state. This is unusual in that the responsibility for pricing the crop policies lies with the RMA but the insurance companies must accept some liability for each policy they write and cannot choose which policy they will or will not write.

Two mechanisms are provided to entice insurance companies to participate. First, given that insurance companies do not set premium rates, there is a mechanism in the SRA by which they can cede the majority of the liability of an undesirable policy. In a private market, the insurance company would not write a policy deemed undesirable. Second, given that RMA premium rates do not reflect a return to the insurance company's capital, the SRA provides asymmetric sharing of underwriting gains/losses. Essentially,...

NOTE: All illustrations and photos have been removed from this article.




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