The ‘Unintended’ Consequences of Taxpayer-Subsidized Crop Insurance

August 23, 2020

By Doug Peterson, Understanding Ag, LLC

There are many things that influence what a person does and how well they take care of the land they own or operate. Several studies show that any kind of absentee or non-operating landowner (investors, heirs, retirees) generally do not invest in conservation on the land as much as owner-operators. There are several reasons for that, but that is a topic for another day. Right now, I want to address why we have so much land ownership by outside investors or non-operating landowners and examine if we really want that much ownership/investment by folks outside agriculture.

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Here is one exercise to help you think through why we have so much rented land in agriculture.

Let’s pretend you are a banker and two people come to you for a loan. For any loan, equity or collateral are needed because the bank wants to hold something the borrower already owns as collateral to make sure the note is paid back. So here are the two scenarios:

Farmer A
This farmer owns 500 acres of land. That land is worth $8,000 an acre and let’s say it is all paid for, which means there is $4 million worth of equity in this farm (500 acres x $8,000).

Farmer A comes to you, the banker, to borrow crop input money of $400 an acre to plant 500 acres (no land cost, inputs only). The loan request is $200,000.
With a client who has $8 million in equity/collateral who is asking for a $200,000 loan, what will your answer be? “You bet!” You will loan the money and not hardly think about it. In fact, Farmer A could lose it all that year and you would likely make that same loan several more times because of such great land collateral that you can take back if Farmer A doesn’t pay.

Farmer B
This farmer also owns 500 acres of land. The land is worth $8,000 an acre, and just like Farmer A, let’s say it is all paid for. So, this farmer also has $4 million worth of equity (500 acres x $8,000) but, in addition to the owned 500 acres, another 4,500 acres is rented, for a total of 5,000 acres.

So, when Farmer B comes to you, as the banker, to borrow that same $400 an acre operating loan for planting the crop, the loan amount is $2 million ($400 x 5,000 acres).

Farmer B has the same $4 million in equity/collateral as Farmer A, but is asking for a $2 MILLION loan on inputs that will only provide a return if the weather cooperates. Will you provide that $2 million loan? Is it as easy to answer “yes” as it was to Farmer A? What if Farmer B experiences a drought or a flood and loses it all for a year, then what will your answer be when Farmer B comes back the second year for another $2 million? How much collateral is available? Answer: Not nearly enough to make it worth the bank’s risk. 

As the banker, you will likely say “no” to Farmer B. There is just too much risk involved relative to the loan/equity ratio and possible weather risk.
But, what if Farmer B says, “Hey, I have crop insurance that will guarantee 80% of expected yield no matter if it rains or doesn’t rain, or no matter what the markets are doing, or even how good of a job I do planting, or how timely my harvest may be. Plus, your bank gets first dibs on any crop insurance payback I may receive.” Then what would you say? 

Incentives for outside investors
Taxpayer-subsidized Federal Crop Insurance that reduces the risk of land-renting operators, allowing them to rent large acreages without land equity/collateral to back up those big operating loans, is incentivizing the outside investor buy-up of land all over the country. Many landowners are retiring and moving to town and renting their land out. Those who inherit land are increasingly renting out that land, too. They can do so because there is someone out there with a banker behind them to rent it. And the only reason the bank can do that is because crop insurance covers most of their risk. 

Don’t misunderstand. I am not against insurance as a product that someone can sell or someone can buy. But taxpayer-subsidized crop insurance is not based on a free-market economy insurance product. 

For example, I could purchase full coverage for every vehicle I have, even the 30-year-old Ford Ranger that I have my 16-year-old drive that’s worth about $500. The premium would be about $500 every six months to purchase full, comprehensive coverage on that crappy old truck. Purchasing full coverage would not be a wise economic choice on my part, would it? But what if someone offered to pay $400 of that policy for me? If that happens, then it looks a little more attractive for me to buy that coverage doesn’t it?

Now let’s assume you are the banker again. Will you be happy if your $2 million borrower (Farmer B from above) only takes out “liability” on his crop? No, because If the weather doesn’t cooperate you might get hung out to dry on part or all of your operating loan. But without 70% of the premium being paid for by the taxpayer, that is very likely what Farmer B would have to do. Margins on commodity crops are just too thin to afford “full coverage” at full price. Taxpayer-subsidized crop insurance means that the farmers can purchase the “full coverage” package and only have to pay “liability” rates. 

Follow the money
This is a complex deal and you have to really study insurance pricing to understand this. Do insurance companies lose money? On the average policy insurance companies do not lose money because their actuaries determine the odds very accurately regarding risks and they set the price accordingly.
Here’s another question worth asking: What homeowners make money on their homeowner’s insurance policy? The only ones who make money over the entire life of their policy are the ones to which something bad happens and for which they have a very big claim. For the insurance companies to stay in business, they have to make money on the average of all policies. Only big events “pay off” for the homeowner. (Not surprisingly, big pay-offs also lead to higher premium payments for all homeowners—both those who suffer the loss and those whose premiums support the general pool of insured.)

If farmers had to purchase insurance on a free market basis, they would only make money on a catastrophic event policy, not the almost-annual payoffs they get now. The insurance companies understand this. Currently, they have it set up so the farmer consistently gets more money back than what they pay for their portion of the premium. That keeps them buying the policy at a high level or the “full coverage” policy. The insurance company makes their profit on the taxpayer-funded portion of the premium. The farmer wins, the insurance company wins, and the banker and all the input companies are protected from almost all risk.
But the taxpayer gets the bill and the land degrades more and more. 

We can beat around the bush all day with other options to help educate non-operator landowners, but at the end of the day, crop insurance is the big dog driving everything. Without heavily subsidized crop insurance, we would have a great deal less rented land. Retirements and deaths would lead to land sales. Farmers would have to bid that weather-related risk into the land prices. More land sales and absorbing weather-related risk would lead to cheaper land prices. 

To repeat, I am not against any individual farmer taking out crop insurance. It is a legal program and that makes it ethical and moral—sort of. However, what I do want folks to understand is the impact that crop insurance has on many things, farmers, taxpayers, land ownership and the conservation ethic that goes along with that.

Kathy Richburg

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