FCIP Industry Presentation

Federal Crop Insurance Program Delivery Cost Study

First Industry Presentation

Cost of Delivery Estimation Methodology

July 10, 2012

 

ANY TAX ADVICE IN THIS COMMUNICATION IS NOT INTENDED OR WRITTEN BY KPMG TO BE USED, AND CANNOT BE USED, BY A CLIENT OR ANY OTHER PERSON OR ENTITY FOR THE PURPOSE OF (i) AVOIDING PENALTIES THAT MAY BE IMPOSED ON ANY TAXPAYER OR (ii) PROMOTING, MARKETING OR RECOMMENDING TO ANOTHER PARTY ANY MATTERS ADDRESSED HEREIN.

The advice, recommendations, work product, and deliverables provided as part of this engagement will be developed for Risk Management Agency management, and are not intended for use by any other party or for any other purpose, and may only be relied upon by Risk management agency management. We disclaim any intention or obligation to update or revise the observations whether as a result of new information, future events or otherwise. Should additional documentation or other information become available which impacts upon the observations reached in our deliverables, we reserve the right to amend our observations and summary documents, including deliverables, accordingly.

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Agenda

	Page
Project Team	4
Introduction	6
Background	8
Study Objectives	19
Technical Approach	23
Challenges	33
Questions and Comments	34

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Project Team

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Project Team

        KPMG LLP (“KPMG”) engagement team is made up of economists, actuaries, sampling specialists, survey specialists, and insurance industry specialists

• • 1. • • • • Jon Silverman, Ph.D. – Project Lead* 

             • LiWei Shi, Ph.D. – Project Manager and Analyst* 

             • Vera Holovchenko, Ph.D. – Econometrician* 

             • Kayla Lamar – Analyst* 

             • Paul Li, Ph.D. – Lead Statistician 

             • Barb Theobald – Campos Market Research, Lead Survey Specialist 

             • Jerome Albright  – Industry specialist 

             • Sharon Carroll – Actuary 

             * Present today

 

Introduction

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Introduction

• • • • • • • In March 2012, Risk Management Agency (“RMA”) engaged KPMG to prepare a study of the economic costs of delivery for the Federal Crop Insurance Program (“FCIP”). 

            • Purpose of the Study 

• • • • • • • • Identify and measure on a regional and national basis the current reasonable and necessary economic costs required for delivery of the FCIP. 

            • Motivation for the Study 

              • The Government Accountability Office (“GAO”) April 2009 findings suggest that  Administrative and Operating (“A&O”) payments have tripled between 2000 and 2009 due to the calculation method that takes into account the value of crop rather than actual cost of selling and servicing policies. 

            • Purpose of this Presentation 

              • Discuss study objectives, proposed methodology, and receive industry feedback. 

            • Note: Data presented in this presentation are preliminary and should not be considered final. 

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Background

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Overview of the Federal Crop Insurance Program

• • • • • • • In 2011, the Federal crop insurance program provided1 

• • • • • • • • coverage for 265.7 million acres 

              • insured liability of $114.2 billion 

              • generated total premiums of $12 billion of which $7.5 billion were premium subsidies 

              • $10.8 billion in indemnity payments 

            • Insurance Agents in FCIP 

              • About 12,400 agents sold federal crop insurance in Reinsurance Year (“RY”) 2011 

              • 1.2 million policies earning premium were written in RY 2011    

              • Average premium for policies earning premium was $10,387 in RY 2011 

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How Money Flows Through the Federal Crop Insurance Program

 

Number of Policies Earning Premium By RY

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Number of Policies Earning Premium2 by RY3

Number of Policies in Thousands

 

 

FCIP has some unique features:

• • • • • • • Product homogeneity 

• • • • • • • • RMA sets premium rates for all Federal crop insurance policies; 

              • RMA establishes underwriting standards, policy terms and conditions, etc. for all Federal crop insurance policies; and 

              • Companies compete for market share on factors other than price. 

            • FCIP premiums are not loaded for expenses. Instead, RMA pays AIPs the A&O subsidy to cover their operating expenses. 

            • Agencies/agents operate independently of the AIPs and can change company affiliations. 

            • AIPs must accept all eligible farmers in a state in which they operate.  

            • Extensive quality control reviews are required for the delivery of a government program. 

            • Selling and servicing the Federal crop insurance policies requires greater frequency of contacts between an insurance agent and the insured farmer relative to Property and Casualty (“P&C”). 

Special Features of the Federal Crop Insurance Program

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Commission, Gross Premium, and A&O Subsidy by RY

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Commission,4 Gross Premium,5 and A&O Subsidy6 by RY

Gross Premium Amount in Billions

 

 

Commodity Prices for Corn and Wheat

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Commodity Prices – Corn and Wheat7

Price Index

 

 

Commission Ratio by RY

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Commission Ratio8 by RY

Commission Ratio

 

 

• • • • • • 2009 GAO Report9 

• • • • • • • A&O payments nearly tripled between 2000 and 2009 because the method used for calculating A&O payments considers the value of the crop rather than the actual costs for selling and servicing the Federal crop insurance. 

          • 2010 Grant Thornton Report Commissioned by NCIS10 

            • All studies conducted by Grant Thornton consistently show that the MPCI program is less profitable than the P&C industry as a whole in the area of profitability and more efficient than the P&C industry in the area of expense management. 

          • 2009 Milliman Report Commissioned by RMA11 

            • From 1989 -2008, the estimated earned rate of return on equity for MPCI insurers was approximately 17.1 percent as compared with an average reasonable rate of return of 12.8 percent over the same period. 

Previous Studies on A&O Payment and AIP Profitability

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• • • • • • • A number of previous studies have typically approached the issue of cost of the crop insurance program from an accounting perspective, with the assumption that the accounting costs reported by AIPs by themselves represent the economic cost of delivery of the FCIP: 

• • • • • • • • Although the sales expenses reported by AIPs are likely to be highly correlated with the level of efforts required for the agents to sell and service the crop insurance policies, they may not be an accurate reflection of the true program delivery cost incurred by the insurance agents; 

              • For LAE and overhead expenses, significant disparities are not presumed to exist between accounting costs (AIP reported expenditures) and economic costs, and these categories are comparatively small relative to sales expenses. 

            • No study has been conducted to appropriately measure the economic cost of delivery for the FCIP, especially the economic cost of delivery incurred by insurance agencies/agents in selling and servicing Federal crop insurance. 

RMA Requests an Independent Study to Determine the Economic Cost of Delivery

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• • • • • • • Accounting Costs 

• • • • • • • • Accounting costs are reported by AIPs to RMA and State insurance departments.         

            • Economic Costs 

              • Economic costs are more difficult to identify and analyze. 

              • Economic costs can exceed accounting costs because there is no recognition on the books and records of the opportunity costs of an activity, e.g., the opportunity cost of use of an owned building for one activity is the rent forgone if the building is rented out. 

              • Accounting costs could also exceed economic costs if the underlying cost of resources could be acquired at a lower price, e.g., at their opportunity cost or value in next best use. 

              • RMA is concerned that accounting costs of the delivery could be greater than economic costs if the method used to compensate agents is driven by premium linked to commodity prices rather than say by level of effort required or wage in an alternative use. 

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Study Objectives

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Determine Costs Incurred by Insurance Agencies/Agents

• • • • • • • Sales Expenses 

• • • • • • • • Costs incurred by insurance agencies and their agents who sell crop insurance to farmers. 

              • Costs of actual provision of services, including salaries, out of pocket expenses (e.g. transportation), and other overhead expenses (e.g. office expenses). 

              • The sales expenses incurred by the AIPs represent the revenue of the insurance agency/agent rather than their cost. 

Determine Costs Incurred by AIPs

• • • • • • • Loss Adjustment Expenses 

              • Fees paid to insurance adjusters to verify claims. 

            • Overhead Expenses 

              • Company overhead, such as employee salaries and labor burden, information technology, general and administrative expenses, underwriting expenses, agent and adjuster training costs, quality control, and maintaining capital levels required by Federal regulations. 

Determine the Economic Cost of Crop Insurance Delivery

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Insurance Company Expenses by RY

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Insurance Company Expenses by RY12

Dollars in Billions

 

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• • • • • • • Factors that might potentially affect the LAE and Overhead Expenses incurred by AIPs: 

• • • • • • • • Geographical Regions: by state or by other geographical segmentation (e.g. Corn Belt), and 

              • Size of the Company: measured primarily by premiums written each year. 

            • Factors that might potentially affect the cost of delivery incurred by insurance agencies/agents: 

              • Geographical Regions: by state or by other geographical segmentation (e.g. Corn Belt), 

              • Agent Type: captive vs. independent Agents, 

              • Policy Characteristics: new policies vs. renewal policies, 

              • Crop Coverage: regular crops (e.g. corn, wheat, soybean) vs. specialty crops, and 

              • Type of Insurance: Catastrophic Loss Coverage (CAT), Area, Yield and Actual Production History (APH)/Revenue. 

Consider Factors Potentially Affecting the Program Delivery Cost

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Technical Approach

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• • • • • • Use RMA data to analyze LAE and Overhead Expenses 

• • • • • • • Use RMA data reported by AIPs to analyze costs AIPs incurred in selling and servicing Federal crop insurance. 

          • Perform benchmarking analysis to compare operational costs of MPCI insurers with those of insurers in other P&C lines of business.  

            • Financials reported by AIPs to RMA and financials for insurers in P&C lines of business from SNL will be used for this analysis. 

            • Compare expense ratios for the MPCI insurers with expense ratios observed in other P&C lines of business. 

Analyze LAE and Overhead Expenses Incurred by AIPs

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• • • • • • The benchmarking analysis includes a comparison of the following key ratios across industries: 

• • • • • • • Commission Ratio: measures expenditure insurers pay to its sales force 

            • Taxes, Licenses, and Fees Ratio 

            • Overhead Expense Ratio 

            • Total Expense Ratio: defined as sum of all three ratios above, measures overall operational efficiency 

            • LAE Ratio: measures expenditure insurers pay to the adjusters 

            • Loss Ratio: measures overall effectiveness in risk control and management 

            • Combined Ratio: measures overall profitability 

            • Delivery Expense Ratio: defined as Total Expense ratio plus LAE ratio, measures the delivery expense incurred by insurance company in selling and servicing the respective insurance policies 

Analyze LAE and Overhead Expenses Incurred by AIPs

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Challenges

• • • • • • Increase the Response Rates for Agents and Farmers 

• • • • • • • The expected response rates for agents and farmers are likely to be low 

            • Ways for us to increase the response rates of the agents 

• • • • • • • • Survey Format (internet, phone, mail) 

              • Survey Time 

              • Survey Duration 

            • Suggestions /Potential Assistance from AIPs 

              • Awareness Campaign 

              • Advance Notification Email 

              • Reminder Email 

          • In estimating the cost of delivery by insurance agents, consider the myriad of differences in levels of selling efforts across geographies, types of crops, insurance plans, coverage levels, and sizes of acreage. 

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Questions and Comments

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Thank you

Jon Silverman                 [email protected]

LiWei Shi                        [email protected]

Vera Holovchenko                [email protected]

Kayla Lamar                 [email protected]

 

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