Taxpayers on the line for Midwestern drought losses; good stewardship can limit damages
Posted August 30, 2012
All summer long, news outlets have been chock-full of rather depressing headlines about the record-breaking drought gripping the center portion of the country. Although it’s too soon to tell just how bad this year’s crops will be, my sources in Nebraska tell me the dryland corn they are harvesting this week is yielding about a third of the kernels it typically does.
Despite these dismal yields, the U.S. Department of Agriculture recently released a report that predicts farm income will rise by 3.7 % over last year, making it the second most profitable year for agriculture since 1970 (after inflation adjustments).
How can farmers make money during a drought?
There are two major factors at work here. First, farmers who are able to produce a crop this year will reap the benefits of unprecedentedly high prices, bumping up average profits across the nation. But, perhaps the more broadly applicable factor is that farmers affected by this year’s uncooperative weather hedged their risk, reducing nation-wide average losses.
The most common risk management tool used by U.S. farmers is the federally subsidized Federal Crop Insurance Program (FCIP); about 279 million acres in the U.S. are covered by crop insurance. Although the FCIP is a federally subsidized program, it is administered by private insurance companies, many of which are part of large insurance conglomerates, such as ACE and Everest Re.
The private companies who administer the FCIP will likely take a hit in their profits, but even their bottom lines will be relatively unscathed.
So if the farmers with low yields aren’t going belly up, and if the insurance companies who are indemnifying the farmers aren’t really going to be hurt by $20 billion in claims, who is bearing the brunt of the costs associated with the dry weather this year?
The U.S. taxpayers will pick up the bill.
The reason the private insurance companies are able to make a profit despite record indemnities is that they too hedged their risk. The federal government reinsures the policies sold by the private companies, which means U.S. taxpayers are on the hook for a large portion of the agricultural losses this year.
That’s right. At the same time U.S. consumers can expect to pay higher prices at the grocery store and the U.S. credit rating is downgraded due to politicians’ inability to deal with massive amounts of government debt, there’s yet another huge bill coming—crop insurance indemnities.
To be sure, there is value in having an effective “safety net” for farmers. The Federal Crop Insurance Program was born out of the Dust Bowl when thousands of farmers lost their land after several dry years in a row left them unable to pay their bills. The fact that most farmers, even the ones hit hardest by this year’s drought, will plant again next year is a testament to the level of sophistication we’ve been able to achieve in the financial risk management tools available to U.S. farmers.
But, as former Secretary of Agriculture Dan Glickman noted earlier this week, “we have yet to apply the same level of enthusiasm to the [farming] techniques and policies that producers can use to mitigate climate risk.” We should be taking a more holistic approach to agricultural risk management and work harder to reduce the need for crop insurance indemnities in the first place.
Agricultural Best Management Practices can hedge the risk of financial losses.
Secretary Glickman recognizes that good stewardship of farmland is among the most valuable risk management strategies available to farmers. For example:
- No-till farming- Farmers who use no-till plant directly into the stubble from last year’s crop. The stubble helps trap precipitation on the field, and leaving the soil undisturbed helps preserve moisture. USDA data shows that corn farmers who used no-till were about one-third less likely to receive a crop insurance indemnity than their conventional tilling peers. And a recent USDA study shows that no-till can be an effective tool to help farmers cope with a warmer climate and changes in precipitation patterns.
- Crop diversity- Growing a variety of crops can hedge risks in two ways. First, if the weather is bad for one crop, it might be good for something else. Diversifying allows farmers to make up the difference of one poor crop with another product that might do better. Second, different crops impact the soil in different ways. A diverse operation helps build healthy soil that is better suited to produce good crops despite uncooperative weather.
Bad years are part of farming; not every year will be a bin-buster. But there are ways to prevent the bad years from being even worse. A holistic approach to agricultural risk management that recognizes the advantages of best management practices would benefit farmers, insurance companies, and taxpayers.