Crop Insurance
USDA Needs to Improve Oversight of Insurance Companies and Develop a Policy to Address Any Future Insolvencies Gao ID: GAO-04-517 June 1, 2004U.S. Department of Agriculture's (USDA) Risk Management Agency (RMA) administers the federal crop insurance program in partnership with insurance companies who share in the risk of loss or gain. In 2002, American Growers Insurance Company (American Growers), at the time, the largest participant in the program, was placed under regulatory control by the state of Nebraska. To ensure that policyholders were protected and that farmers' claims were paid, RMA agreed to fund the dissolution of American Growers. To date, RMA has spent about $40 million. GAO was asked to determine (1) what factors led to the failure of American Growers, (2) whether RMA procedures were adequate to monitor companies' financial condition, and (3) how effectively and efficiently RMA handled the dissolution of American Growers.
The failure of American Growers was caused by the cumulative effect of company decisions that reduced the company's surplus, making it vulnerable to collapse when widespread drought in 2002 erased anticipated profits. The company's decisions were part of an overall strategy to increase the scope and size of American Growers' crop insurance business. However, when anticipated profits did not cover the company's high operating expenses and dropped its surplus below statutory minimums, Nebraska's Department of Insurance (NDOI) declared the company to be in a hazardous financial condition prompting the state commissioner to take control of the company. In 2002, RMA's oversight was inadequate to evaluate the overall financial condition of companies selling federal crop insurance. Although RMA reviewed companies' plans for selling crop insurance and analyzed selected financial data, oversight procedures generally focused on financial data 6 to 18 months old and were insufficient to assess the overall financial health of the company. Additionally, RMA did not routinely share information or otherwise coordinate with state regulators on the financial condition of companies participating in the crop insurance program. For example, NDOI had identified financial and management weaknesses at American Growers. Since American Growers' failure, RMA has acted to strengthen its oversight procedures by requiring additional information on companies' planned financial operations. It is also working to improve its coordination with state insurance regulators. However, as we completed our review, neither of these initiatives had been included in written agency policies. When American Growers failed, RMA effectively protected the company's policyholders, but lacked a policy to ensure it handled the insolvency efficiently. RMA has spent over $40 million, working with the state of Nebraska, to protect policyholders by ensuring that policies were transferred to other companies and that farmers' claims were paid. NDOI accommodated RMA's interests by allowing RMA to fund the operation of the company long enough to pay farmers' claims. Prior to American Growers' failure, RMA did not have an agreement with the NDOI commissioner defining state and federal financial roles and responsibilities. If the NDOI commissioner had decided to liquidate the company, RMA may have incurred more costs and had less flexibility in protecting policyholders.
RecommendationsOur recommendations from this work are listed below with a Contact for more information. Status will change from "In process" to "Open," "Closed - implemented," or "Closed - not implemented" based on our follow up work.
Director: Team: Phone:GAO-04-517, Crop Insurance: USDA Needs to Improve Oversight of Insurance Companies and Develop a Policy to Address Any Future Insolvencies
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Report to Congressional Requesters:
June 2004:
CROP INSURANCE:
USDA Needs to Improve Oversight of Insurance Companies and Develop a
Policy to Address Any Future Insolvencies:
GAO-04-517:
GAO Highlights:
Highlights of GAO-04-517, a report to congressional requesters.
Why GAO Did This Study:
U.S. Department of Agriculture‘s (USDA) Risk Management Agency (RMA)
administers the federal crop insurance program in partnership with
insurance companies who share in the risk of loss or gain. In 2002,
American Growers Insurance Company (American Growers), at the time,
the largest participant in the program, was placed under regulatory
control by the state of Nebraska. To ensure that policyholders were
protected and that farmers‘ claims were paid, RMA agreed to fund the
dissolution of American Growers. To date, RMA has spent about $40
million.
GAO was asked to determine (1) what factors led to the failure of
American Growers, (2) whether RMA procedures were adequate to monitor
companies‘ financial condition, and (3) how effectively and efficiently
RMA handled the dissolution of American Growers.
What GAO Found:
The failure of American Growers was caused by the cumulative effect of
company decisions that reduced the company‘s surplus, making it
vulnerable to collapse when widespread drought in 2002 erased
anticipated profits. The company‘s decisions were part of an overall
strategy to increase the scope and size of American Growers‘ crop
insurance business. However, when anticipated profits did not cover
the company‘s high operating expenses and dropped its surplus below
statutory minimums, Nebraska‘s Department of Insurance (NDOI) declared
the company to be in a hazardous financial condition prompting the
state commissioner to take control of the company.
In 2002, RMA‘s oversight was inadequate to evaluate the overall
financial condition of companies selling federal crop insurance.
Although RMA reviewed companies‘ plans for selling crop insurance and
analyzed selected financial data, oversight procedures generally
focused on financial data 6 to 18 months old and were insufficient to
assess the overall financial health of the company. Additionally, RMA
did not routinely share information or otherwise coordinate with state
regulators on the financial condition of companies participating in
the crop insurance program. For example, NDOI had identified financial
and management weaknesses at American Growers. Since American Growers‘
failure, RMA has acted to strengthen its oversight procedures by
requiring additional information on companies‘ planned financial
operations. It is also working to improve its coordination with state
insurance regulators. However, as we completed our review, neither of
these initiatives had been included in written agency policies.
When American Growers failed, RMA effectively protected the company‘s
policyholders, but lacked a policy to ensure it handled the insolvency
efficiently. RMA has spent over $40 million, working with the state of
Nebraska, to protect policyholders by ensuring that policies were
transferred to other companies and that farmers‘ claims were paid.
NDOI accommodated RMA‘s interests by allowing RMA to fund the operation
of the company long enough to pay farmers‘ claims. Prior to American
Growers‘ failure, RMA did not have an agreement with the NDOI
commissioner defining state and federal financial roles and
responsibilities. If the NDOI commissioner had decided to liquidate the
company, RMA may have incurred more costs and had less flexibility in
protecting policyholders.
What GAO Recommends:
GAO recommends that RMA (1) develop written policies to improve reviews
of companies‘ financial condition, (2) develop written agreements with
states to improve coordination on the oversight of companies and (3)
develop a policy clarifying RMA‘s authority as it relates to federal
and state actions and responsibilities when a state regulator takes
control of a company.
In commenting on this report, RMA agreed with our recommendations and
has begun implementing them.
www.gao.gov/cgi-bin/getrpt?GAO-04-517.
To view the full product, including the scope and methodology, click on
the link above. For more information, contact Lawrence J. Dyckman at
(202) 512-3851 or dyckmanl@gao.gov.
[End of section]
Contents:
Letter:
Results in Brief:
Background:
Company Decisions Contributed to American Growers' Failure:
RMA Financial Oversight Was Inadequate to Identify American Growers'
Financial Weaknesses:
RMA Effectively Protected American Growers' Policyholders but Lacked a
Policy to Efficiently Address Insolvencies:
Conclusions:
Recommendations:
Agency Comments and Our Evaluation:
Appendixes:
Appendix I: Scope and Methodology:
Appendix II: Penalties and Financial Losses Associated with Marketing
CRC Plus for Rice Reduced American Growers' Surplus:
Appendix III: Agent Commissions and Other Expenses Created High
Operating Costs:
Appendix IV: Purchase of Competitor's Crop Insurance Business Created
Additional Expenses:
Appendix V: American Growers' Surplus Was Inadequate to Cover Expenses
When Underwriting Gains Did Not Materialize:
Appendix VI: RMA Paid Policyholders' Claims after American Growers'
Failure:
Appendix VII: Rain and Hail's Proposal to Purchase Selected Assets of
American Growers:
Appendix VIII: RMA's Decision to Pay American Growers' Agent
Commissions:
Appendix IX: Comments from RMA:
GAO Comments:
Appendix X: GAO Contacts and Staff Acknowledgments:
GAO Contacts:
Acknowledgments:
Tables:
Table 1: Comparison of Ratio Requirements and American Growers' 6 Failed
Ratios for December 2000:
Table 2: Comparison of Ratio Requirements and American Growers' 5 Failed
Ratios for December 2001:
Table 3: RMA Costs Incurred in the Dissolution of American Growers as of
March 2004:
Table 4: Claims Paid to Policyholders After American Growers' Failure:
Figure:
Figure 1: American Growers' Policyholders Claims Paid vs. RMA
Reimbursements:
Abbreviations:
CRC Plus: Crop Revenue Coverage Plus:
FCIC: Federal Crop Insurance Corporation:
IRIS: Insurance Regulatory Information System:
NAIC: National Association of Insurance Commissioners:
NDOI: Nebraska Department of Insurance:
RMA: Risk Management Agency:
SRA: Standard Reinsurance Agreement:
USDA: U.S. Department of Agriculture:
Letter May 27, 2004:
The Honorable Bob Goodlatte:
Chairman, Committee on Agriculture:
House of Representatives:
The Honorable Charles W. Stenholm:
Ranking Minority Member, Committee on Agriculture:
House of Representatives:
The Honorable Jerry Moran:
Chairman, Subcommittee on General Farm Commodities and Risk Management:
Committee on Agriculture:
House of Representatives:
The Honorable Collin C. Peterson:
Ranking Minority Member, Subcommittee on General Farm Commodities and
Risk Management:
Committee on Agriculture:
House of Representatives:
Federal crop insurance is part of an overall safety net of federal
programs for American farmers.[Footnote 1] Federal crop insurance
provides protection for participating farmers against the financial
losses caused by droughts, floods, or other natural disasters and
against the risk of crop price fluctuations. Participation in the
program is voluntary; however, participation is encouraged through
federal premium subsidies. In 2003, the program provided nearly $40
billion in risk protection for over 200 million acres of farmland at a
cost of over $3 billion to the federal government. The U.S. Department
of Agriculture's (USDA) Risk Management Agency (RMA) has overall
responsibility for the crop insurance program. RMA manages the
contracts with the companies that sell and service crop insurance,
oversees the development of new insurance products for farmers, and
monitors compliance with program provisions by both farmers and
insurance companies. RMA also acts as the ultimate guarantor for policy
losses, in the event companies are unable to fulfill their obligations
under the federal crop insurance program. RMA administers the program
in partnership with private insurance companies that share a percentage
of the risk of loss or gain associated with each insurance policy
written. In addition, RMA pays companies an expense reimbursement--a
percentage of premiums on policies sold--for the administrative costs
of selling and servicing federal crop insurance policies. Companies
sell crop insurance to farmers through agents, who are paid a
commission by the companies on the policies they sell.[Footnote 2]
American Growers Insurance Company (American Growers) failed in 2002;
at that time, it was the largest participant in the federal crop
insurance program, accounting for about 20 percent of the premiums
written in 2002. American Growers experienced a 50 percent decline in
its surplus over a 9-month period, from January through September
2002.[Footnote 3] This decline in the company's surplus prompted the
Nebraska Department of Insurance (NDOI), the regulator for the state in
which American Growers was chartered, to take control of the company,
due to its hazardous financial condition. On November 22, 2002, NDOI
issued a state order of supervision. Under the order of supervision,
American Growers could not sell any new insurance policies or conduct
other nonroutine business without the approval of the supervisor
appointed by NDOI. Rather than immediately liquidating the company,
NDOI decided with RMA to place the company in rehabilitation--the
process where the regulator, in this case NDOI, takes control of the
management of the company--and to operate the company to settle
remaining claims and transfer existing policies to other companies. On
December 20, 2002, NDOI obtained a court order that placed American
Growers into rehabilitation under the auspices of NDOI. Under
rehabilitation, NDOI appointed a rehabilitator who took control of
American Growers to oversee the orderly termination of the company's
business and to allow for an orderly transfer of policies to other
companies. To ensure continued service to farmers who purchased crop
insurance through American Growers, RMA chose to pay costs associated
with managing the company while American Growers finished collecting
and processing premiums and settling claims. To date, RMA's funding of
American Growers' operations has cost taxpayers over $40 million to pay
agent commissions, staff salaries, and other operating expenses.
You asked us to determine (1) what key factors led to the failure of
American Growers, (2) whether RMA procedures were adequate for
monitoring crop insurance companies' financial condition, and (3) how
effectively and efficiently RMA handled the dissolution of American
Growers. In addition, you asked us to determine the factors that led to
RMA determinations that affected a proposed sale of American Growers'
assets to Rain and Hail LLC (Rain and Hail); and RMA's decision to
guarantee that all American Growers' agent commissions be paid.
Information related to Rain and Hail's proposal is provided in appendix
VII. Information on RMA's decision to pay agent commissions is provided
in appendix VIII. To determine the key factors that led to the failure
of American Growers, we examined company documents and financial
statements, reviewed RMA and NDOI files, conducted interviews with
employees and company personnel, and obtained statistical analyses of
the crop insurance program from RMA's data mining center.[Footnote 4]
We compared American Growers' financial information with that of other
companies in the crop insurance program. We also spoke with crop
insurance companies to gain an industry perspective on the failure of
American Growers and RMA's actions. To evaluate RMA's procedures for
monitoring companies, we reviewed RMA's regulations and methods,
interviewed RMA staff, and reviewed documentation to verify that
monitoring procedures were followed. To determine the effectiveness of
RMA's handling of the dissolution of American Growers, we examined
RMA's decision-making process, reviewed financial and other documents,
and interviewed RMA and American Growers' staff, National Association
of Insurance Commissioners (NAIC)[Footnote 5] officials, and industry
groups. We also contacted state insurance commissioners where crop
insurance companies are chartered to discuss oversight issues and
coordination with RMA. We performed our work between July 2003 and May
2004, in accordance with generally accepted government auditing
standards. Appendix I contains more detailed information on our scope
and methodology.
Results in Brief:
American Growers failed because of the cumulative effect of a number of
business decisions by the company. First, in 1999, the company
developed and sold a new supplemental insurance product that was not
guaranteed by RMA. The new insurance provided supplemental revenue
protection for rice, a crop with which American Growers had limited
revenue protection experience. Claims and litigation associated with
the sale of this new product resulted in significant losses to the
company's surplus. Second, the company incurred above average operating
expenses in an effort to increase market share. From 2000 to 2002,
American Growers paid agent commissions that averaged 12 percent higher
than other companies participating in the program. The company also
paid expenses not directly related to the sale and service of federally
funded crop insurance, such as trips to resort locations. These
expenses, among others, created operating costs that were 11 percent
greater than the average operating costs of other companies selling
crop insurance, and these expenses exceeded the reimbursement RMA
provides companies. Third, in 2001, American Growers attempted to
increase its market share by purchasing policies and assets from
another company, but it failed to achieve the level of efficient
operations necessary to make this decision profitable. The cumulative
effects of failed growth strategies and high operating costs weakened
the financial condition of the company and reduced its surplus, setting
the stage for its eventual financial failure. Finally, in 2002, the
company projected underwriting gains--the amount by which the company's
share of retained premium exceeds its retained losses--in excess of its
10-year average--and was relying on these anticipated profits to cover
the company's high operating expenses. When such profits did not
materialize, as the result of a widespread drought in 2002, American
Growers' surplus dropped significantly, leading NDOI to declare the
company to be in a hazardous financial condition, and prompting NDOI to
take control of the company.
In 2002, when American Growers was experiencing financial difficulties,
RMA's oversight was inadequate to evaluate the overall financial
condition of the companies participating in the program. One of RMA's
primary responsibilities is to ensure a sound system of federal crop
insurance, in part, by monitoring insurance companies' compliance with
provisions of the federal crop insurance program. However, we found
that although RMA reviewed companies' operation plans and analyzed
certain financial data, oversight procedures were insufficient to
assess the overall financial health of a company. RMA oversight
procedures focused on historical financial information--from the prior
6 to 18 months--and whether a company had the financial resources to
pay claims on policies based on past surplus, not on whether the
company would be able to cover its operating expenses in the upcoming
year. In the case of American Growers, RMA was unaware that the company
was projecting profits on crop insurance policies sold in excess of
historic averages to pay for its operating expenses, or that failure to
achieve these profits could result in the financial failure of the
company. Additionally, RMA did not routinely share information or
otherwise coordinate with state regulators on the financial condition
of companies participating in the crop insurance program. NDOI had
identified financial and management weaknesses at American Growers and
had considered planning an on-site examination of the company to
determine the extent of those weaknesses; but NDOI was unable to
disclose this information because RMA had not signed an agreement that
would allow NDOI officials to share such confidential business
information with RMA. Since the failure of American Growers, RMA has
taken steps to improve its financial oversight of companies
participating in the crop insurance program. However, at the time of
our review, RMA had not developed written policies to formalize its
oversight procedures. Additionally, RMA was working with state
regulators to increase RMA-state coordination and was working with NAIC
on draft language for confidentiality agreements that would allow state
regulatory agencies to share sensitive business information with RMA.
RMA effectively protected farmers insured by American Growers, but it
lacked a policy to efficiently address insurance provider insolvencies.
Once the company failed, RMA worked with NDOI to protect policyholders
by ensuring that policies were transferred to other companies
participating in the federal crop insurance program and ensuring that
claims were paid. To date, all American Growers' policies have been
transferred, and nearly all of the claims have been paid. However,
servicing the company's crop insurance policies cost RMA over $40
million for such things as agent commissions, employee severance
packages, and staff salaries. RMA would like to recoup some of these
costs if American Growers' assets are sold, but whether this will occur
is unknown. Finally, while RMA was able to effectively cooperate with
NDOI to dissolve American Growers, RMA has no written policy or
information sharing agreements to guide its coordination with states
for ensuring the most effective and efficient resolution of any future
insolvencies in the federal crop insurance program. As the failure of
American Growers demonstrates, without written agreements RMA is
vulnerable to state insurance regulators' actions when a company fails.
To address these issues, we are recommending that the Secretary of
Agriculture direct RMA to (1) formalize actions under way to improve
the financial and operational reviews used to monitor the financial
condition of companies, (2) improve coordination with state insurance
regulators regarding the financial oversight of companies, and (3)
develop a written policy clarifying RMA's and states' authority and
responsibility when a state regulator decides to place a company under
supervision or to liquidate a company.
We provided USDA with a draft of this report for its review and
comment. We received written comments from the Administrator of USDA's
Risk Management Agency. RMA agreed with our recommendations and stated
that it is (1) formalizing the improvements in oversight that we
recommended in the new Standard Reinsurance Agreement (SRA) and (2)
developing written agreements with state insurance regulators and the
NAIC to improve data sharing and oversight and to clarify RMA's
authority, as it relates to federal/state actions when a state takes
action against a crop insurance company. Our detailed response to RMA's
written comments are presented with RMA's written comments in appendix
IX.
Background:
Farming is an inherently risky enterprise. In conducting their
operations, farmers are exposed to both production and price risks.
Crop insurance is one method farmers have of protecting themselves
against these risks. Over the years, the federal government has played
an active role in helping to mitigate the effects of these risks on
farm income by promoting the use of crop insurance.
Federal crop insurance began on an experimental basis in 1938, after
private insurance companies were unable to establish a financially
viable crop insurance business. The federal crop insurance program is
designed to protect farmers from financial losses caused by events such
as droughts, floods, hurricanes, and other natural disasters as well as
losses resulting from a drop in crop prices. The Federal Crop Insurance
Corporation (FCIC), an agency within USDA, was created to administer
the federal crop insurance program. Originally, crop insurance was
offered to farmers directly through FCIC. However, in 1980, Congress
enacted legislation that expanded the program and, for the first time,
directed that crop insurance--to the maximum extent possible--be
offered through private insurance companies, which would sell, service,
and share in the risk of federal crop insurance policies. In 1996,
Congress created an independent office called RMA to supervise FCIC
operations and to administer and oversee the federal crop insurance
program.
Federal crop insurance offers farmers various types of insurance
coverage to protect against crop loss and revenue loss. Multiperil crop
insurance is designed to minimize risk against crop losses due to
nature--such as hail, drought, and insects--and to help protect farmers
against loss of production below a predetermined yield, which is
calculated using the farmer's actual production history. Buy-up
insurance, the predominant form of coverage, provides protection at
different levels, ranging from 50 to 85 percent of production.
Catastrophic insurance provides farmers with protection against extreme
crop losses. Revenue insurance, a newer crop insurance product,
provides protection against losses in revenue associated with low crop
market prices in addition to protecting against crop loss. RMA, through
FCIC, pays a portion of farmers' premiums for multiperil and revenue
insurance, and it pays the total premium for catastrophic insurance.
However, farmers still must pay an administrative fee for catastrophic
insurance.[Footnote 6] RMA determines the amount of premium for each
type of insurance policy by crop. RMA, through FCIC, contracts with
private insurance companies who then sell these policies to farmers.
Companies sell crop insurance to farmers through agents. An agent, a
person licensed by the state in which the agent does business to sell
crop insurance, is employed by or contracts with a company to sell and
service eligible crop insurance policies. While most companies pay
their agents a commission to sell and service crop insurance policies,
some companies pay agents a salary. American Growers paid its agents a
commission.
RMA establishes the terms and conditions to be used by private
insurance companies selling and servicing crop insurance policies to
farmers through a contract made with the companies called the SRA. The
SRA is a cooperative financial assistance agreement between RMA,
through FCIC, and the private crop insurance companies to deliver
federal crop insurance under the authority of the Federal Crop
Insurance Act.[Footnote 7] Under the SRA, FCIC reinsures or subsidizes
a portion of the losses and pays the insurance companies an
administrative fee or expense reimbursement--a preestablished
percentage of premiums--to reimburse the companies for the
administrative and operating expenses of selling and servicing crop
insurance policies, including the expenses associated with adjusting
claims.[Footnote 8] While the reimbursement rate is set at a level to
cover the companies' costs of selling and servicing crop insurance
policies, the companies have no obligation to spend their payment on
expenses related to crop insurance, and they may spend more than they
receive from FCIC. The current reimbursement rates, set by statute, are
based on recommendations in our 1997 report[Footnote 9] of the costs
associated with selling and servicing crop insurance policies. However,
RMA does not have a process for regularly reviewing and updating these
rates. RMA is currently conducting a limited review of companies'
expenses to validate the costs of selling and servicing federally
reinsured crop insurance policies.
RMA, through FCIC, is the reinsurer for a portion of all policies
covered by the federal crop insurance program. Reinsurance is sometimes
referred to as insurance for insurance companies. It is a method of
dividing the risk among several insurance companies through cooperative
arrangements that specify ways in which the companies will share risks.
Reinsurance serves to limit liability on specific risks, increase the
volume of insurance policies that may be written, and help companies
stabilize their business in the face of wide market swings in the
insurance industry. As the reinsurer, RMA shares the risks associated
with crop insurance policies with companies that sell federal crop
insurance. However, if a crop insurance company is unable to fulfill
its obligations to any federal crop insurance policyholder, RMA, as the
ultimate guarantor for losses, assumes all obligations for unpaid
losses on these policies. Reinsurance is also available through private
reinsurance companies. Crop insurance companies must maintain certain
surplus levels to issue crop insurance policies. However, they may
increase their capacity to write policies and may further reduce their
risk of losses by purchasing reinsurance from private reinsurance
companies on the risk not already covered by FCIC.
American Growers was originally established in 1946 as Old Homestead
Hail Insurance Company. The company went through several
reorganizations and name changes between 1946 and 1989. In 1989, the
company became American Growers Insurance Company, operating as a
subsidiary of the Redland Group, an Iowa-based insurance holding
company. Acceptance Insurance Companies Inc.,[Footnote 10]
(Acceptance)--a publicly owned holding company that sold specialty
property and casualty insurance--acquired American Growers in 1993.
As a wholly owned subsidiary of Acceptance, American Growers was
primarily responsible for selling and servicing federal crop insurance
policies and shared the same general management as the parent
organization. Another wholly owned subsidiary of Acceptance, American
Agrisurance Inc., served as the marketing arm for American Growers.
Company Decisions Contributed to American Growers' Failure:
American Growers' failure was the result of a series of company
decisions that reduced the company's surplus, making it vulnerable to
collapse when widespread drought erased anticipated profits in 2002.
The company's decisions were part of an overall management strategy to
increase the scope and size of American Growers' crop insurance
business. The company's surplus declined due to losses and other costs
from mistakes made when introducing a new crop insurance product,
decisions to pay higher than average agent commissions, and the
purchase of a competitor's business. Additionally, the company's
operating expenses were about 1 1/3 times its reimbursement from RMA.
In other words, American Growers was spending $130 for every $100 it
was receiving from RMA to pay for selling and servicing crop insurance.
American Growers planned to use profits from policy premiums to pay for
the expenses not covered by RMA's reimbursement. When these gains did
not materialize due to widespread drought, the company's surplus
dropped below statutory minimums, prompting NDOI to take control of the
company.
First, the company introduced a new crop insurance product, but
mistakes associated with the sale of this product resulted in
significant losses in the company's surplus. In 1997, the company chose
to market a new crop insurance product, Crop Revenue Coverage Plus (CRC
Plus), which was a supplement to federal crop insurance, but which was
not reinsured by RMA. In 1999, American Growers expanded the sale of
this product into rice, a crop with which it had little experience.
When the company realized it had mis-priced the product for rice and
withdrew the product, farmers who had planned on using CRC Plus sued
the company. Financial losses, legal settlements, and other costs
related to CRC Plus caused significant losses in the company's
financial surplus. Appendix II provides further details on the losses
associated with CRC Plus.
Second, American Growers chose to spend more than RMA reimbursed it for
selling and servicing crop insurance, in part, because the company
chose to pay above-average agent commissions in order to attract more
agents to sell for the company. As part of its effort to expand
operations, the company in 2000 to 2002, paid agent commissions about
12 percent higher, on average, than those offered by other crop
insurance companies. In addition to paying agent commission rates above
the average of other companies in the industry, American Growers
offered agent sales incentives, such as trips to resort locations, and
funded other expenses not required to sell and service federal crop
insurance. These expenses, among others, created operating costs that
were 11 percent greater than the average operating costs of other
companies selling crop insurance, and these expenses exceeded the
reimbursement RMA provided companies. Appendix III provides additional
details of the high operating costs associated with agent commissions
and other expenses.
Third, the company purchased the crop business of a competitor, which
increased its expenses. In 2001, American Growers attempted to expand
its share of the crop insurance market by purchasing assets from
another company, including that company's book of crop insurance
business. Because American Growers was unable to achieve the
operational efficiencies it had anticipated, this acquisition resulted
in additional operating costs and expenses that were higher than the
reimbursement that RMA provided companies to cover the sale and service
of crop insurance. Appendix IV provides additional details on the
operating expenses incurred from the purchase of a competitor's crop
insurance business.
Finally, the company relied on large underwriting gains to pay for its
expenses, rather than RMA's reimbursement. When these gains did not
materialize due to widespread drought in 2002, the company's surplus
dropped to a level that prompted NDOI to take control of the company.
In its 2002 operating budget, American Growers projected profits in
excess of its 10-year average and relied on these anticipated profits
to cover the company's operating expenses and to further its growth.
The company's profit projections were based, in part, on retaining a
higher percentage of the risk for the policies it sold than in past
years. By retaining a higher percentage of the risk on the policies,
American Growers could increase its profits if claims were low.
Conversely, the company increased its exposure to loss if claims were
high. However, profits did not materialize as the result of widespread
drought, which caused overall federal crop insurance program losses to
increase from $3 billion in 2001 to $4 billion in 2002. When American
Growers' expenses and losses dropped the company's surplus below
statutory minimums, NDOI declared the company to be in a hazardous
financial condition and took control of the company--first placing the
company under supervision in November 2002 and then in rehabilitation
in December 2002. Appendix V provides additional details on the decline
in American Growers' surplus.
RMA Financial Oversight Was Inadequate to Identify American Growers'
Financial Weaknesses:
At the time of American Growers' failure, RMA's financial oversight
processes were inadequate to identify the full extent of financial
weaknesses of insurance companies participating in the federal crop
insurance program. RMA's actual oversight procedures focused primarily
on whether a company had sufficient surplus to pay claims based on its
past performance, rather than the overall financial health and outlook
of the company. In addition, RMA did not generally share information or
coordinate with state regulators on the financial condition of
companies participating in the federal crop insurance program. Although
RMA reviewed companies' operational plans and selected financial data,
such as annual financial statements, in the case of American Growers,
RMA was unaware that the company was projecting underwriting gains in
excess of historic averages to pay for its operating expenses. The
company's failure to achieve these gains resulted in a substantial
reduction in its surplus and its subsequent financial failure. In the
case of American Growers, RMA and NDOI did not begin cooperating on
overseeing the company until it had been placed into supervision in
November 2002.
RMA's Procedures Were Inadequate to Evaluate Companies' Overall
Financial Condition:
In 2002, when American Growers failed, data provided to RMA by the
companies participating in the federal crop insurance program provided
an overall picture of company operations and complied with RMA's
regulations. However, the information provided was typically 6 to 18
months old; and, according to an RMA official, the agency's oversight
focused primarily on whether a company had financial resources to pay
claims on crop insurance policies and not on the overall financial
health of the company.[Footnote 11] RMA's approach to financial
oversight stemmed, in part, from the fact that the companies
participating in the program are private and are licensed and regulated
by state insurance departments. State insurance departments are
responsible for monitoring the overall financial condition of companies
chartered and licensed to operate in their state. In addition, some of
the companies selling crop insurance are affiliated with holding
companies or other related companies, which RMA does not review for
financial soundness. Since American Growers' failure, RMA has begun
requiring federal crop insurance companies to provide additional
financial data to help the agency determine if companies are adequately
financed to perform their obligations under their SRAs.
One of RMA's primary responsibilities is to ensure the integrity and
stability of the crop insurance program, in part, by monitoring
insurance companies' compliance with program criteria such as
submitting statutory statements required by state regulators and
meeting certain financial ratios, as defined in federal regulations. To
ensure that the companies participating in the federal crop insurance
program sell and service insurance policies in a sound and prudent
manner, the Federal Crop Insurance Act[Footnote 12] requires crop
insurance companies to bear a sufficient share of any potential policy
loss. Title 7, Code of Federal Regulations, chapter IV, contains the
general regulations applicable to administering the federal crop
insurance program. The SRA between RMA and participating crop insurance
companies establishes the terms and conditions under which RMA will
provide subsidy and reinsurance on crop insurance policies sold or
reinsured by insurance companies. These terms and conditions state, in
part, that companies must provide RMA with accurate and detailed data,
including their (1) annual plan of operation, (2) financial statements
filed with the applicable state insurance regulator, and (3) any other
information determined necessary for RMA to evaluate the financial
condition of the company.
When approving a company to participate in the crop insurance program,
RMA analyzes it according to 16 financial ratios set forth in RMA
regulations.[Footnote 13] Combined, these 16 ratios are intended to
provide RMA a reasonable set of parameters for measuring insurance
companies' financial health, albeit generally from a historical
perspective.[Footnote 14] The 16 financial ratios include such things
as (1) change in net writings, (2) 2-year overall operating
ratio,[Footnote 15] (3) change in surplus, and (4) liabilities to
liquid assets. Ten of the 16 ratios specifically refer to changes
related to companies' surplus--the uncommitted funds used to cover
policy claims. When a company fails more than 4 of the 16 financial
ratios, RMA requires the company to submit an explanation for the
deviation and its plans to correct the situation.[Footnote 16] If the
explanation appears reasonable, RMA approves the company to sell and
service crop insurance for the next crop year.
In August 2001, RMA notified American Growers that the company had 6
ratios, based on its December 2000 financial statement, that fell
outside acceptable ranges, including its 2-year overall operating
ratio, change in surplus, and 2-year change in surplus. Table 1 shows
the 6 ratio requirements and American Growers' ratio for each of the 6
ratios it failed.
Table 1: Comparison of Ratio Requirements and American Growers' 6
Failed Ratios for December 2000:
Ratio: Two-year overall operating ratio;
Ratio requirement (percent): < 100%;
American Growers' ratio (percent): 122%.
Ratio: Investment yield;
Ratio requirement (percent): 4.5 to 10%;
American Growers' ratio (percent): 13%.
Ratio: Change in surplus;
Ratio requirement (percent): -10 to +50%;
American Growers' ratio (percent): -22%.
Ratio: Combined ratio after policyholders' dividends;
Ratio requirement (percent): < 115%;
American Growers' ratio (percent): 145%.
Ratio: Two year change in surplus;
Ratio requirement (percent): > -10%;
American Growers' ratio (percent): -18%.
Ratio: Return on surplus;
Ratio requirement (percent): > -5%;
American Growers' ratio (percent): -40%.
Source: GAO analysis of RMA data.
[End of table]
According to an RMA memorandum dated October 2001, American Growers
reported that most of its unacceptable ratios were due primarily to
underwriting losses related to its multiperil crop insurance that
produced unfavorable results due to drought conditions in 2000,
particularly in Nebraska and Iowa, and the impact of the federally
subsidized reimbursement not covering the company's expenses.
Additionally, American Growers cited the cost of the class-action
lawsuit relating to its CRC Plus product as a contributing factor.
Finally, American Growers explained that the expansion of its crop
operations through the purchase of a competitor's crop insurance
business was expected to provide efficiencies that would reduce
expenses and help improve the company's profitability in the future.
Based on American Growers' explanations, RMA determined that the
company's 2002 SRA should be approved. RMA did not believe that the
adverse developments that American Growers had experienced were
significant enough to move the company close to insolvency. RMA's
decision was partially based on anticipated improvements in overall
performance resulting from American Growers' acquisition of another
company's assets and the potential for achieving greater economies of
scale.
Furthermore, while American Growers failed more than 4 of the 16
financial ratios, it was not the only company with such results. Of the
18 companies participating in the federal crop insurance program in
2002, other companies had a higher number of failed ratios than
American Growers, though most had fewer. Specifically, of the other 17
companies, 3 companies had 7 or more failed ratios, 1 had 6--the same
number as American Growers, and 13 companies had 4 or fewer failed
ratios.
In March 2002, American Growers had 5 ratios, based on its December
2001 financial statement, that fell outside acceptable ranges,
including change in net writings, 2-year overall operating ratio, and
liabilities to liquid assets. Table 2 shows the 5 ratio requirements
and American Growers' ratio for each of the 5 ratios it failed.
Table 2: Comparison of Ratio Requirements and American Growers' 5
Failed Ratios for December 2001:
Ratio: Change in net writings;
Ratio requirement: (percent): -33 to +33%;
American Growers' ratio: (percent): 51%.
Ratio: Two-year overall operating ratio;
Ratio requirement: (percent):
