April of 2014 is wrapped up and we look forward, hopefully, to better weather, at least here in the upper Midwest. We have been “blessed” with cold and wet weather to say the least. The corn planting progress in several states is at the lowest level in years and we need a nice burst of warm weather with abundant sunshine. This is the opposite of north Texas, Oklahoma, and California, where we would be pleased to send our excess moisture to the drought stricken if we could.
At this time of year, at least at the company level, we try to forecast what our total premium might be, as we are well past sales closing dates for the major spring crops. We start by taking a count of the renewals, then add up all of the transfers in, and finally deduct the transfers out. This gives us an estimate of our “crop count” for 2014. We also go through an exercise to review the changes in policy activity, particularly looking at plan and coverage level shifts, to see if the grower’s buying behavior has changed between 2013 and 2014. Using this information along with various actuarial formulas that contemplate base RMA rate and price election changes, the Approved Insurance Provider (AIP) can start to forecast their premium volume for a given crop year. We don’t generally need acreage reports or exact information to arrive at reasonable estimates.
We know that commodity price levels and volatility factors on revenue policies are down. We also know that in several states the RMA has changed – for no sound reason – the premium rate formula on corn and soybeans. This rating methodology change has resulted in generally lower base rates in most states, although occasionally higher rates in others. Finally, we know that farmers, taking excellent advice from their local agent, tended to buy up to a higher level in 2014 than was the case in 2013. At the very least, they maintained their coverage level if they were already at 80% or 85% in 2013.
This brings us to the title of this particular blog –“ Is That All There Is”… a song by this title was released in 1969 by the very famous Jamestown, North Dakota native and award winning singer, Norma Egstrom. It won the Grammy for best female pop artist in 1970. Back in the late 1930’s, Norma left North Dakota for Southern California and adopted the stage name “Peggy Lee”. Incidentally, the first name Norma was abandoned by both Peggy Lee and Marilyn Monroe, trivia I’m sure you can use going forward!
Well, back to the story…My American Legion baseball coach in 1970 and 1971 used to say that MC had a “Peggy Lee fastball”, meaning “is that all there is,” which was quite easy for an opponent to hit. Similarly, we are almost certain to have a “Peggy Lee premium year” in 2014 across the US crop insurance industry. To be sure, the question is going to be asked many times, “is that all there is”?
In 2011, the industry produced a record $11.96 billion of MPCI premium. In 2012, this dropped to $11.08 billion, followed by a robust recovery to $11.78 billion in 2013. For 2014 there are estimates that range as low as $9.7 billion, or roughly a 20% drop in the top line. My personal opinion is that we will be slightly above $10 billion. In either case, the answer will be “yes” to the oft asked 2014 MPCI premium question “is that all there is.”
The formula in the SRA that is used to calculate A&O and therefore agent commissions is such that most agents will see minimal change in year over year commission income, to the extent that they have renewed the same amount of acres. Some may be slightly higher and some slightly lower in dollars earned, but nationally we expect minimal impact at the agent level.
The financial impacts to the AIP are primarily related to changes in the expected expense ratios and the underwriting gain. Using industry numbers from 2013, let’s assume that the industry loss adjustment expense (LAE) ratio was 3.5% of premium. If you take $11.78 billion times 3.5%, then you have approximately $400 million of LAE for 2013. Dividing this same, if not growing, $400 million by $10 billion of 2014 premium means that the expense ratio for LAE is now around 4%. The story is the same for an AIP’s other operating expenses, which are seldom falling and usually rising. Taken together you can see that there will be an expense ratio reality crunch.
On underwriting gain side (premiums less losses, but before expenses), we also see the negative effects of a falling top line. The commercial fund premium is where the AIP makes their money, at least in those years where losses do not exceed premium! Assuming that on average 75% of all gross written premium ends up in the commercial fund, and that a 16% underwriting gain is a reasonable estimate for the “typical” year, then in 2013 the industry would have budgeted for about $8.8 billion in commercial fund premium and an underwriting gain of $1.4 billion. Author’s note: the 2013 industry underwriting gain will ultimately be less than $800 million, but that is for another day and another blog. Fast forward to 2014 and apply the same basic math to $10 billion of expected premium and the budget shrinks to $7.5B of premium and $1.2B of expected underwriting gain. Again, as a reminder to my readers from the Environmental Working Group, underwriting gain is not pure profit to the AIP as it does not count any of the previously discussed expenses that an AIP incurs to deliver the program.
So in summary, the AIP has a declining revenue and underwriting gain budget, and static to increasing expense levels. The financial crunch for 2014 is going to be real and substantial. That said, ProAg takes a long term view of the crop insurance business. While we will have to be more diligent in monitoring our expenses, we cannot and will not allow service levels to slide, especially with respect to processing business or working claims timely.
This financial reality is an industry-wide phenomena for 2014, and agents should be aware that these pressures will cause differing management reactions at the AIP level. Our view is that when “things” are going well, these “things” are probably not as rosy as they might appear. By the same token when “things” are difficult, they usually are not a reason for a complete “doom and gloom” forecast. Yes, premiums are down, but the opportunity for a good year in 2014 still exists.
Let’s work smart and do the best we can with a positive attitude for our policyholders. They certainly have issues of their own and most won’t be too concerned that the industry premium volume is down in 2014. Yes, that’s all there is to this blog….