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By ANNE FREEDMAN, senior editor of Risk & Insurance®

Insurers may be able to survive the claims following the projected crop harvest brought on by the worst drought in seven decades, but other consequences may be far more severe.

Deputy Head of Political Risk Forecasting Alexia Ash said the drought is projected to reduce the corn crop by 30 percent. In addition, U.S. corn reserves hit an 8-year low of 6 billion bushels in March, which is down 7.9 percent from the same time period in 2011.

The reduced availability of corn -- not to mention soybeans, wheat, and meat and dairy products (because livestock is affected by the lack of grain-based animal feed) -- could lead to food riots in developing countries, she said. That's what happened in 2008, when grain prices nearly doubled leading to riots in countries varied as Cameroon, Bangladesh and Egypt.

The poor harvest could also add to economic problems in countries that subsidize food, such as Mexico, which subsidizes corn prices, and Egypt, which subsidizes cooking oil, which is often made from corn, Ash said.

Karsten Berlage, managing director and head of weather solutions at Allianz Risk Transfer in New York, noted that corn prices had already gone up nearly 50 percent since the beginning of April. And the price of wheat and soybeans has also seen "significant price increases."

"Clearly, a lack of supply by a lot of farmers giving up on their crop could impact the prices [even more] dramatically," he said.

The increased cost of feeding livestock is causing farmers and ranchers to cull herds. The overall shortages have resulted in estimated price hikes for milk, beef, chicken and pork of between four and five percent, according to the New York Times. The United States, Ash said, exports 53 percent of the world's corn. "There is no country in the world ... or no collection of countries that can make up for that," Ash said. "The U.S. is far and away the greatest producer of [corn, wheat and soybeans]. That shortfall will not be made up for."

Carl Ashenbrenner, a principal and actuary at Milliman in Brookfield, Wis., said the current U.S. Department of Agriculture corn yield forecast is 146 bushels per acre, compared to the original projection of 166 bushels per acre. That's a decrease of 12 percent, slightly better than the one offered by Ash.

But, he noted, "I think most people in the industry think it will be lower than that." The National Agricultural Statistics Service will release forecasted yields by state in August, he said.

Forecasted Losses of $2.8 Billion

Even so, using the current USDA forecast, combined with projected soybean yields, will result in a projected underwriting loss of $2.8 billion for corn and soybeans in the 12 states reviewed by Ashenbrenner in his report, titled "Significant Losses Forecasted for Crop Insurance Industry Due to 2012 Drought."

The losses, he said, are "probably going to be worse than 2002," when a minor drought led to a 138.3 percent loss ratio for the 12 major corn-producing states: Illinois, Indiana, Iowa, Kansas, Michigan, Minnesota, Missouri, Nebraska, North and South Dakota, Ohio and Wisconsin.

His overall forecasted loss ratio for corn and soybeans for the 12 states this year is 147 percent, which, of course, will vary significantly by state.

"The underwriting loss excludes both the private insurance companies' expenses and the A&O subsidy provided to the private insurers by the FCIC [Federal Crop Insurance Corp.]," he wrote in his report.

Most insurers, Ashenbrenner said, have "decent reinsurance," first through the FCIC, which offers two funds by state -- an assigned risk fund (where the FCIC takes most of the risk) and a commercial fund (for which the private insurer takes a substantial amount of the risk). This is supplemented with additional reinsurance provided by third parties, which is typically on a quota share and stop-loss basis.

He projects the loss ratio for private insurers to be worst in Illinois, Indiana, Kansas, Missouri and Wisconsin, noting that, typically, most carriers in those states don't put a lot of business in assigned risk. Since he performed his analysis, crop conditions have been trending worse and he plans to update his analysis once USDA issues forecasted yields by state.

Fitch Ratings said: "private insurers' net losses, after federal and private reinsurance, are anticipated to have more of an impact on earnings rather than capital. We believe the leading writers of crop insurance will be able to absorb any near-term crop losses and are likely to maintain current levels of financial strength due to the primary writers' size, diverse portfolios, conservative use of additional reinsurance, and the business line's historic profitability."

Two of the largest crop insurers, Wells Fargo's RCIS and Ace Ltd.'s Rain & Hail, said careful underwriting and reinsurance would allow them to handle what many expect to be billions of dollars in total payouts for crop losses this year, according to Reuters.

Multiperil crop insurance "is a relatively small segment" of the U.S. property/casualty insurance industry, representing about 1 percent of annual net written premiums, according to Fitch Ratings.

Allianz' Berlage said most farmers -- about 85 percent -- do have crop insurance, noting that only about 25 percent were insured when the severe drought of 1988 hit.

He said that, because of the FCIC, "ultimately, the taxpayer bears the majority of the costs. But, collectively, we need to provide stability ... that our food supply is ensured." The government-run crop insurance programs paid $10.8 billion for losses in 2011, he said.

In addition to crop insurance, Berlage said, some farmers are beginning to consider weather insurance, noting that agricultural problems this year are being caused not only by drought but by a heat wave.

More common in other industries, particularly the energy sector, weather insurance "is increasingly known and used within the agricultural field," he said. It can either protect insureds against a single peril -- such as frost during the planting season or rain during the growing season -- or be more tailored and based on an analysis and correlation of weather patterns and an insured's projected yields.

Farmers were given a bit of help when the USDA recently reduced the interest rate on emergency loans for them and extended by 30 days the deadline for crop insurance companies to pay uncollected premiums. The department also encouraged those companies to voluntarily forego charging interest or penalties to farmers for that 30-day period.

More help would be forthcoming, said Exclusive Analysis' Ash, if Congress would pass the omnibus farm bill currently being debated in Congress. She said it is "completely unprecedented" that the bill is being held up on the floor of Congress because of the "political stalemate" in Washington. She noted the bill has been held up previously when in committee, most recently during the Clinton administration.

The bill -- which is up for its 5-year renewal -- could offer needed assistance and subsidies to farmers, she said.

Worries for the Future

Even more worrying than this year's crop will be the long-term implications, she said. Should farms be bankrupted and future crop harvests be disrupted, "you will be looking at more than this one bad crop, which is the real concern."

And last year, Ashenbrenner said, "wasn't a great year" for crops either, especially in Texas and the Southern Plains due to the drought, and in the Midwest, due to flooding conditions. "The 2012 drought will test both the farmers' and crop insurers' risk management strategies," he said.

Such strategies require farmers and ranchers to be strategically planning for the future -- whether it is thinking about next year or further down the road, said Mike Hayes, director of The National Drought Mitigation Center at the University of Nebraska at Lincoln.

He suggests documenting what strategies are working in this current severe drought.

That includes what they are learning "about their own land and management of their crops," Hayes said, as well as identifying partners and establishing communication with state and federal officials, agricultural extension programs, market specialists, vendors, suppliers and others.

Drought planning should also include the identification of objectives and resources, and understanding drought risks and benefits. Critical dates for making decisions are beneficial and management strategies should be evaluated and implemented, according to NDMC's "Managing Drought Risk on the Ranch" website.

Farmers and ranchers, Hayes said, should also aim to be "as diversified as makes sense for their operations and hopefully have a portfolio of actions they can take."

"Lessons learned aren't lessons learned if you aren't acting upon them," he said. "It's a process of being prepared and thinking ahead for what you can do when a drought occurs and trying not to panic in that type of situation."

July 31, 2012

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