AN INSURANCE INDUSTRY VIEW

March 2, 2001

Submitted By:
Donald L. Griffin, CPCU, ARe, ARM, AU
Director - Business & Personal Lines
National Association of Independent Insurers

Introduction
The insurance industry has long been a partner with the agricultural community. In the past, that relationship has been tested and, oftentimes, strained. In part, this is why many farm bureaus formed insurance companies to provide members with the coverage they need. Many insurance companies throughout this period, and in recent years, have also been competitive providers of insurance coverage for agricultural operations.

This was not always the case. In the mid-1980s, the "liability crisis," as it came to be known in the insurance industry, presented significant challenges and agricultural losses were among the very first to indicate the coming "crisis." Claims from farming operations (including significant property losses) well outstripped premiums. Insurance affordability and even availability became a major challenge for both groups. Many consider insurers' competitive marketing practices the cause of this problem, and indeed these practices, when combined with the economics of the period, did make a significant contribution. However, there were other contributing factors, not the least of which were fundamental changes in society's views with regard to litigation.

Be that as it may, the insurance industry's financial health, and its ability to provide coverage for agricultural operations, has improved dramatically since the mid-1980s. In fact, the insurance industry is stronger than it has ever been, financially, despite significant catastrophic losses in the late 1980s and early 1990s. In recent years, mergers, acquisitions and the passage of the Financial Services Modernization Act continue to provide challenges for the insurance industry in the new millennium and the industry stands ready to meet those challenges. Insurers are also committed to their partnership with the agricultural community and to improving the safety of farming operations.

This paper will provide readers with information on basic insurance principles, how insurers evaluate loss potential for agricultural risks, insight into the underwriting/risk selection process, a look at the recent history of agricultural losses and some suggestions for the future.

The Basics
Before discussing agricultural risks specifically, a brief review of some basic insurance principles might be helpful. There are three basic methods for handling uncertainty - avoidance, retention, or transfer. You can avoid it altogether (e.g., if you don't buy the combine, you don't have to worry about it being damaged). You can keep the risk (e.g., you buy the combine, and, if you own it outright, take the chance that it won't be damaged or stolen and if something happens to it, pay for its replacement). You can transfer the risk (e.g., buy insurance or transfer the responsibility to someone else).

Insurance is the "transfer" of uncertain financial consequences for a certain financial cost (i.e., premium). You may never use the insurance; however, by purchasing insurance you are gaining some piece of mind, protecting your financial assets, or satisfying an obligation required by a third party (e.g., a bank loan).

The premiums collected by the insurer are used to pay claims for losses and the expenses associated with those losses. There are also administrative costs in generating and underwriting the insurance. Additionally, investors (stock companies) or policyholders (mutual companies) demand either a competitive rate of return on the investment or competitive premiums by keeping costs in line.

In order for an event to be insurable, the basic principle of insurance provides that the event that gives rise to a loss must be accidental or "fortuitous." In other words, if you know something is going to occur, it is usually not insurable. Also, insurance is built on the principle of indemnification, i.e., putting the insured back TO SUBSTANTIALLY THE SAME PLACE/CONDITION as before the loss.

Frequency and severity also impact insurance premiums. Frequency is how often claims occur (e.g., 1, 5, 10 times per 100 policies). Severity is how much each claim costs (for example, the average cost of X-type of loss is $500). These statistics are analyzed to determine, for a given set of circumstances, over a given period of time, how often and how much losses will cost.

There are also costs associated with paying these losses. The insurer must have staff to obtain the information after a claim, adjusters to review the damages and settle the loss, accounting personnel to generate checks, and attorneys to resolve disputes. These costs must be analyzed to determine the average cost per claim.

This is all well and good for what happened in the past, but insurance is purchased to cover future events. Insurers must develop trends in the number of claims over a period of at least 3-5 years (usually). They also look for changes during this same time period with regard to medical costs, claims settlement costs (including legal fees) and jury awards. The purpose again is to determine trends, this time with regard to severity. In order for companies to develop rates that are "adequate, but not excessive or unfairly discriminatory," they need to be able to predict with some reasonable degree of certainty, the costs associated with insured losses.

Agricultural operations are becoming increasingly complex and insurers must understand the exposures and loss potential before being able to provide the proper coverage at the appropriate price.

Evaluating Agricultural Risks
As stated above, agricultural operations have become increasingly complex in recent years. The increased use of chemicals, sophisticated, expensive and dangerous equipment, and animal confinement operations are just some examples. The involvement of governmental agencies, such as the Environmental Protection Agency, in setting guidelines, rules and regulations for agriculture, has also increased and farmers, including their insurers, must constantly be aware of changes required by such governmental agencies. The use of genetically engineered seed is a new exposure that will need to be evaluated and addressed. Also, since many farming operations have grown in size, protection of employees (and their employer) is paramount. Insurers are faced with underwriting these very sophisticated agricultural businesses, which can be, due to the variety of tasks and operations performed, much more difficult to evaluate than other large businesses or manufacturers that provide one specific service or product.

There is a formal "risk management process" that insurers, and agricultural risks, rely on to help evaluate and address loss potential. This process includes four specific steps; 1) identify the exposures and determine methods or alternatives to address each exposure, 2) select the best (or most appropriate) method or alternative, 3) implement the selected method, and 4) monitor the results and make any needed adjustments.

Insurers must evaluate each individual agricultural risk on its own, usually with an on-site inspection/review of the premises and many of the associated operational activities. These "loss control" visits are designed to accomplish several of the "risk management process" goals and also to provide the insurer with enough information so that the underwriter can make an informed decision with regard to insuring each of the risks for which coverage is requested, at the appropriate premium.

Insurers have forms specifically designed to evaluate agricultural operations, and although these vary from company to company they generally include a detailed evaluation or inspection of:
· The residence and other farm buildings. This includes design and construction, fire safety procedures and protection, lightning protection, heating sources, electrical service, safety and usage, and insulation.
· The use of flammable or combustible materials.
· Crop storage, fire prevention and control.
· The use of anhydrous ammonia.
· The storage and use of other chemicals.
· Potential arson exposures.
· Animal confinement operations, including manure storage, and water treatment.
· Machinery theft potential, including alarm systems.
· Field and roadway inspections.
· Implement equipment condition, safety and operational procedures.
· Tractor, hauling and other transportation equipment condition, safety and operational procedures.
· Training and experience of farm family and employees.
· Crop or animal sales practices, procedures and/or leases.
· Any other "incidental" business pursuits.
· Values for all buildings, livestock, crops and equipment.

Agricultural operators can evaluate many of these areas prior to an insurance company's loss control visit, either by requesting information or assistance from their farm bureau, from the insurer, or from a variety of other organizations. An example is The Farm Safety Association's "How does safety rate on your farm." This detailed list for rating the safety of an agricultural risk includes: rating the farm residence(s), out-buildings, looking at fire prevention, electrical safety, workshop safety, fields, driveways, lanes, farm tractor safety, PTO driven equipment, other farm machinery, pesticide storage, animal handling facilities, ladder safety, materials handling, emergency procedures, special structures, transportation vehicles and lawn mower hazards. This guide provides owners of agricultural operations with an excellent method of identifying exposures and setting completion dates for addressing deficiencies. Again, this is just one example and there are many other sources available to assist an agricultural operator in completing its own "risk management" evaluation.

Once the review of the agricultural risk is completed, the loss control report is written and submitted to the insurer. The underwriting department then reviews this information, including recommendations for improvement, as part of the risk selection process.

Underwriting Agricultural Risks
While the loss control report is an important part of the overall evaluation of an agricultural risk, it is by no means the only information an underwriter must review before he or she can make important decisions. Insurers and underwriters look at past industry losses as well as the losses of the specific insured or potential insured. An insurer may "specialize," through its marketing practices or underwriting guidelines, by insuring certain types of agricultural risks (e.g., livestock, crops, family farms, etc.). The underwriter must evaluate the insured or potential insured to make sure it meets the overall marketing/selection philosophy of the company. Insurers also look at industry trends, changes in general operations, changes in personnel, and, oftentimes, review the operation's financial statements.

The underwriting process includes an evaluation of the property, livestock, crop and equipment values to be insured, liability exposures, recommendations for the appropriate coverages, limits, and deductibles, and premium determination. Insurers are increasingly concerned with a variety of issues surrounding agricultural property loss, safety, employee protection and liability.

Windstorms, tornadoes, winter storms, hail, collapse, fire, collision, vandalism and lightning all represent significant agricultural property loss potential for insurers. Agricultural equipment has become very expensive, dangerous to operate, and has its own inherent loss potential (e.g., combine fires, theft). Another safety concern is the misuse of tractors by allowing riders or the lack of a proper rollover protection system. Attacks by wild animals, collision with vehicles, suffocation and drowning are all concerns with regard to evaluating the insured livestock exposure.

Protecting employees through the purchase of workers' compensation insurance, health care coverage, and other benefits is becoming more and more important as the farm policy does not provide medical or death coverage. While many workers (migrant farm workers, etc.) are, or may be considered "contractual" employees, differing state laws may require the "employer" to provide workers' compensation coverage anyway. Training of these employees is equally important to eliminate or reduce injuries and the costs associated with these types of losses.

Farming of leased land may become a liability concern for either the lessor or the lessee, or both (Did the contract "transfer" responsibility for this liability?) and sometimes there are road safety issues associated with getting equipment from one location to another. "Attractive nuisances" like ponds or lakes where trespassers can drown, or easy access to animals may prove problematic. Roadside stands, pick-your-own, boarding stables, and other primary or incidental business operations that increase public "traffic" on the premises also increase liability exposure. The potential for food processing or animal processing liability has increased due to recent scientific advancements that improve the ability to identify the source of the sickness or disease all the way back to a specific farm.

Unfortunately, the financial problems experienced by agricultural risks have led to increased fraud. While not unique to farming, this means that insurers must evaluate the financial stability of the operation through financial statements, credit reports, or by using other financial tools.

As you can see, underwriting agricultural risks requires a significant amount of time, experience and expertise in order to select, recommend and price the appropriate coverages, limits and deductibles.

Agricultural Losses
Insurers report losses to statistical agents such as the Insurance Services Office, Inc. (ISO) and the National Association of Independent Insurers (NAII) to meet state regulatory reporting requirements and to develop aggregate numbers that are used in the development of rates. The following chart shows "countrywide incurred losses" for the period from 1996 through 1998 as reported in 1999 (the latest aggregate numbers available).
Countywide Incurred Losses (1996-1998 Combined)
Peril/Loss Category Incurred Losses % Distribution
Fire/Lightning $292,613,722 32.35%
Wind/Hail $318,810,612 35.26%
Water Damage $36,229,872 4.01%
Theft $31,354,132 3.47%
All Other Physical Damage Losses $86,636,455 9.58%
Liability/Medical Payments $138,642,426 15.33%
Total $904,287,219 100%
The chart brings into sharp focus the fact that property-related losses for agricultural risks represent 84.7% of all insured claim payments, while liability losses only account for 15.3% of the total.

Therefore, the insurance industry, while always concerned with liability and the "human factors" side of safety, must focus on efforts aimed at preventing or reducing property loss for agricultural businesses.

Several conclusions could be drawn from these numbers. First, that agribusiness and insurers have done a good job in managing possible human injuries, deaths and the liability exposures associated with them. Another possible conclusion could be that since farm policies do not provide coverage for first party or employee injuries and/or deaths, these results "mask" the "human cost" related to farming operations. Then again, the conclusion could be that property losses really do represent the "bulk" of losses in agribusiness overall.

While the true conclusion may be some combination of the above or other factors, it is clear that the insurance industry should focus predominately on property loss prevention and mitigation for agricultural risks. Far and away the greatest proportion of losses (67.6%) involves four perils - fire, lightning, wind and hail. This is why insurance company research, loss control, and underwriting personnel spend the majority of their time evaluating and looking for ways to reduce these types of losses. Indeed, insurers must continue to pay close attention to reducing losses from these perils if they are to keep coverage both available and affordable for agricultural risks, and remain competitive in the marketplace.

The information presented in the "Evaluating Agricultural Risks" section highlights the importance of property-related issues, while still emphasizing efforts to eliminate or reduce human injuries or death.

The Future
The insurance industry will continue to support any and all measures to reduce injuries and loss of life, especially when many of these occurrences are easily preventable if precautions are taken and procedures are followed.

Insurers are committed to working with the agricultural community to develop processes and techniques that will reduce all farm-related losses. We are also interested in education programs that increase awareness of preventative measures, inexpensive retrofitting to reduce property losses, and promoting better design and construction for farm structures.

Oftentimes, an agribusiness' insurer is the first, and maybe only, source for occupational and property-related hazard control. You may say - we see it all, as insurers have unique access to their policyholders. Therefore, insurers should be looked upon as key participants in national policy discussions and efforts.