Actuarial Impacts of Loss Cost Ratio Ratemaking in U.S. Crop Insurance Programs

This study examines the actuarial implications of the loss cost ratio (LCR) ratemakingmethodology employed by the Risk Management Agency as a component of base ratesfor U.S. crop insurance programs, and identifies specific conditions required for the LCRmethodology to result in unbiased rates when liabilities trend. Specifically, constant relativeyield risk resulting in growing absolute variance through time and other restrictiverequirements are required for the LCR to result in unbiased rates. These requirements aretested against a large farm-level data set for Illinois corn. Our findings indicate that theconditions required for appropriate use of the LCR methodology are violated for this highpremium volume market, resulting in large implied rate biases. The process does notcorrect itself through time with the addition of longer rating periods as sometimes claimed.A simple correction function is suggested and demonstrated.