RMA releases results of studies on catastrophic poultry disease coverage
The 2014 Farm Bill required the Risk Management Agency (RMA) to conduct two studies on poultry, “Final Study on Poultry Catastrophic Disease” and “Insurance Program Development for Poultry Business Interruption.”  Below is the Executive Summary from the “Final Study of the Poultry Catastrophic Disease.”  Full copies of both reports can be found at http://www.rma.usda.gov/pubs/#farmbill. 

The purpose of this study was to gather information and determine if providing catastrophic poultry disease coverage would benefit producers.  The information gathered was also meant to help members of Congress understand how these risks could be addressed by the crop insurance system. 

Final Study on Poultry Catastrophic Disease

Use or disclosure of information or data Risk Management Agency contained on this sheet is subject to the Order No: D15PD00012

SECTION I.

EXECUTIVE SUMMARY

The Statement of Work (SOW) for Order Number D15PD00012 identifies the objectives of the project as “...to obtain information and to determine if providing poultry catastrophic disease coverage would benefit agricultural producers; to help poultry producers and Congress understand how these risks are being, or could be addressed by the crop insurance system; to find and evaluate any existing policies or plans of insurance that provide coverage for any and all poultry catastrophic disease events; and, to determine what practical challenges are present that need to be overcome in order to create actuarially sound products related to a poultry catastrophic disease event.”

The sheer size and complexity of the commercial poultry industry are two of its defining features. The industry produces meat and eggs from numerous species as well as live birds. Each of these sectors has different characteristics. For the egg sector, the birds are a capital resource rather than a crop, although there are some analogies to a wheat plant being the capital resource that produces the grain crop. Table and breaking eggs are used as a food, while hatching eggs are used to produce laying hens and meat birds. Game bird hatching eggs are used to produce game birds for meat as well as live game birds for release. The production cycle for eggs can last a year or more, while the production cycle for meat and live birds is much shorter. For broilers, live chicks and poults, a production cycle may be completed in a matter of weeks. 

Much of the poultry meat industry is vertically integrated. Integrators typically control feed production, grow-out, transportation, slaughter, processing, and wholesale distribution and may control brood egg production and hatching. Production facilities and services are provided by contracted growers whose compensation depends on meeting objectives such as growth rates, disease control, feed efficiency, etc. The major sector stakeholders, the integrators, consequently have remarkable control of their products and vast market power relative to contract growers.

There are many fewer contract growers in the layer sector than in the meat sectors. Nonetheless, many of the producers in the layer sector are also vertically integrated.

Large integrators generally indicated their preferred risk management for disease does not involve catastrophic disease loss insurance. Instead, their risk management relies on geographic isolation of production and strict biosecurity measures required of growers. On the other hand, the low margins for growers and the limited options for alternative uses of their facilities create a situation where downtime following a disease event is a major concern. Yet the appropriate response to a catastrophic disease event is to mandate a longer downtime before introducing a healthy flock. If a United States Department of Agriculture (USDA) Risk Management Agency (RMA) policy were to be offered to growers to address their greatest risk management concerns, changes in the Act would be required to establish indisputably a grower’s insurable interest not only due to loss of a “crop” but also due to the inability to use their production facilities. While this is somewhat analogous to prevented planting coverage offered for field and row crops, it differs in the respect that the period of loss is not a crop year but rather one or more production cycles. Insurance coverage addressing such an extended period of loss is allowed under Subsection 508(l) for trees including losses due to disease and partial indemnification addressing such an extended period of loss for trees is offered under Section 531(f).  Nonetheless, for contract growers of poultry, the ownership of the crop most often resides with the integrator and therefore the issue of insurable interest in the foregone productive value of their facilities remains even if the long term losses due to destruction of the capital asset can be addressed.

A small cohort of traditional producers of poultry exists, especially in the layer sector and in niche markets for meat and live birds. These include producers of “free range” poultry and poultry raised for ethnic markets. The strongest interest for disease insurance among owners of poultry is in this group, although here too the most substantial interest was for managing risk due to the downtime following a disease outbreak.

As this report neared completion, the Contractor identified an offer of insurance for business interruptions resulting from depopulations due to Highly Pathogenic (HP) Avian Influenza (AI).  This offer appears to be underwritten by an international consortium and is available as a standard policy and on a surplus line basis. Although the Contractor examined policy materials, the examination was constrained by a confidentiality agreement. However, the Contractor is permitted to indicate business interruption coverage is offered following depopulation due to a government action resulting from a verified HPAI infection. Fixed costs identified in the policy, as well as continuing expenses and lost profits are indemnifiable until either the end of the insurance period or the release of the facility for repopulation.  Coverage is available for both the poultry meat and layer sectors.  The reader should note, the Federal Crop Insurance Act requires that “no program may be undertaken [by the Federal Crop Insurance Corporation] if insurance for the specific risk involved is generally available from private companies.”

Poultry industry data, including estimates derived by the USDA National Agricultural Statistics Service (NASS) from surveys, are available for the larger sectors of the industry: chickens (including layers and the eggs they produce), ducks, and turkeys. Production data on other sectors of the poultry industry are geographically limited, sporadic, and in many cases anecdotal. The proprietary nature of poultry industry data and contracts has made it particularly difficult to obtain farm-level data. Such data is important for development of an actuarially-sound crop insurance product.

Two commercial services provide price data on poultry for a fee. These price data focus on wholesale and retail markets rather than on farm-level sales.  NASS and the USDA Economic Research Service (ERS) estimate “prices received” values for poultry based on live-weight-equivalent prices calculated by subtracting processing costs from ready-to-cook wholesale prices and multiplying that result by the dressing percentage.

Over the course of 6 on-site and 4 telephone listening sessions, the Contractor gathered feedback from more than 120 stakeholders. While there were several common themes in the stakeholder feedback, there were differences in emphasis regionally and by sector. Representatives from major integrators, the owners of a majority of the birds producing meat, indicated no interest in catastrophic disease insurance. They noted widespread disease outbreaks have the potential to increase their profits as prices rise. Even when diseases affect their own production, the size and internal diversification of the larger integrators limits the potential “catastrophic” impact because a single affected flock represents a small percentage of the total birds in production. However, this attitude is not reflected by contract growers. These growers frequently have heavily leveraged operations and a disease outbreak that results in the loss of even a single production cycle can cause bankruptcy. While a majority of listening session attendees who spoke expressed concerns related to diseases, many growers expressed the opinion that most of this risk could be controlled by proper biosecurity. However, recent losses in the Midwest suggest that current biosecurity protocols may not be sufficient to avoid losses.

The USDA Animal and Plant Health Inspection Service (APHIS) offers programs providing indemnities to poultry producers and integrators who incur disease losses resulting from depopulation. APHIS determines the net present value for commercial birds which have been “taken” as a part of a disease management program. The APHIS values for meat and live birds for release are generally based on the price of day-old birds offered by mail order hatcheries plus an estimated cost of feeding the birds from birth to the age attained at the time of depopulation.

APHIS considers market pricing for marketable birds, the productive potential of layers, and the value of the intellectual property rights in breeding stock, when appropriate. Consequently, APHIS valuations are on a one-off basis. Furthermore, the percentage of the value of the taken poultry paid by APHIS is not always perceived as consistent by the industry. Since the integrators generally own the birds APHIS indemnities are not always distributed between integrators and contract growers, although growers have received some share of APHIS payments for some depopulations.

Private insurance has been offered by the Catlin Group (Bermuda) and Lloyd’s (London) on a surplus line basis for coverage for all mortality risks of livestock, including disease and down time. The premiums for such insurance are high. Furthermore, after the recent outbreak of HPAI, offers for mortality insurance and business interruption with disease listed as an insurable cause of loss have been withdrawn. 

The Contractor considered alternate insurance designs to address widespread disease events in poultry. None of these alternative designs met all the RMA insurance development feasibility criteria. The most substantial barriers were imposed by the Crop Insurance Act, RMA’s enabling legislation. The Crop Insurance Act has been interpreted to preclude provision of insurance for rent and labor payments to growers because the authority for indemnities is limited to “... losses of the insured commodity...”

Due to the sporadic and catastrophic nature of the proposed causes of loss, traditional quantitative rating approaches would be difficult to implement and most likely rates would need to be established for broad geographic regions. The biggest potential customers for catastrophic disease insurance, the large integrators, are generally satisfied with their non-insurance risk management strategies. It is smaller producers who would be most likely to purchase the insurance. Consequently, the distribution of the insurance liability is unlikely to mirror the distribution of poultry throughout the country. Underwriting or policy language to address the short production cycle will be required to avoid adverse selection. While pricing meat birds will be relatively straight-forward, establishing a value for breeders, layers, and pullets will introduce complications in establishing the insurance pricing. These confounding factors and the very thin margins for the on-farm component of the poultry income stream means the cost of insurance may create opportunities for movement in the supply curve, at least regionally if not nationally.

From RMA’s perspective, there are the fundamental questions regarding the insurability of the grower’s interest, and non-trivial questions regarding identification, measurement, and tracking of the value of a livestock “crop.” Moreover, the proprietary and closely guarded nature of production data makes the prospect for development of meaningful premium rates without a significant uncertainty load questionable. Furthermore, the existing reinsurance agreements with Approved Insurance Providers (AIPs) are likely not appropriate, barring meaningful adjustments, for livestock mortality products. In light of the many issues identified in this study, including the failure of insurance approaches for the poultry industry to meet some of the RMA criteria of feasibility, the Contractor believes it is currently not feasible to develop catastrophic disease insurance for the poultry industry without substantive changes in the current crop insurance paradigm.  Any development effort to address catastrophic disease coverage would have to be very large in scope and include broad authority to request formal USDA counsel positions regarding legal authority for coverage so policy language could be appropriately structured; recommend potential changes to federal reinsurance agreements; utilize potentially alternative quantitative and qualitative data methods in ratemaking; require unique underwriting standards based on biosecurity practices; and operate under an indefinite and likely extended timeline to accommodate structural changes that would be appropriate to support the approval and implementation of the potential product.