BULLETIN NO.: MGR-97-015 TO: All Reinsured Companies All Risk Management Field Offices All Other Interested Parties FROM: Kenneth D. Ackerman Administrator SUBJECT: Questions Regarding the Draft 1998 Standard Reinsurance Agreement At the request of private insurance companies reinsured by the Federal Crop Insurance Corporation (FCIC), the Risk Management Agency (RMA) will extend the date for the receipt of industry comments on the Draft 1998 Standard Reinsurance Agreement (Draft 1998 SRA) until COB Friday, May 2, 1997. All comments regarding the Draft 1998 SRA must be received by May 2 at the address provided under Manager's Bulletin MGR 97 011. On April 3, 1996, the Risk Management Agency (RMA) held a public meeting to discuss the Draft 1998 SRA. During that meeting a series of questions was presented to RMA by private insurance companies currently holding a Standard Reinsurance Agreement. RMA agreed to respond to these questions by COB Friday, April 11, 1997. Also as requested, the slides used during the April 3, 1997, meeting including the posters are also attached.With respect to the question regarding the foundation data supporting the Draft 1998 SRA risk sharing formulas, documentation of the Federal Crop Reinsurance (FCR) model could not be completed by today, April 11. The documentation of the model will be completed early next week and will be distributed when completed. A briefing on the FCR model has been scheduled for Thursday, April 24, 1997. The briefing will be held at the Risk Management Agency Office Building, 9435 Holmes Rd., Kansas City, MO. The briefing will be held from 8:30 a.m. until 4:00 p.m. in rooms 126A and 126B on the first floor of the building. Space will be limited to approximately 30 persons. You are requested to fax an attendance confirmation with the name of the persons attending and the company being represented to Verlerie Eddleman at (816) 926 1825. Persons attending this briefing will be responsible for their own travel and hotel arrangements.Except for the question regarding the FCR, each question received at the April 3rd meeting and the FCIC response are as follows: GENERAL Has the Board of Directors of Federal Crop Insurance Corporation reviewed and approved the proposed SRA? FCIC response: The FCIC Board of Directors (Board) has delegated the overall management and administration of the Standard Reinsurance Agreement (SRA) to the Manager of FCIC. The Manager has briefed the Board on the Draft 1998 SRA issues in general, but the Board did not formally review and approve the Draft 1998 SRA. The Manager will brief the Board in greater detail at the next scheduled Board meeting. Why did RMA attempt to advance the proposed 1998 SRA with Congress and the commodity groups without first discussing it with the private sector delivery system? FCIC response: There was no intent to discuss the Draft 1998 SRA with any group in any particular order; it was a matter of scheduling. However, the SRA also impacts both Congress and commodity groups. Congress,as our appropriator, is interested in the manner in which FCIC responds to budget pressures and the regulatory oversight of the private and Federal delivery system. Commodity groups, representing producers, have a similar interest in the amount of funding provided for services impacting producers, specifically the delivery of the multiple peril crop insurance and other crop insurance programs, and regulatory oversight. What is the RMA's definition of "risk" and "risk retention?" FCIC response: Random House defines risk as the exposure to the chance of injury or loss; a hazard or dangerous chance; the hazard or chance of loss; the probability of such loss; the amount that the insurance company may lose. FCIC's definition of risk is the same. Risk retention is the amount of risk an insurer assumes for its own account. Under the SRA risk retention is the risk assumed by the company after all cessions to FCIC. RISK SHARING Why is RMA employing a nonstandard method, Return on Capital At Risk (ROCR), for computing industry returns? There have been many studies of insurance company profitability, and there are standard methods of calculation. ROCR is a non standard method. FCIC response: In a verbal request for clarification on what the crop insurance industry considered the "standard" for computing returns, industry spokesperson Bob Vancrum replied "return on equity". ROCR is a return on equity measurement. By isolating multiple peril crop insurance (MPCI) income in the numerator and capital at risk in the MPCI program in the denominator, ROCR effectively carves out a company's MPCI return on equity from its total return on equity. Therefore, ROCR is a standard method of computing returns. FCIC is in agreement that the previous standard, Return on Retained Premium, was less than meaningful and a significant deviation from standard business practice. FCIC is aware there have been many profitability studies of private insurers and regulated utilities and that there are other methods of calculating profitability. FCIC will consider any studies or alternative profitability measure that any company wishes to present. In RMA's view, what is the acceptable rate of return for companies underwriting crop insurance based on ROCR? How is this rate to be determined? Do the changes bring the rate of return to the acceptable level? FCIC response: The acceptable rate of return under the Draft 1998 SRA was established during the development of the 1995 SRA(see attached Informational Memorandum for the Under Secretary dated May 13, 1994). That rate, 7 to 8 percent on retained premium, was authorized by the U. S. Department of Agriculture in consultation with the Office of Management and Budget (OMB). The 7-8 percent rate was a pretax measurement. In determining the acceptable rate of return for the 1998 reinsurance year, FCIC converted the 7 to 8 percent on retained premium pretax rate to a ROCR basis, which resulted in a pretax rate under ROCR of approximately 12 percent. According to FCIC analysis, the Draft 1998 SRA reinsurance terms yield an estimated ROCR of 12 percent. If the model is applied to 1992 to 1996, what is the rate of return (ROCR)? Exactly how did RMA develop the ROCR formula and the target percentage. Is ROCR rate of return pretax or posttax? FCIC response: The FCR model uses actual yield data and such data was not inputted for 1995 and 1996. Therefore, the model cannot be applied to 1992 through 1996. However, the FCR model was used to determine the Draft 1998 SRA reinsurance terms, which when applied to 1981 to 1994, the estimated is ROCR is 12 percent. The paper outlining the development of ROCR attached to Bulletin No.: MGR 97 011 is also attached to this bulletin. ROCR is a pretax rate of return. Please provide the foundation and data RMA used in proposing the changes to the gain/loss formulas. FCIC response: (Not yet available). Is ROCR consistent with RMA's standard of financial approval? FCIC Response: Yes. The ROCR and FCIC's standard of financial approval are both based on the maximum possible underwriting loss (MPUL). ROCR uses MPUL as the denominator of the formula, and the standards of financial approval use MPUL to determine MPCI writing capacity. FCIC requires companies to possess 2 to 2.5 times MPUL in surplus for approval of the SRA and its plan of operation. Since the reinsurance year does not correspond to the fall or spring planted crop years (i.e., spring planted crops are obligated before July 1 so are under the reinsurance year in which the obligation occurs, even though the crop is harvested and most losses occur after July 1, the next reinsurance year) companies may have two or three SRA's active at any one time. The minimum surplus requirement is the estimated amount a company has at risk under these multiple, active SRAs. ROCR measures return on the capital at risk in any one reinsurance year under one SRA. Has RMA computed a 1993 loss scenario using 1996 retained premium under the current SRA or under the proposed SRA? FCIC response: Yes. Under the current SRA, for the 1996 reinsurance year, assuming 1993 loss ratios, the net loss to companies would have been approximately $195 million. Under the current SRA, for 1996 reinsurance year, assuming 1994 loss ratios, the net gain would have been approximately $345 million. Under the proposed 1998 SRA, using 1996 retained premium, assuming 1993 loss ratios, the net underwriting loss to companies would have been approximately $266 million. Companies would have also been charged $17 million in Fixed Reinsurance Premium (FRP) resulting in a net loss of $283 million. Under the proposed 1998 SRA, using 1996 retained premium, assuming 1994 loss ratios, the net gain would have been $297 million. Companies would also had been charged $17 million in FRP resulting in an approximate net gain of $281 million. Has RMA analyzed the CAT program under a deficit year (such as 1988 or 1993) scenario? If so, what were the results and if not, why? FCIC response: In years such as 1988 and 1993, the loss ratio for the CAT business generally will be higher than the loss ratio of the additional business. Conversely, in years with lower overall loss ratios, CAT will have a lower loss ratio than the additional business. Over many years, the loss ratio should be approximately the same for CAT as the additional business. However, the gain and loss sharing parameters of the SRA make CAT more profitable for a company than the additional business. For example, in a year such as 1993, the loss exposure of the company may already be near its maximum, therefore, a higher loss ratio on CAT will have absolutely no impact. This would have occurred in Minnesota, which had an overall loss ratio of 616 percent in 1993. Most companies had incurred the maximum rate of loss (75 percent in the commercial fund) because the loss ratio exceeded 500 percent. The company's loss would have remained at 75 percent of premium in the commercial fund even if the CAT business had a loss ratio of 900 percent that year. In Illinois and North Dakota, the overall loss ratio exceeded 500 percent in 1988. Again, most companies incurred the maximum rate of loss in those States in 1988, and a higher loss ratio on CAT would have had no additional impact on the company's rate of loss. In the better years, the lower CAT loss ratio will enable the company to achieve a higher rate of profitability. Consequently, the combination of small or no changes in rate of loss in an occasional year such as 1993, coupled with greater rates of gain in other years, increases the rate of return on CAT business relative to additional business within a state and fund. At the national level, CAT also has a moderating impact within a year. Severe losses tend to be localized, such as in the Eastern Corn Belt or the Western Corn Belt, the Southern Plains, or the Northern Plains, etc. The SRA with CAT increases profits in those areas not affected by the severe losses but has limited or no effect in the severe loss areas. At the national level, overall reinsurance losses for CAT alone due to the SRA are estimated to be one third to one half lower than for the combined additional business plus CAT business. For example, if the national loss were on the order of 25 to 30 percent of risk capital for CAT and additional business combined in a year such as 1993, the loss on risk capital for CAT alone is estimated to be 15 to 20 percent. RMA has made the assigned risk and developmental funds relatively more attractive, compared to the commercial fund. Does RMA wish companies to take less risk than they have been, by switching part or all of their business from the commercial to the other funds? FCIC response: Under the FCR model, the 1998 SRA ROCR is estimated at 12 percent compared to the 1995 SRA ROCR estimate of 24 percent. This is equal to a 50 percent reduction in overall estimated ROCR. However, by fund, the reduction is 48 percent in the commercial fund, 64 percent in the developmental fund and 35 percent in the assigned risk. The 1998 SRA reinsurance terms have increased the relative difference between the commercial and developmental fund estimated returns. The developmental and assigned risk funds do not predominate in States such as Iowa, and FCIC expects minimal shifts from the commercial fund in similar States. With respect to other States, FCIC wishes to provide a return for all crops, insurance plans, and areas sufficient to support a delivery system capable of reaching all producers. However, certain crops and areas have been disproportionately represented in the developmental and assigned risk funds because they are innately more risky and less profitable, and thus have generated less financing with which to support the delivery system. By increasing the potential returns for business in these two funds, FCIC will provide needed support for those companies that choose to write the less attractive crops, plans, and areas. If the companies have alternative percentages that meet the statutory mandate that the companies retain a greater portion of the risk and the 12 percent ROCR rate, they should submit this information to FCIC for consideration. Why is a company penalized for misestimating their percentage of assigned risk by placing the excess in the commercial fund instead of the developmental? FCIC response: In general, companies do not use the assigned risk fund to the maximum cessions stated in Exhibit 15 of the plan of operation. However, in several states such as Texas, the assigned risk fund is utilized in excess of the maximum cessions. FCIC continues to be concerned about proper claims management in areas where crop loses tend to be higher and a high percentage of crop insurance business is designated to the assigned risk fund to minimize the risks to the company. By transferring the premium amounts inexcess of the maximum cession limitation to the commercial fund, FCIC hopes to encourage more companies to focus more on claims management in order to protect the integrity of the program. Why has RMA instituted reinsurance fees on the commercial fund for CAT and revenue products? What is the foundation for these fees? FCIC response: Loss ratios from year to year for both CAT and revenue insurance will differ significantly from the MPCI buy up policies for which the SRA has been designed and would result in a higher gain than the 12 percent ROCR. The reasons for the difference for CAT gains were explained above and similar reasoning applies to the revenue products. Using the FRP contained in the Draft 1998 SRA, all insurance plans fit in one set of stop losses. The current SRA already has 150 stop loss funds three in each State. More funds are not needed. RMA estimated the additional amount that should be charged in order to bring the applicable product being analyzed in line with the ROCR yield for buy up MPCI and then quoted a portion of that as the FRP. The quoted FRP is lower than indicated by the analysis because each of these products is new and there is limited historical data to analyze. ADMINISTRATIVE & OPERATING EXPENSE/PREMIUM SUBSIDY Is RMA not bound by Section III.E. of the current SRA, which States: "For the 1998 and 1999 reinsurance years, the amount of premium subsidy for administrative and operating expenses included in subsections B. and C. above will be equivalent to the maximum authorized amount specified by law, or such other amount as FCIC and the Company may agree upon."? Has FCIC's Board of Directors authorized this position of RMA? FCIC response: FCIC is not bound by the terms of an SRA after it has been canceled in accordance with the terms of that SRA. The provisions regarding the 1998 and 1999 reinsurance years were only included to ensure that the parties would know the terms and conditions applicable to such reinsurance years in the event that the 1997 SRA was not canceled. Once canceled, FCIC can offer reinsurance under any term or condition authorized by law. In any event, FCIC has offered the maximum amount of expense reimbursement currently authorized. Section 508(k)(4) of the Federal Crop Insurance Act, as amended (Act), states that the rate for expense reimbursement cannot exceed 28 percent of the net book premium for the 1998 reinsurance year. However, the President's budget submitted to Congress authorized an expense reimbursement of 24.5 percent of the net book premium. It would violate the Anti Deficiency Act for FCIC to agree to make a payment under a contract or cooperative agreement in excess of the amount that indications show will be appropriated for such use. Until Congress acts, FCIC will be bound by the amount specified in the President's budget. The FCIC Board has delegated the negotiation and management of the SRA to the Manager of FCIC. Therefore, the FCIC Board authorization is not required. Why has RMA abandoned the Legislative mandate and contractual responsibilities on premium subsidy for A&O? What is the basis used to determine the amount of premium subsidy for administrative and operating expenses, as such term is used in Section III.H. of the RMA's proposed 1998 SRA? FCIC response: FCIC has not abandoned its contractual responsibilities. Once the 1997 SRA was canceled, FCIC no longer had any contractual responsibilities with respect to the 1998 reinsurance year. Further, there is no legislative mandate. The Act simply provides the maximum amount of expense reimbursement that FCIC can offer. FCIC certainly has the authority to offer less than this maximum amount. Since Congress has determined that the payment of the administrative and operating expenses of the insurance companies are to be included in the premium, payment of those expenses by FCIC is considered a premium subsidy. FCIC uses the terms "premium subsidy for administrative and operating expenses" and "expense reimbursement" interchangeably. In the past, the basis for determining the amount of premium subsidy has been an agreement between FCIC and the insurance companies. However, Congress recently limited the amount of expense reimbursement by appropriation and in the Act. Currently, the best analysis of the of the actual costs of the program is being provided by the General Accounting Office (GAO) report. This amount of premium subsidy is to reimburse companies for an expected level of service. If the services the insurance company is required to perform deviates from the services required for other plans of insurance, then FCIC has maintained its right to adjust the amount it pays to the companies. Now that companies are also required to report their allowable expenses on their plans of operation, FCIC will be able to more accurately assess costs. Why did RMA adopt the fixed fee with the percentage reimbursement alternative without even waiting for the industry response to the GAO's proposals? FCIC response: As indicated in its preamble,the purpose of the SRA is to "deliver multiple peril crop insurance." FCIC's goal is that all producers in all areas of the nation have access to all available crop insurance products that are best suited to meet their risk management needs. Reliance on a method that is a flat commission creates marketing incentives in favor of high premium/high profit crops, plans, and market areas. A composite method, such as proposed for buy up MPCI $100 per premium earning crop policy plus 18 percent of net book premium, will tend to support FCIC's goals by: Encouraging companies to serve all producers, even those with small acreage and low value crops. Encouraging companies to aggressively sell all crop plans that may be appropriate for some producers, even plans with low premium rates. Providing incentives for companies to develop and present to FCIC, under section 508(h) of the Act, new crop plans that may be more affordable for producers (i.e., lower out of pocket costs) and that generate lower overall budgetary pressures. FCIC considered a composite reimbursement prior to, and independent of the GAO report. FCIC has not, as the question states, "adopted" the composite reimbursement plan. FCIC is proposing this plan for reimbursement to the companies and will consider all company comments before deciding whether or not to adopt it. Does FCIC consider the SRA a cost plus contract or a flat reimbursement contract? FCIC response: The Act authorizes FCIC to pay a flat reimbursement and the current language in the President's budget also supports a flat reimbursement. Provided that the Act or the budget does not change, companies will receive a flat rate of 24.5 percent of the net book premium. The draft 1998 SRA also contains the flexibility to pay the companies based on a $100 plus a percent of the net book premium, if such a payment method is authorized by law. FCIC has submitted statutory language which will remove the requirement that the expense reimbursement be paid as a flat rate and authorize exceeding the 24.5 percent cap on expense reimbursement if program participation increases, rates increase, or a change in the mix of policies between high premium policies and smaller dollar premium policies result in excess expense reimbursement being paid. If authorized by law, the $100 plus percent of the net book premium is not a cost plus contract since the $100 is not based on any particular cost. It is simply an amount determined to provide an incentive for companies to aggressively market the additional levels of insurance to smaller farms. Why does the proposed 1998 SRA list allowable expenses if expenses are not directly reimbursed? FCIC response: FCIC is using public funds to operate the Federal crop insurance program, including its delivery by the companies. Even though FCIC does not directly reimburse expenses, it still has a responsibility to ensure that the funds paid to companies are only used for proper purposed, the delivery of the program. The list of allowable expenses (Exhibit 20A) is to provide guidance for preparing Exhibit 20B, which reflects the actual company MPCI expenses for the prior calendar year. Exhibit 20B is to aid in determining the adequacy of FCIC's expense reimbursement relative to the delivery of MPCI. If RMA considers this a flat reimbursement contact, why is it requiring companies to collect data differently for RMA than for corporate reporting? FCIC response: Corporate reporting takes into consideration all expenses of the company, However, FCIC is only concerned about the costs data for delivery of the crop insurance program. Therefore, FCIC issued guidance for allowable expenses (Exhibit 20A) and the reporting form (Exhibit 20B) to provide a tool for formal reporting of company delivery expense. Prior to Exhibits 20A and B, FCIC had no formal process for reporting delivery expense. The reporting of delivery expense is important, not only to assess the adequacy of the administrative and operating expense subsidy, but also to provide FCIC a basis to audit delivery expenses to ensure that taxpayer dollars are being utilized for the intended purpose. Does RMA's pending legislative proposal contain specific authority for payment of excess LAE? FCIC response: No. What is RMA's justification for the reduction of CAT LAE from 14 percent to 4 percent? Does RMA view the proposed reduction as resulting in a net increase or decrease to a company's operating expenses? FCIC response: FCIC erred in its draft, which should have read 4.8 percent of CAT premium instead of 4.0 percent. FCIC is proposing to pay $50 plus a percent of the actual CAT premium for each premium earning CAT policy, such that the aggregate of these amounts do not exceed 4.8 percent of the CAT premium. This calculation is similar to that proposed for the expense reimbursement where FCIC will pay a fixed fee plus a percentage of the premium up to the maximum allowable. This is in addition to the CAT administrative fee paid by the producer. The CAT loss adjustment expense was reduced to be commensurate with the estimated cost of loss adjustment provided in section V.Y of the Draft 1998 SRA. LIQUIDATED DAMAGES What is the justification for the liquidated damages provisions in the proposed SRA? When actual damages can be calculated, why are they not sufficient? FCIC response: When actual damages are quantifiable, they are sufficient and collectable under section V.K. of the SRA. However, there are instances where FCIC suffers damages and the amount of such damages are difficult to quantify. FCIC is paying the companies to perform services in the delivery of the Federal crop insurance program in accordance with its approved policies and procedures. When the companies violate the policies and procedures, FCIC is not receiving the benefits for which it paid and is entitled to be reimbursed for value of these services. Liquidated damages is a measurement of the damages that FCIC has suffered in those cases because the actual damages are difficult to quantify. FCIC has made a reasonable estimate of the damages suffered in each provision. If the companies believe that there is a more accurate estimate of these damages, it should inform FCIC and provide evidence in support. Why is the liquidated damages provision unilateral? FCIC response: Although section V.Y appears unilateral, the company will also receive compensation in the event that FCIC breaches the SRA in accordance with section V.A. of the Draft 1998 SRA. What criteria were used to establish the percentages to be assessed as liquidated damages? Is the liquidated damages provision viewed by RMA as a penalty? FCIC response: The percentages to be assessed as liquidated damages were estimated based on cost data submitted by the companies and provide FCIC's best estimate of the damages it has suffered as a result of the breach of the SRA by the company. Since these liquidated damage provisions are a measure of FCIC's damages, they are not a penalty. If a policyholder is paid the correct indemnity, but the company violated loss adjustment procedures in determining the indemnity, what damages has RMA suffered? FCIC response: When proper procedures are not followed, FCIC must expend its own funds and resources to verify that the loss was correctly paid. In essence, FCIC must readjust the loss. Liquidated damages provides FCIC's reasonable estimate of these damages associated with this readjustment. What procedural rights and rights of due process do the SRA holders have against an arbitrary use of the liquidated damage provision? FCIC response: Since the liquidated damages provision is part of the SRA, the company will have the same appeal and due process rights as for any other provision of the SRA. The company can appeal any imposition of liquidated damages under 7 C.F.R.  400.169. The following also provides some clarification of the liquidated damage provisions. Section Y. 1 The expense reimbursement will be reduced 1.5 percent of the net book premium per week for only those policies that are submitted after the 11th week after the transaction cut off date. Section Y.2 The expense reimbursement is only reduced for those policies for which FCIC takes over the loss adjustment. The amount will be increased to 4.8 percent of the net book premium to be consistent with section IV. Section Y.3 In the event of termination of the SRA for cause, the company will be required to reimburse 10 percent of the total net book premium for the policies reinsured under the terminated SRA to offset the administrative costs associated with ensuring that the policies are properly serviced. Section Y.4 The requirement that the company reimburse the entire expense reimbursement when the company commits a pattern of acts or omissions existed in section V.U. of the 1997 SRA. Any contract not reinsured under the SRA is not eligible for premium subsidy or expense reimbursement. Section Y.5.a The company will be required to reimburse the amount paid for loss adjustment only for those policies where the company failed to comply with FCIC approved loss adjustment procedures. Section Y.5.b The company will be required to reimburse the amount paid for calculating the actual production history only for those policies where the company failed to comply with FCIC approved actual production history procedures. Section Y.5.c This provision will be revised to distinguish between the different requirements under M-14010 and when liquidated damage will be imposed on a per policy or the total book basis. Section Y.5.d FCIC has determined that 0.5 percent of the net book premium for all policies in the county is a reasonable estimate of the damages it will suffer in attempting to establish the correct claim information when the company has failed to take those actions necessary to verify the existence or amount of any loss. Section Y.6 FCIC has determined that 3.0 of the gross premium included in the quota share agreement is the reasonable value of its agreement to insure a portion of the company's book of business in excess of the amount of premium authorized under the SRA under a quota share agreement. PROCEDURES & OPERATION What changes has RMA anticipated in the plan of operations? Does RMA view the proposed changes in the plan of operation as resulting in a net increase or decrease to a company's operating expenses? FCIC response: The proposed revision to M14010 requires that companies submit detailed descriptions of their own internal operating procedures (i.e., policy selection methodology, corrective action processes, procedures used to expand the scope of reviews, etc.) developed to satisfy M-14010 requirements and the SRA. The detailed descriptions requested in the plan of operation are nothing more than a business plan. In addition, companies are to submit the forms used to document the completion of M-14010 requirements, as well as identify the appointed program managers and individuals assigned the oversight responsibilities for the various programs. For those companies that are in compliance with M14010 and developed their internal operating procedures, the overall effect should be limited to the reproduction and submittal of the procedures as part of their plans of operation. For companies who have not developed internal operating procedures, the initial development of the procedures may increase operating expenses to a level consistent with the amount of reimbursement that companies have been already receiving to perform this function. However, all companies must still evaluate their respective internal operating procedures to ensure that the procedures allow them to satisfy M14010 requirements. This will afford companies the occasion to reevaluate the effectiveness of their operations. The proposed changes to the plan of operation will provide FCIC reasonable assurance that companies are familiar with M14010 requirements. The results of recent compliance activities indicate that companies were not as familiar with the requirements as necessary to ensure compliance. The proposed revisions to M14010 will also allow FCIC to reallocate its resources and to concentrate on areas of suspected program abuse. FCIC is also requiring the companies to submit an annual report of the results of the reviews conducted under M14010. The only cost associated with this report should be the compilation of the report since the companies are already required to conduct and document the reviews. The costs associated with this report should be more than offset by costs savings resulting from the less intrusive and resource intensive national operations evaluations conducted by the Risk Compliance Division (RCD), and the more timely evaluations of the company. FCIC also proposed that companies perform a quarterly review of the managing general agent's finances and operations. To the extent that companies do not conduct such reviews, this activity will initially result in a net increase to a company's operating expenses. However, this cost should be offset by future savings resulting from closer oversight of the companies operations. Compliance reviews have revealed that, in many instances, the company has been unaware of the activities of its managing general agent and its noncompliance with FCIC requirements. FCIC is also requiring the company to submit to FCIC a plan as to how policyholders will be serviced in the event a managing general agent is unable to do so because of a financial or operational impairment, regulatory action initiated by a state, or by FCIC. To verify that the managing general agent has errors and omissions insurance coverage, a written certification is only required. What is the justification for the changes to M14010? FCIC response: M14010 was revised to realign, consolidate and, when applicable, rescind the requirements for the purpose of program simplification. In the past, companies have expressed concern with regard to the apparent duplication of M14010 requirements and the resources required to satisfy those requirements. Evaluations of M-14010 requirements and companies' actual practices disclosed that the company was correct and that M14010 could be revised to correct these deficiencies without sacrificing program integrity. During the course of the compliance activities, the RCD identified program inefficiencies and developed recommendations to allow for the consolidation oseveral M14010 requirements. Therefore, even though the total number of reviews may not have decreased, multiple reviews can now be conducted on the same policies and only records of the reviews need to be maintained separately. The consolidation of these requirements should allow companies to reallocate their respective resources and concentrate on the delivery and administration of the Federal crop insurance program. In addition to the consolidation, the RCD also identified the need to rescind several nonproductive M14010 requirements which used a significant percentage of the companies' resources. One such requirement involved training. RCD reviews revealed that a majority of the problems arising from agent conduct resulted from new agents. Therefore, companies are now only required to provide complete training to new agents, which should provide considerable savings to companies because they will no longer have to expend resources to annually train all agents, copy and disseminate training materials, etc. In view of the proposed changes to the Draft 1998 SRA with respect to the liquidated damages provision, this is especially critical because companies will not be required to forfeit a portion of their expense reimbursement for noncompliance with requirements deemed nonproductive. A comparison of FCIC's responsibilities with regard to assuring program integrity to the crop insurance programs, authorized under sections 508(h) and (m) of the Act, disclosed that these programs were not previously subjected to the types of oversight activities required to identify program vulnerabilities. Therefore, in order to comply with its responsibilities, FCIC implemented the appropriate program changes in the proposed M14010. This will afford FCIC the opportunity to accurately assess the soundness of the programs authorized under the cited sections of the Act. What criteria has been used to benchmark the adequacy/inadequacy of the current programs under M14010? FCIC response: The requirements contained in the current M14010 were evaluated based upon the results of the compliance activities, company recommendations, statistical studies of the data maintained in the FCIC Statistical Database, FCIC's responsibilities for assuring program integrity, and the effectiveness of the current oversight programs to assure program integrity. The results of recent compliance activities (those completed within the past 2 calendar years) have dictated a need for revising the current M14010 requirements. The companies' November 1996 response to the draft M14010 was also taken into consideration regarding the proposed revisions to the manual. During the operational evaluations, the RCD identified egregious departures from M14010 requirements by companies. Consequently, the impact on program integrity was evaluated, which resulted in the recommendations for rescinding several of the requirements. The RCD concluded that there was negligible or no adverse impact on program integrity in the requirements designated for rescission. Concerns with regard to the required review activities, competency testing, loss adjuster training combinations, tables summarizing the review activities, documenting of sales representative evaluations, new producer reviews, and review checklists were addressed in the proposed revision. Consequently, the number of required review activities was drastically reduced; the issues regarding competency testing and training combinations were clarified; the requirements for sales representative evaluations, new producer reviews and review checklists were deleted; and a table was attached to the manual identifying possible consolidation of M14010 requirements. Does RMA view the proposed changes to M14010 as resulting in a net increase or decrease in a company's operating expenses? FCIC response: In comparison to the program requirements set forth in the current M-14010, the proposed revisions significantly reduce the companies' training and quality control requirements and correspondingly, the costs associated with these requirements. Companies will not be required to develop systems to track and monitor the training of all sales representatives (only those classified as new agents and those requiring additional guidance) nor will they be directed to develop, publish, disseminate, and retain the training materials previously needed to satisfy the requirements under the current manual. Further, companies will no longer be required to conduct or retain documentation of the proficiency evaluations of sales representatives previously identified as experienced, random APH reviews, and sales representative APH reviews. A study of two companies, one on each end of the size spectrum in relation to the number of policies serviced, disclosed that the proposed M14010 requirements will reduce the companies' responsibilities by more than 50 percent (see attachment 2). However, companies will be required to conduct more indepth assessments of the sufficiency of the crop insurance contracts necessary to protect program integrity. Some of the information required to determine the actual reduction was not made available during the course of the operation evaluations. Note, that the information required to determine the dollar savings (i.e., the cost of conducting APH reviews, sales representative training, etc.) are not reported to FCIC. What is the criteria used in developing the additional training requirements under M14010? FCIC response: The greatest vulnerability with regard to sales representatives rests primarily with the individuals who have never serviced crop insurance contracts under the Federal crop insurance program, the new agent. Therefore, FCIC has actually reduced the training requirements since only a small percentage of the sales representatives are classified as new agents (a study of three companies shows the actual percentage to be less than 1 percent) and there is no longer a requirement for recurring annual training for all other sales representatives. However, the training requirements for new agents is increased. The new training requirements allows for on the job training (as defined in M14010) under the guidance of a qualified individual during the course of processing applications, production and yield reports, and acreage reports. This type of training allows the companies to give guidance during three of the most critical aspects of servicing and delivering the Federal crop insurance program. It also affords the companies the opportunity to evaluate the individuals' proficiency in "real world" situations. Note, that the companies are also satisfying the proficiency evaluation requirements in addition to providing their agents on the job training. The training requirements for loss adjusters was reduced from the 10 days identified in the previous draft to 8 days in the proposed revision. A review of companies' responses to the previous draft disclosed that no one commented on the length of training. However, the companies did comment that, other than the required classroom training, they should be authorized to complete the remainder of the training in a combination of any other approved method. The proposed revision allows the companies to complete the training requirements in any combination of classroom, on the job training (as defined in the manual), and field training seminars. However, companies must ensure the minimum classroom training requirements are satisfied. What is the supporting detail to the changes announced by RMA to M13 for the 1998 reinsurance year? Does RMA view the proposed changes to M13 as resulting in a net increase or decrease to a company's operating expenses? Including: 1. Automation of the escrow funding process 2. RMA ceasing to create and distribute accounting reports 3. Implementation of the ineligible regulations 4. Conversion of crop policies to the common policy format 5. Reimbursements for FCIC errors FCIC response: The changes outlined in Informational Memorandum R&D 97 023 for Manual 13 are designed to reduce errors and enhance error resolution that was previously done manually. These changes, as suggested by company data processing representatives, are targeted at improving the efficiencies of a processing operation, thus lowering overall expenses. The addition of the application signature date on the Record type 14 will provide the means for an automated determination of policy ownership in handling duplicate policies. This reduces the time companies now spent contacting other companies and Farm Service Agency offices and waiting for follow up corrective actions. Some companies requested this during June 1996 to eliminate questions associated with duplicate policies. The recommendation was agreed to by all company data processing representatives at the November 1996 Data Processing Managers' meeting. The addition of the "record" linkage will clarify edits and error resolution. When an acreage record is processed, for most crops, a match to a yield record must be made. Due to yield differences within a crop, it is difficult to find the correct yield record for the edit and to conduct error resolution properly and efficiently. The record link identifies the yield record the Data Acceptance System (DAS) should use to accept the acreage record. In the case of an error, the company can quickly determine which yield or acreage record needs to be reviewed. The same applies to matching the loss record to the acreage record. This change, requested by a number of companies, has been discussed with data processing managers over the past year and is available for companies to use in 1997 to match an acreage record to a yield record to determine the correct yield and is required for 1997 Revenue Assurance. Both FCIC and companies will utilize the automated written agreement system when it is moved into production for Actuarial Data Master references when editing a policy. This will improve policy processing at the company and FCIC levels, and automate a manual system while addressing some program vulnerabilities associated with incorrect rates being used on land covered via a written agreement. The following edit improvements will be added to the 1998 DAS to prevent the acceptance of invalid or incorrect data and to notify the company of incorrect data within its system: (1) An edit on tax ID will only allow one EIN tax number for the policy including the SBI records to enforce the current regulations on policy reporting; (2) The unit loss guarantee and liability can no longer be greater than the acreage guarantee or liability; and (3) The zip code, state and county combination submitted on the agent record must be valid according to the US Postal Service zip code directory. Companies were notified of these enhancements during the February 1997 Data Processing Managers' meeting. 1. Automation of the escrow funding process. The automation of escrow funding will enhance the timing of the process considerably and provide companies with an electronic means to identify and track losses reimbursed by the FCIC at a policy level. This system improvement should decrease company operating expenses in general. Companies will no longer be required to submit hard copy check registers to support their escrow requests. When escrow funding is automated, companies should have an electronic means to perform any reconciliation between the companies escrow data and the escrow data received by FCIC. Currently, accounting reconciliation of losses that have been funded currently is a manual process. The company also should be able to readily identify any losses which have not been funded. 2. RMA ceasing to create and distribute accounting reports The proposal calls for FCIC to provide a company with all accepted data records. This change will enable companies to produce their own internal reports as desired and provide the capability to produce their own accounting reports, create other reports within their own accounting system, and reconcile data in their own system using FCIC edited and accepted data. By submitting its own accounting report, the company may be reimbursed sooner for any amounts due. These records were requested by representatives of the company's accounting departments during the Accounting Reports Workgroup Simplification meeting. If a company chooses not to generate its own accounting report, FCIC will continue to provide these reports. 3. Implementation for the ineligible regulations The development and implementation of an ineligible file have involved FCIC working jointly with companies to design and implement an automated system that will identify producers who are ineligible to participate in crop insurance programs insured or reinsured by FCIC. A Cost Benefit Analysis as reflected in the proposed rule published in the Federal Register concluded that approximately $6 million in debts owed will be able to be collected annually. FCIC received over 60 comments to the proposed rule that were due December 30, 1996, none of which suggested this regulation should not be implemented. Although some startup and maintenance costs will be incurred by FCIC and companies, it is expected that the costs will be offset by the savings associated with collections of past due debts, denying coverage to producers who may already be indebted for prior years, and denying coverage to producers who may ineligible due to program fraud, misrepresentation or concealment of material information. Additionally, this will be an automated system that will allow companies to submit and receive information regarding ineligible producers automatically rather than the current method of trying to monitor these producers manually, which was open to vulnerabilities. 4. Conversion of the crop policies to the common policy format The conversion of policies to the common policy format has been a cooperative venture with the crop insurance industry dating back to the early 1990's. Under this initiative, each specific crop provision is used in conjunction with the single Common Crop Insurance Policy Basic Provisions, which contains standard terms and conditions common to most crops. This action also includes making policy changes identified by FCIC or the crop insurance industry as problematic or difficult to administer and better meet the needs of the insured. Although this action began prior to the Regulatory Reform Act of 1995, initiated by the Vice President, it is consistent with Regulatory Reform that focuses on reducing the regulatory burden of the Federal government on the general public. Companies will experience initial costs associated with the distribution of the new policies as they become final rule. However, FCIC expects the end result will be increased operating efficiencies for the companies. The results of this initiative include but are not limited to: (1) increased acceptance and participation because producers and companies have requested many of the changes; (2) changes that will mitigate ambiguity or clarify language that have resulted in arbitration or litigation costs in the past; (3) reduction of the number of policies and policy forms that must be maintained; (4) greater consistency in training due to standard terms and conditions; (5) less procedural requirements and clarifications which will reduce administrative costs; (6) elimination of loop holes or clarifying provisions resulting in less unanticipated losses; (7) potential for increased underwriting gains; and (8) potential for reduced loss adjustment costs due to clearer communication of policy terms and conditions. 5. Reimbursement for FCIC errors During the past year, FCIC worked with companies on an error identification and resolution process to design an error report companies can fax to the Data Quality Section, which identifies error conditions the companies believe to be RMA's responsibility. In return, a weekly DAS Status report is sent to all companies listing modifications that have been made to DAS, corrections that are in the process of being made, items being researched, and items that were closed. If a company reports an error on a DAS Error Report, and the error is due to a FCIC problem and it is not corrected by the second monthly accounting report, the company may be paid interest on the amount of premium rejected with the error condition identified in the DAS Error Report. Program Change Provision: How does RMA propose to evaluate compensation to companies for increased administrative costs as a result of FCIC unilateral changes or actuarial errors during the contract term? Please provide specific examples of the types of program changes for which RMA will compensate the companies. FCIC response: Provided that companies can show that they have suffered damages as a result of a breach of the SRA by FCIC, FCIC will examine the evidence offered by the companies to establish the amount of such damages. This provision will be revised to allow the flexibility for FCIC and companies to agree to an amount of damages only in those cases where there is clear evidence that the improper conduct of FCIC caused a material increase in the cost of performing services under the SRA and the amount is difficult to quantify. The burden will remain on the companies to establish the increase in costs. Specific examples include changes in the policy after the contract change date, such as the 1995 prevented planting changes. Not included are requirements that companies conduct inspections, monitoring programs and appraisals which are intended to reduce the costs to companies by reducing fraudulent or erroneous claims. Does MGR 93 020 survive under the 1998 draft SRA? Does it apply to company exposure due to the collection of civil rights data? FCIC response: MGR 93 020 has no relationship to the SRA. It was a program created by FCIC, at its sole discretion, to assist companies and FCIC when it is necessary to litigate a case to protect program integrity. Notwithstanding any provision of the SRA, FCIC may amend, revise, or eliminate MGR 93 020 at any time. Although MGR 93 020 is currently being reevaluated, it will remain separate from the SRA. As currently written, MGR 93 020 does not cover collection of civil rights data. Further, since there is no identifiable liability associated with the collection of civil rights data, there are no plans to incorporate such liability into MGR 93 020. What is RMA's justification for requiring companies to collect civil rights data? Does RMA view the proposed change as resulting in a net increase or decrease in a company's operating expenses? FCIC response: The requirement to collect civil rights data has been in existence since the 1995 SRA and was agreed upon by the parties. Ensuring that the delivery of any Federal program is performed in a nondiscriminatory manner is a requirement under the Civil Rights Act of 1964 and U.S. Department of Agriculture regulations, 7 C.F.R. part 15. Directive No. 15 of OMB Circular No. A46 provides the standards for providing Federal statistics and administrative reporting. FCIC does not currently have a mechanism to collect this data except through its delivery systems. Data of this type have never been collected by the private delivery system; however, this data is necessary to determine if Federal crop insurance programs are being offered to minorities as required. Collection of this data should result in a net increase in a company's operating expenses. At what level of company supervision does RMA intend to mandate dual staffing of marketing and loss adjustment functions? FCIC response: Since companies may use different field management programs, FCIC cannot identify the specific level of company supervision. As stated in section V.H.4. and 5. of the Draft 1998 SRA, companies will not be able to employ one person to supervise the day to day activities of claims and sales personnel. There is no line of insurance which permits sales agents to direct loss adjustment. Most companies maintain separate sales and claims departments. Even in the automobile insurance industry, which may give agents the discretion to pay small claims, such authority only exists after the policyholder has received three estimates from persons not connected with the agent. Therefore, FCIC's requirement is in line with the rest of the insurance industry. In light of the current status of the SRA, what are companies' responsibilities given the April 1 Plan of Operation date and approval of the SRA by July 1, 1997? FCIC response: FCIC will issue a final SRA by mid May, 1997. This will provide ample time for companies that chose to participate in the Federal crop insurance program to have its signed SRA received by FCIC prior to July 1, 1997. The April 1, 1997, date stated in the Draft 1998 SRA will be waived the first year as this date has obviously passed. Does either the expected, long term underwriting gain or the administrative expense allowance (AER) provide a return on capital assets? (Submitted verbally) Return on capital assets is not included in the AER. The expense of capital assets measured by depreciation is included in the AER. This effectively reduces the risk associated with a given capital investment. The same is true of the interest expense and lease payments if the asset is leased. The amount of risk involved with a particular capital investment is dependent on subjective factors such as the skill and competence of the company's management and the company's decision to purchase the assets instead of leasing them. The risk component associated with capital assets is included in the underwriting gain of the SRA. Return on capital assets for other insurers and other business firms is included in those firms' overall profitability, which RMA reviewed when it considered what should be the appropriate level of expected, long term profitability under the SRA.