Overview of Current Ratemaking Methodology (cont.)

Stabilization of the pure premiums is accomplished by the use of an 80/20 rule. Since 20 years of experience are currently used in the analysis, the 16 smallest pure premiums (80% of 20 years) are considered to be normal. The remaining four years of experience (20% of 20 years) are capped at the largest value among the 16 normal pure premiums. This rule has been selected judgmentally, based on a study of 1948 through 1979 experience for corn and wheat. This study found that the 80/20 rule resulted in a larger reduction of variance relative to the reduction in expected losses than the two alternatives of 75/25 and 70/30 which were considered. The indicated pure premium for each county is selected as the straight average of the capped pure premiums for all the years in the experience period. The pure premium is not adjusted for trend since trend is expected to have an equal impact on losses and the liability exposure.

The previous steps produce a preliminary value for the base pure premium for each county. However, even with the use of 20 years, the experience is not sufficiently credible to establish rates due to the large uncertainty in the expected value. This uncertainty can be observed from the countrywide loss ratios for all crops combined in Chart 1. The magnitude of variation in the loss ratios is much larger than that normally experienced in Property/Casualty coverages. The variability in the losses is significant even on a countrywide basis for all crops combined. The variability at a county level for a single crop is much greater.