Risk preferences of commodity crop producers and specialty crop producers: An application of prospect theory

Producers’ decisions, such as crop insurance, contract agreement, and technology adoption, involve considerable risk and uncertainty. Particularly, specialty crop production is more vulnerable to risk and requires more intensive management than commodity crop production, while risk mitigation tools for specialty crop production are comparatively limited. We apply Prospect Theory (PT) to analyze risk preferences of U.S. producers, and further compare the preference differences between commodity crop and specialty crop producers. Reference dependent, diminishing sensitivity, loss aversion, and probability weighting, as well as certain farm characteristics and producer demographics, are found to have a significant impact on grower risk attitudes. In addition, we do not observe significant differences in the base PT estimates between commodity crop and specialty crop producers. However, the relationships between risk behavior and individual characteristics vary between the two types of producers, which shed lights on the development of agricultural policies and provide implications for the design of contract and insurance.     

Advantageous Selection in Crop Insurance: Theory and Evidence

We extend the recently proposed multi‐dimensional asymmetric information model to show that advantageous selection could be present in crop insurance with two types of coverage: (i) multiple perils (e.g. a multi‐peril, ‘all risk’ policy), and (ii) a specific named peril (or set of perils). Our theoretical model suggests that certain characteristics of an insured farmer (or farm) under both types of coverage can be sources of advantageous selection. Farmers who advantageously select are more likely to purchase insurance coverage and less likely to realise a loss. A supplementary empirical analysis, based on data from the Philippine crop insurance market, illustrates how sources of advantageous selection can be identified econometrically.     

Crop Insurance Under Catastrophic Risk

We develop a new insurance model that shows how catastrophic risk affects the nature and existence of a crop insurance market equilibrium. A reservation preference level is used to characterize long-run equilibrium when catastrophic risk makes insurance companies risk responsive. Catastrophic risk is shown to increase premiums, reduce farmer coverage levels and, under some conditions, lead to a complete breakdown of the crop insurance market. Reinsurance can help facilitate an equilibrium and/or increase participation, particularly if the reinsurance is subsidized. The analysis has important implications for the design and management of crop insurance and reinsurance programs.     

Demand for Crop Insurance in Developing Countries: New Evidence from India

Determining farmers’ real demand for crop insurance is difficult, especially in developing countries, where there is a lack of formal financial sector integration and a high reliance on informal risk mitigation options. We provide some new estimates of farmers’ willingness‐to‐pay for insurance in the context of a large‐scale subsidised programme in India. We conducted a discrete choice experiment with agricultural households across four states in India, enabling us to estimate preferences for specific insurance policy attributes such as coverage period, method of loss assessment, timing of indemnity payments and the cost of insurance. Our results suggest that farmers do value crop insurance under certain conditions and some are willing to pay a premium for such coverage in excess of the subsidised rates they are currently required to pay under this programme. In particular, farmers value the assurances that they will receive timely payouts when they incur losses, and may not have a strong preference for the method with which losses are assessed. On the other hand, farmers are quite sensitive to coverage periods. Our baseline assessment shows that when optimised to farmer requirements, there can be a sizeable demand for crop insurance by developing country farmers.     

Motivations to grow energy crops: the role of crop and contract attributes

Perennial energy crops are a promising source of bioenergy whose production involves production risks, long‐term commitment of land and need for crop‐specific investments without the coverage of crop insurance potentially available for conventional crops. We conduct a choice experiment in five states in the Midwestern and South‐central regions of the U.S. to examine the effect of crop‐contract attributes on the joint discrete‐continuous choice decisions to adopt an energy crop and convert acres to it from a status quo use, while controlling for the effect of various farmers’ risk and time preferences, sociodemographic characteristics, and availability of crop insurance for conventional crops. We find robust evidence that high discount rates, high upfront establishment costs and need for crop‐specific investments create disincentives for adoption and allocation of land to energy crop production. The effects of riskiness of returns and risk aversion are less robust across specifications. The effect of conventional crop insurance on the energy crop adoption decision differs across types of insurance; in particular, farmers with revenue insurance are statistically significantly less likely to adopt an energy crop. Our results have implications for the design of effective contracts and policy incentives to induce the production of energy crops.     

Producer Experience, Learning by Doing, and Yield Performance

Current crop insurance rating procedures consider only performance for the individual crop in question. Recent farm legislation has given producers considerable planting flexibility and, as a result, many have shifted to new crops. Producers without a production history for the new crop may be offered levels of insurance that do not accurately reflect their expected yields. Likewise, premium rates may not reflect a producer's actual risk for a new crop. We examine the extent to which information about expected yields may be gleaned from a consideration of historical performance on other crops. We also consider the extent to which yield performance exhibits learning by doing such that yields improve with experience. Though the results are mixed, we generally find that yield performance tends to improve with experience. However, when yields are conditioned on historical yield performance for other crops, the importance of experience is diminished significantly. Yield performance is related to a number of farm characteristics. Finally, we examine the extent to which yield variability is correlated across crops for individual farmers. Implications for crop insurance rating practices are discussed. The results demonstrate robust correlation between a farm's historical yield on other crops and a newly produced crop—a factor largely ignored in current crop insurance contracts.     

Effects of subsidized crop insurance on crop choices

This study focuses on how subsidized crop insurance affects crop choices. Crop insurance may change farm investments by reducing risks and providing subsidies. First, actuarially fair insurance reduces risks in crop production and marketing, holding the expected return constant. Second, insurance subsidies encourage farms to purchase crop insurance, which increases the expected return to insured risky crops. Farms also have many self‐insurance mechanisms such as crop diversification or working off the farm. We derive conditions under which (1) unsubsidized and actuarially fair crop insurance or (2) insurance premium subsidies lead to more investment in a risky higher return crop. We then examine the role of self‐insurance for these conditions. The impact of premium subsidies is decomposed into a direct profit effect and an indirect coverage effect. These effects are explained by substitutions between market insurance and self‐insurance and between a risky crop and a safe crop. We discuss each effect as a combination of subsidy and risk effects. Numerical illustrations show that an insurance subsidy has a larger impact on risky crop investments compared to that of an input subsidy when farms are more risk‐averse and have high costs of self‐insurance. The framework provides a novel way to evaluate subsidized crop insurance programs.     

Did the Federal Crop Insurance Reform Act Alter Farm Enterprise Diversification?

We estimate how much United States farms changed enterprise diversification in response to a marked increase in crop insurance coverage brought about by the 1994 Federal Crop Insurance Reform Act, which substantially increased insurance subsidies. The analysis exploits farm‐level panel census data to compare farm‐specific changes in enterprise diversification over time. By examining diversification decisions of the same farms over time, we control for time‐invariant unobserved individual heterogeneity. We then use pooled cross‐sectional data from the United States Department of Agriculture (USDA) Agricultural Resource Management Survey to estimate the relationship between farm diversification and average returns. We find that the insurance subsidies caused a modest increase in enterprise specialisation and production efficiency. Estimated efficiency gains are far less than the subsidies.     

Farmer Participation,Entry and Exit Decisions in the Italian Crop Insurance Programme

The factors affecting the demand for agricultural insurance in the USA have been extensively studied over the last two decades. However, the determinants of a farm's entry and exit decisions in the insurance market have received relatively little attention. Turnover in the insurance book of business is an important issue in most private and public crop insurance plans. Moreover, insurance markets in the EU are still largely under‐investigated. We investigate empirically the determinants of crop insurance participation in Italy. We show that the participation rate is high for large firms and that it is negatively correlated with crop diversification, which is itself a form of insurance. High premiums tend to inhibit both entry and exit from the insurance market. Larger and wealthier farms are more likely to adopt insurance and renew coverage over time. We discuss implications of our results for public intervention and the private industry. In particular, we demonstrate that the decision to drop coverage by an insured grower may differ significantly from the corresponding decision to enroll in an insurance programme by an uninsured farmer. To the extent that policymakers want to encourage participation in subsidized crop insurance programmes, education and outreach efforts toward uninsured farmers may differ substantially from those directed toward keeping insured farmers enrolled in the programme. We investigate these differences.     

Area Yield Index Insurance or Farm Yield Crop Insurance? Chinese Perspectives on Farmers' Welfare and Government Subsidy Effectiveness

We evaluate the performance of area yield crop insurance (AYCI) and farm yield crop insurance (FYCI) using farm-level yield data from China, focusing on their effects on farmers' welfare, and their cost-effectiveness in terms of government subsidy. Given a subsidy rate sufficient to generate a politically acceptable participation level, the price advantage of AYCI may no longer offset its higher basis risk, and consequently FYCI may be preferred by farmers. From the government's perspective, AYCI is the cheapest option to maintain reasonable farmer participation in insurance, but is not necessarily the most cost-effective choice. Our findings suggest that, contrary to an assumption that informs many developing country agricultural insurance programmes, AYCI schemes are not necessarily preferred to FYCI. Decisions on the structure of a national agricultural insurance programme should be based on careful consideration of local conditions.     

The impacts of multiperil crop insurance on Indonesian rice farmers and production

This article analyzes the effect of multiperil crop insurance policy for risk‐averse Indonesian rice farmers located in Tuban and Gresik Regencies of the East Java Province. Based on the model, comparative static analysis of a change in policy variables (coverage levels and premium subsidies) on input use through the coupling, wealth, and insurance effects are presented. The comparative static results are largely ambiguous and left as empirical questions. Consequently, the model is numerically simulated to quantify the effects of different coverage levels and subsidy rates on input use, expected net insurance payments, and certainty equivalents. The empirical analysis shows that MPCI crop insurance results in a decline in expected yield for coverage levels above about 82.5% for both regencies. Furthermore, higher subsidy rates amplify the reduction in input use and yield. Therefore, incomplete coverage with relatively low premium subsidies is the best policy to minimize the impact on input use and yield. However, from the farmers’ perspective, the optimal policy combination results from the highest coverage level and subsidy, which offer the largest expected net insurance payments and certainty equivalent.     

Actuarial Fairness of Crop Insurance Rates with Constant Rate Relativities

Increased availability and demand for low-deductible crop insurance policies have increased focus on crop insurance rating methods. Actuarial fairness cannot be achieved if constant multiplicative factors are used to determine how premiums change as coverage levels increase. A comparison of premium rates generated by the factors used by the two most popular crop insurance products with those generated by a standard yield distribution shows that the popular insurance products overcharge for low-deductible policies in most counties. This overpricing may explain why large premium subsidies were required to induce farmers to move from low-deductible to high-deductible policies beginning in 2001.     

Input use under cost-of-production crop insurance: Theory and evidence

There have been a number of previous studies that examined the effects of yield- or revenue-based crop insurance products on input use of farmers. However, no study has specifically investigated the input use impacts of a cost-of-production (COP) crop insurance policy, even though this type of crop insurance is the predominant one used in several other countries outside of the United States (such as the Philippines and China). This article aims to theoretically and empirically examine the effect of a COP crop insurance product on farmers’ chemical input use. Our theoretical model suggests that the effect of COP insurance on input use can either be positive or negative, with the resulting impact depending on the strengths of (a) the traditional moral hazard effect of insurance (i.e., an input use decreasing effect); versus (b) the marginal incentives to apply more inputs due to input levels being the main determinant for expected indemnity amounts in this type of insurance (i.e., an input use increasing effect). A survey data set from corn farmers in the Philippines is then used to empirically illustrate how a particular COP insurance product influences input use in a real-life context. In this case, we find that COP insurance increases the use of chemical inputs (e.g., fertilizers and total chemical expenditure), implying that the positive marginal incentive to apply more inputs dominates the negative moral hazard effect.     

Interaction between crop insurance and technology adoption decisions: The case of wheat farmers in Chile

This paper examines relationships between crop insurance and input technology decisions among Chilean wheat farmers. Using nationwide farm‐level data, a bivariate probit model is estimated. We investigate the extent to which the adoption of production input technologies is associated with farmers’ participation in the insurance program. We find that relationships between insurance and technology decisions are significant only for family farmers. In particular, there is a negative relationship between participation in the insurance program and the adoption of modern irrigation. Interpretations based on the role of input technologies on insurance adoption and adverse selection behaviours are discussed.     

Moral hazard and subsidized crop insurance

Along with adverse selection, moral hazard is one of the major hurdles that private and public insurance plans must contend with. Moral hazard occurs if risks are endogenous to a producer's behavior and if the insurer is unable to properly monitor the insured. We review the role of moral hazard in the US crop insurance program. We conduct an empirical analysis of one important aspect of the US crop insurance program—prevented planting. This provision provides indemnity payments if conditions are not suitable for planting. The program has been the subject of considerable controversy, especially during 2019, when the rate of claims is expected to be especially high. Because loss adjustors may encounter difficulties in assessing the weather conditions associated with prevented planting claims, the program is susceptible to moral hazard. We consider the extent to which prevented planting claims may be endogenous to prices. We find significant evidence of moral hazard. The likelihood of prevented planting claims increases as the expected market price decreases or as fertilizer costs increase for corn and soybeans in the Prairie Pothole Region and for grain sorghum and cotton in all states.     

我国森林保险的市场失灵与政策建议——基于福建省森林保险工作的研究

森林保险是我国农业保险体系中的重要组成部分,具备降低受灾损失和为林业改革提供保险保障两方面的作用。由于存在市场失灵,为了更加广泛地对营林户提供保险保障,需要国家对经营森林保险业务的商业保险公司提供政策支持。通过对福建省森林保险工作的研究,总结了所观察到的市场失灵现实表现并提出了相应的政策对策。     

How crop insurance influences agrochemical input use: Evidence from cotton farmers in China

Crop insurance is critical in risk management in global agricultural production (e.g. by helping stabilise farmers' incomes in the long term and reducing risk-bearing costs). In this paper, using field survey data on cotton farmers in Xinjiang, China, we examine the influence of crop insurance on farmers' behaviours regarding agrochemical inputs and aim to investigate the synergy between crop insurance and reductions in fertiliser and pesticide usage. We find evidence that crop insurance significantly negatively affects farmers' use of fertilisers and pesticides, as well as significantly positively affects their adoption of green agricultural technologies (GAT) that can replace or complement traditional fertilisers and pesticides. Moreover, our results reveal that compared with small-scale farmers, crop insurance has a stronger effect on large-scale farmers' use of agrochemicals. Finally, when the insured amount is higher or the relative deductible is lower, farmers are more likely to reduce fertiliser and pesticide usage and adopt GAT. Overall, this paper scientifically identifies crop insurance can improve farmers' agrochemical input behaviour, by reducing farmers' use of traditional agrochemical inputs and increasing their adoption of GAT, which is of great significance for ensuring the safety of the agricultural ecological environment.     

A Comparative Evaluation of Yield Risk Reductions with Alternative Crop Insurance Programs in Manitoba

Three crop insurance programs are evaluated in terms of their effectiveness of yield risk reductions for 371 Manitoba farms. The examination is first conducted with a proposed index method, with which the relative yield risk reduction magnitude is calculated and compared for each farm under each alternative program. The generalized stochastic dominance (GSD) methodology is also used to provide an alternative analytical framework in analyzing producers’relative preferences among those alternatives by comparing the net yield distributions generated by each program for each farm. The results suggest that, given an actuarially sound basis, the filly individualized crop insurance (FI) program is the most favorable choice for risk-averse producers. The area coverage and individual indemnity program (IA) is generally the second best option. The full area crop insurance program (FA) is least preferred by risk-averse farmers.     

Coping with systemic risk in index‐based crop insurance

The implementation of index‐based crop insurance is often impeded by the existence of systemic risk of insured losses. We assess the effectiveness of two strategies for coping with systemic risk: regional diversification and securitization with catastrophe (CAT) bonds. The analysis is conducted in an equilibrium pricing framework which allows the optimal price of the insurance and the number of traded contracts to be determined. We also explore the role of basis risk and risk aversion of market agents. The model is applied to a hypothetical area yield insurance for rice producers in northeast China. If yields in two regions are positively correlated, we find that enlarging the insured area leads to higher insurance premiums. Unless capital market investors are very risk averse, a CAT bond written on an area yield index outperforms regional diversification in terms of certainty equivalents of both farmers and insurers.     

Asymmetric Information,Externalities and Incentives in Animal Disease Prevention and Control

Incentives influence behaviour while an understanding of farmer behaviour facilitates the control and prevention of infectious livestock disease. This paper lays out several perspectives on how information problems and other externalities affect biosecurity incentives. We use the principal–agent framework to examine livestock disease management in the presence of potential moral hazard and adverse selection. Moral hazard may apply to biosecurity decisions while adverse selection may apply to disease reporting. The example of compensation policies illustrates the importance of creating appropriate incentives: compensation must be sufficient to ensure early reporting but not so large as to discourage appropriate levels of biosecurity effort. Other cases of externalities are more diffuse than those modelled using principal–agent analysis, placing emphasis on third‐party effects and coordination problems. Three examples are provided. One concerns free‐riding when facing an endemic disease pool that can be managed by limiting sources and flows. Another regards coordination failure when securing against an exotic disease where farmer efforts complement and communicating actions are important. The last arises from absence of a risk market where an adverse infrastructural support externality could be managed by disease outbreak insurance.