Conceptual issues in livestock insurance.

Abstract

IntroductionRecent epidemics of animal diseases, coupled with the events of September 11/2001 and other incidents of terrorism, have raised issues concerning the risks facing livestock producers and how those risks can be managed through insurance products. In the fall of 2001 the Risk Management Agency of the U.S. Department of Agriculture approved livestock gross margin (LGM) and livestock gross revenue (LGR) insurance policies for swine. In addition to revenue based insurance products there is also considerable interest in livestock insurance products against onfarm diseases and catastrophic losses from the market effects of particular pathogens such as foot and mouth disease 1 .A key policy question is the appropriate role of agricultural insurance in the U.S. (and elsewhere) to reduce losses from animal diseases and market prices. Is a joint policy possible, or should production and market related risks be insured separately? Should insurance policies cover catastrophic risks due to natural or bioterrorist outcomes and can catastrophic risks in the livestock market be reinsured?The purpose of this paper is to explore, first in a general way, and then more specifically, the attributes of insurance for livestock producers. First, a general model is used to illustrate the complexity of the risks at the farm level, and several possibilities for insuring all risks are discussed in a qualitative way. Second, a more specific class of net revenue insurance models are presented and empirically evaluated. These models assume certainty in production and feed use, but allows for variability in livestock and feed prices. Monte Carlo approaches to calculating the value of several conventional and path-dependent livestock net revenue insurance possibilities are illustrated assuming the existence of a futures market. Third, insuring catastrophic market risks arising from the introduction of a disease that would cause market livestock prices to evaporate is modeled as a jump process with a disease arriving at unknown times, but with known frequency. Calculation of a Poisson-induced indemnity as an insurance product could be 1 Several definitions of catastrophic risks have emerged. Schlesinger (1999) refers to catastrophic risks as extreme events found and rarely occurring in the extreme tails of a probability distribution. Likewise, Duncan and Myers (2000) define catastrophe as an infrequent event that has undesirable outcomes for a sizeable subset of the insured population. To be insurable, Kunreuther (2002) points out that the risks have to be identifiable in probability space, and if it occurs the extent of loss must be calculable.2 considered in addition to conventional livestock or revenue insurance, or the revenue insurance should be adjusted to include the probability of catastrophic market risk.A background on some major disease outbreaks is discussed in the next section. This is followed by three sections on the principles of 1) livestock insurance, 2) Net revenue insurance and 3) catastrophe insurance. The paper t...

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