Effects of subsidized crop insurance on crop choices

Likely climate change impacts include damages to agricultural production resulting from increased exposure to extreme heat. Considerable uncertainty remains regarding impacts on crop insurance programs. We utilize a panel of U.S. corn yield data to predict the effect of warming temperatures on the mean and variance of yields, as well as crop insurance premium rates and producer subsidies. While we focus on corn, we demonstrate that the subsidy impacts are likely to carry over to other major program crops. We find that warming decreases mean yields and increases yield risk on average, which results in higher premium rates. Under a 1°C warming scenario, we find that premium rates at the 90% coverage level will increase by 39% on average; however, there is considerable statistical uncertainty around this average as the 95% confidence interval spans from 22% to 61%. We also find evidence of extensive cross-sectional differences as the county-level rate impacts range from a 10% reduction to a 63% increase. Results indicate that exposure to extreme heat and changes in the coefficient of variation are large drivers of the impacts. Under the 1°C warming scenario, we find that annual subsidy payments for the crop insurance program could increase by as much as $1.5 billion, representing a 22% increase relative to current levels. This estimate increases to 3.7 billion (57%) under a 2°C warming scenario. Our results correspond to a very specific counterfactual: the marginal effect of warming temperatures under current technology, production, and crop insurance enrollments. These impacts are shown to be smaller than the forecasted impacts under a commonly used end-of-century general circulation model for even the most optimistic CO 2 emissions projection.JEL classifications: Q1, Q18, Q54

Section: Introductionmentioning

confidence: 99%

Warming temperatures will likely induce higher premium rates and government outlays for the U.S. crop insurance program

Tack

Coble

Barnett

2018

“…Because showing the level of subsidies offered in the form of crop insurance directly encourages insurance purchases, which usually leads to increased asset allocation in production. According to Yu and Sumner (2018), regardless of the level of self‐insurance or the degree of the risk aversion, farmers would increase risky crop investments when crop insurance subsidies increase. Therefore, considering the objective risk differences between specialty and commodity crop production, policy evaluators should make practical use of the framing effect along with subsidy to carry out effective crop insurance programs and alternative farm policies targeting specialty crops.…”

Section: Discussionmentioning

confidence: 99%

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

Zhao

Yue

2020

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.

“…Area‐wide index insurance has been proposed as an instrument to manage moral hazard (see Chambers & Quiggin, 2002; Miranda, ). Yu and Sumner () found that subsidized crop insurance has a significant impact on crop choices. This occurs through a shift toward riskier crops.…”

Section: Moral Hazard and Prevented Plantingmentioning

confidence: 99%

Moral hazard and subsidized crop insurance

Wu¹,

Goodwin

Coble

2019

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.