Input Demand under Yield and Revenue Insurance

Abstract

The question of how insurance programs affect agricultural input use is commanding increasing attention. Previous studies disagree on the likely effects of insurance on fertilizer application rates. Whether insurance is a complement or a substitute for fertilizer depends, in part, on whether the probability of low yields is positively or negatively affected by increased fertilizer rates. This study uses field-level data measuring the response of corn yields to nitrogen fertilizer to determine if the technical relationship between yield and nitrogen fertilizer supports the hypothesis that crop insurance or revenue insurance could induce increased application rates. Our results indicate no support for this hypothesis. At all nitrogen fertilizer rates and reasonable levels of risk aversion, nitrogen fertilizer and insurance are substitutes, suggesting that those who purchase insurance are likely to decrease nitrogen fertilizer applications. Disciplines Agricultural and Resource Economics | Agricultural Economics | Economics | Insurance ABSTRACTThe question of how insurance programs affect agricultural input use is commanding increasing attention. Previous studies disagree on the likely effects of insurance on fertilizer application rates. Whether insurance is a complement or a substitute for fertilizer depends, in part, on whether the probability of low yields is positively or negatively affected by increased fertilizer rates. This study uses field-level data measuring the response of com yields to nitrogen fertilizer to determine if the technical relationship between yield and nitrogen fertilizer supports the hypothesis that crop insurance or revenue insurance could induce increased application rates. Our results indicate no support for this hypothesis. At all nitrogen fertilizer rates and reasonable levels of risk aversion, nitrogen fertilizer and insurance are substitutes, suggesting that those who purchase insurance are likely to decrease nitrogen fertilizer applications. INPUT DEMAND UNDER YIELD AND REVENUE INSURANCEThe effect of agricultural insurance on optimal per acre input levels is in dispute. The issue of how input decisions change under crop and revenue insurance schemes is attracting increased attention because of proposals to force farmers to rely more on insurance and less on direct government subsidies. For example, a group oflowa farmers and farm organizations has proposed the elimination of current commodity programs in favor of a plan that insures gross revenue. If optimal chemical use increases under insurance, as suggested by Horowitz and Lichtenberg, then it is likely that a move away from direct government payments and towards increased reliance on insurance will result in greater environmental pollution from agriculture. However, if optimal chemical use declines significantly under insurance, as concluded by Smith and Goodwin and Quiggins, Karagiannis, and Stanton, then the environment may benefit, but moral hazard issues will make the pricing of insurance difficult. 2The Horowitz ...

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