A Spatial Econometric Analysis of Loss Experience in the U.S. Crop Insurance Program

Abstract

Patterns in loss-ratio experience in the U.S. corn insurance market are investigated with a spatial econometric model. The results demonstrate systematic geographically related misratings and provide estimates of the impacts of several observable factors on the magnitude of misrating in the program. The model is used to estimate actuarial cross-subsidizations across the primary corn-producing states and counties. The impacts of the primary factors are substantial, resulting in net premium transfers of approximately 26 percent of total premiums annually. The misratings likely have important insurance demand, welfare, and land-use implications.Insurance markets are typically best suited for risks that are uncorrelated, occur with high frequency, and have a large number of like participants-among a handful of other standard conditions. Systemic risks (such as in crop production) induce correlation in losses, violating the standard insurability conditions and potentially leading to market failures (Glauber, 2004). Complementary causes of market failures in such systemic risk markets may include capital market imperfections, inadequate reinsurance capacities, capital and information shocks due to unexpected events, fattailed distributions that prevent diversification, and agency problems (see, e.g.,

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