Title

Rationality of Choices in Subsidized Crop Insurance Markets

Campus Units

Economics, Center for Agricultural and Rural Development

Document Type

Article

Publication Version

Submitted Manuscript

Publication Date

4-2017

Journal or Book Title

American Journal of Agricultural Economics

Volume

99

Issue

3

First Page or Article ID Number

732

Last Page

756

DOI

10.1093/ajae/aaw035

Abstract

The U.S. crop insurance market has several features that set it apart from other insurance markets. These include explicit government subsidies with an average premium subsidy rate of about 60% in recent years, and the legislative requirement that premium rates be set at actuarially fair levels, where the federal government sets rates and pays all costs related to insurance policy sales and services. Bearing these features in mind, we examine the extent to which farmers’ crop insurance choices conform to economic theory. A standard expected utility maximization framework is constructed to analyze trade-offs between higher risk protection and larger subsidy payments. We decompose the effect of coverage level on expected utility into insurance, premium loading, and subsidy transfer effects where the loading effect vanishes if rates are actuarially fair. Given an actuarially fair premium, we infer that a rational farmer should choose either the coverage level with the highest premium subsidy or a higher coverage level. Evidence from a large insurance unit-level dataset contradicts this theoretical inference, and so suggests anomalous insurance decisions. In a novel application of the mixed logit framework, we show that the probability an insurance product is chosen declines as out-of-pocket premium expenditures increase, even though higher values of these expenditures should reflect improved grower welfare. Premium expenditures appear to be more salient than the uncertain future benefits they support. We apply our regression to the recent trend yield adjustment innovation in crop insurance.

JEL Classification

D03, Q18

Comments

This is a working paper of an article published as Du, Xiaodong, Hongli Feng, and David A. Hennessy. "Rationality of choices in subsidized crop insurance markets." American Journal of Agricultural Economics 99, no. 3 (2017): 732-756. doi:10.1093/ajae/aaw035. Posted with permission.

Copyright Owner

Agricultural and Applied Economics Association

Language

en

File Format

application/pdf

Published Version

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