Agricultural economists study how moral hazard affects crop insurance
New research by agricultural economists at the University of Nebraska–Lincoln challenges traditional thinking on federal crop insurance.
Since the inception of the federal crop insurance program, researchers have questioned whether the program causes moral hazard in input usage, meaning that if producers are shielded from yield risk via crop insurance, they respond by increasing low-yield risk exposure by applying fewer inputs. Opponents of the federal crop insurance program claim moral hazard leads farmers to use crop insurance to transfer costs from themselves to taxpayers, who help fund the program.
Previous research found evidence of moral hazard in input usage, suggesting crop insurance gives producers an incentive to reduce the economic-maximizing input amount, particularly nitrogen, to reduce yields and receive crop insurance payments.
Unlike previous research, the new project includes Actual Production History when examining producer input use behavior related to crop insurance. The addition of APH is important as it is used to calculate liability when producers file crop insurance claims and directly influences indemnity payments. For example, when APH decreases, the size of indemnity amounts decreases as does the likelihood of a payment.
When the role of APH is considered, the amount of moral hazard declines to miniscule amounts. When producers are thinking ahead to future growing seasons, their current year input use is not heavily influenced by the presence of crop insurance.
“Our research is based on the assumption that farmers want to farm next year with a strong crop insurance policy,” said Cory Walters, assistant professor of agricultural economics and study co-author. “Results from the study indicate that the presence of APH in the liability calculation can do a lot in limiting the amount of moral hazard in input usage in crop insurance.”
Walters is active in his family’s farming operation. His experience with production agriculture inspired the new research.
“It did not make sense to me that crop insurance research would not take into account the role of APH and the fact that farmers are forward-thinking,” he said.
Other study co-authors are Lilyan Fulginiti, professor of agricultural economics, and Taro Mieno, assistant professor of agricultural economics.
The results were recently published in the American Journal of Agricultural Economics.