IMPACT OF FEDERAL CROP INSURANCE ON OUTPUT MIX AND WELFARE.

Abstract

The Federal Crop Insurance program is a management tool which is available to U.S. farmers and which is designed to protect them against low yields arising from natural disasters. Since the program is optional in nature, its provisions cannot be detrimental to a rationally behaving farmer. This work analyzes but goes beyond the private benefits of the Federal Crop Insurance program to farmers and represents a qualitative and quantitative attempt at investigating the implications of the availability of the program on risk-taking behavior and social welfare. Analytically, a simple model of the allocation of land among two crops (one safe and the other risky in the yield) is used along with the behavioral hypothesis of expected utility maximization. It is indicated that a subsidized program will, in general, induce greater risk-taking behavior. The impact of the program on crop-mix is, however, ambiguous when the expected insurance indemnities fall short of the premium paid. Given insurance availability, however, it is demonstrated that, under some reasonable assumptions about farmers' risk preferences, a premium subsidy will tend to induce greater risk taking. A major portion of the empirical work, which is undertaken within an expected value of income-variance of income framework, relates to the estimation of farmers' risk preferences on the basis of actual crop-mix data for individual farms in Arizona and estimated subjective distributions about prices, yields and costs of production. The estimation of the subjective distribution of prices is based on futures as well as cash prices. Given the risk aversion coefficient estimates for a sample of thirteen farmers, predicted crop-mixes are then obtained under the cases of insurance availability and no insurance. Results of the empirical study suggest that the Federal Crop Insurance program (in its pre-1980 version at least) does not have a significant impact on crop-mix. Finally, using the Arrow-Lind criterion of welfare assessment under uncertainty, the study casts doubt on the social desirability of the Federal Crop Insurance program.