Thursday, May 23, 2013

Mud in the Crop Insurance Tires

Thanks to tinyprayers at flickr.
Last month, the Environmental Working Group, an advocacy group focused on minimizing government subsidies, released a report on crop insurance.  Bruce Babcock, an economist from Iowa State University, authored the report.  The report was big news, picked up in several places including NPR.

The EWG report focused attention on a type of policy that offers revenue protection, which it dubs the Cadillac Crop Insurance Policy.  The central argument is that payouts are greater then premiums demonstrating a public subsidy.  The report advocates that "farmers pay a larger share of the incremental cost" of the insurance coverage to reduce the subsidies.
EWG Report p.15
However, uncertainty about revenue is a speculative business risk.  These types of risk are uninsurable because they encourage willy-nilly risk taking in the marketplace to the potential sacrifice of public policy goals of wellbeing.

So, the coverage in question being offered by the Feds is not really insurance.  It may be called as much for whatever reason, but it's more akin to a financial mechanism like, perhaps, a put-option.  The EWG report alludes to this at the end of the report when it argues that the Cadillac coverage is a means to hedge bets in agricultural trades.
There is only one possible risk management benefit for farmers who buy RP. Farmers who forward sell their crop face the risk that they will not have enough yield to deliver on the contract. If the price of the contracted commodity rises, producers with a short crop will lose money because they must purchase more expensive grain to honor their contract. Farmers who forward contract the exact same proportion of their crop that they insure with RP will find that the additional payout under RP compensates them exactly for this hedging loss. Thus purchasing RP lowers the risk to farmers of forward selling their crop. 
Perhaps, it is the case that the program was intended as insurance but over the years, develoved into a political tool of some sort used to stabilize aspects of the economy.  This would be similar to Florida's Citizens.  I am not familiar enough with the history of US agricultural policy to say.  

My only point here is that attempting to solve a perceived problem with insurance, that is not in fact insurance, muddies the policy waters, masks the underlying debate (whatever that may be) and misleads expectations of policy outcomes.  It also facilitates movement into an endless battle over the right risk so as to charge the appropriate premium.  This skirts the debate about whether or not the public wants the agricultural market risk at all, why the financial mechanism is in place, who wins and who loses from removing or altering the program, and other possible solutions.

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