Compulsory Insurance and Allocative Efficiency in Agriculture

Abstract

This note addresses the question of how the compulsory use of crop insurance by farmers who participate in agricultural credit programs will affect allocative behavior. We will restrict our analysis to the case where insurance is provided without administrative or safety loadings, i.e. where the insurance is actuarially fair. Some economists, particularly Roumasset ( 1978), have concluded that compulsory crop insurance will result in misallocation of resources. Specifically, it is hypothesized that resources will be misallocated because . . . a risk-neutral individual who is forced to buy insurance will subsequently make decisions as if he is risk preferring. (Roumasset 1978) While there may be some validity to that position in the case of risk seeking individuals with some crop insurance programs, it is not generalizable to all situations. In particular, it is our position that the hypothesis is not valid for crop credit insurance where credit is granted by a publicly-owned insurance program. We will show here that properly designed public programs of crop credit insurance do not lead to a misallocation of resources. We do not deny that the effective design of public insurance credit programs may present difficulties, but rather that the criticism of allocative inefficiency is unfounded in the case of crop credit insurance.