Estimating The Maximum Value of Crop Hail Insurance Under Stochastic Yield and Price Risk

Abstract

ABSTRACTThe objective of this article is to estimate the maximum value of crop hail insurance according to the financial extent of hail risk's impact on the enterprise in two regions, North West (low hail risk area) and Mpumalanga (high hail risk area). The difference in the cumulative probability distributions of the Net Present Value (NPV) of the margin after interest and tax in the event of hail and in the event of no hail will provide a graphic indication of the financial impact of hail. To determine if the decision maker is willing to pay in order to remove the impact of hail on the enterprise, the utility weighted risk premium (UWRP) must be calculated with the use of stochastic efficiency with respect to a function (SERF) analysis. The calculated maximum benefit (or UWRP) that the decision maker will receive through the elimination of hail will set the upper limit for the cost of crop hail insurance. The results indicate that hail does have a negative impact on the financial position of the farms in North West and Mpumalanga. The effect of hail risk in Mpumalanga is, however, more severe. The calculated maximum benefit (UWRP) from the elimination of hail damage in two regions is R83.50/hectare in North West and R708.70/hectare in Mpumalanga. The conclusion can thus be made that decision makers in both regions will be willing to pay for crop hail insurance, but much more so in Mpumalanga than in North West.