Moral Hazard in Agricultural Yield Insurance

Boyingzi Luo

doi:10.14738/abr.81.7753

Abstract

In agricultural yield insurance practices, there are two main categories of insurance products which differed from the targeted insured yield, namely area-yield based insurance and individual-based insurance. A common knowledge is that individual-yield based insurance has more flexibility that could meet the real demand of insureds, while having much more severity of moral hazard and higher administration costs. Relatively, area-yield based insurance has lower risk of moral hazard, but obtaining bias, or so-called basis risk at the same time. In this paper, we use an improved modified Miranda Decomposition Model to establish a theoretical framework of farmers behaviors when assuming their goals are to maximize the expected rate of return in agricultural production process under both individual-yield and area-yield insurance. The results show that these two distinct arrangements may cause different motivation to farmers, seducing them act or not act in moral hazard manner.

Highlights

In many literature([1], [2], [3]), moral hazard is regarded as a very severe problem is agricultural insurance practices
Moral hazard refers to the act and its consequence that occurred when passive actions are taken under high risk situations that could cause unfavorable outcomes, i.e., farmers get loss in their crop yield due to low precipitation
One thing should be figured out first, that is, how farmers would behave under different arrangements of insurable “yield”

Summary

INTRODUCTION

In many literature([1], [2], [3]), moral hazard is regarded as a very severe problem is agricultural insurance practices. STATIC MODELS OF MIXED COVERAGE CROP YIELD INSURANCE BASED ON THE MIRANDA DECOMPOSITION. Theoretical framework we build a mathematical framework depicting the mixed coverage crop insurance based on the Miranda Decomposition. Miranda (1991) proposed a famous yield decomposition that It decomposes the individual yield deviation NK − [K into product of a partly correlated systemic component NU − [ and a perfectly correlated non-systemic component. With the help of the Miranda Decomposition, the indemnity of a simple stop loss form crop yield insurance distinctively covering both systemic yield risk and non-systemic yield risk could be expressed as 3 sKtK/ = OU + OK = (qU − NU)( + (qK − ]K)( , where qU and qK are predetermined indemnity thresholds for systemic and non-systemic yield risk coverage.

NU and

If qU

In the case

ΔiK jvi

So that