Optimal design of agricultural insurance subsidies under the risk of extreme weather

Abstract

Extreme weather events can pose a significant threat to the agricultural economy, and agricultural insurance serves as an effective tool to mitigate the risk. Motivated by the Chinese government agricultural policies, this study develops two theoretical models to analyze the full-cost insurance and the income insurance, and how should governments design insurance subsidies. Our results show that the government's optimal insurance subsidies under different insurance formats are closely related to the yield uncertainty and the production efficiency under the risk of extreme weather. When the production efficiency of the farmers is low, regardless of the subsidy level, the sufficient supply of the agricultural products can be guaranteed under full-cost insurance. However, when production efficiency is high, a lower subsidy level should be set under full-cost insurance, while a higher subsidy level is required under income insurance. Moreover, we find the optimal levels of the government insurance subsidies under different insurance formats may not always align with the interests of farmers. In the extension, we show that the government can maximize social welfare by ensuring the stable supply of agricultural products.