The Tangled Web of Agricultural Insurance: Evaluating the Impacts of Government Policy

Abstract

This paper examines the effects of changes in major elements of the U.S. federal crop insurance program on the structure of the agricultural insurance industry. We model the interactions between farmers, insurance agents and insurance companies. Two symmetric equilibria are determined: one with competitive insurance companies and one where insurance companies form a collusive monopsony. We evaluate how marginal changes in government policy (changes in the premium subsidy rate, A&O subsidy rate, and loading factor) affect the insurance premium rate, agent compensation rates, agent effort levels, and market demand for crop insurance. Conditional on no prior government policy, farmers prefer a marginal increase in the premium subsidy rate. This change has the lowest associated net social cost, but is the policy least preferred by insurance companies. The insurance companies’ most preferred policy is a marginal increase in the A&O subsidy rate, which has the highest associated net social cost, the highest cost to the government, and does not benefit farmers. We also evaluate the consequences of changes in crop prices. If the market for insurance agent services is competitive, then a change in crop prices does not change agent compensation rates, but otherwise the agent compensation rate will change. This result suggests an empirical test regarding insurance company market performance.