US farmers’ insurance choices under budget heuristics

Abstract

Purpose Regional differences in crop insurance uptake have persisted over time. To partly explain this phenomenon, the purpose of this paper is to propose and evaluate a budget constraint (heuristic) effect within the standard expected utility theory (EUT) framework through simulation methods. Design/methodology/approach Within the EUT framework, a standard simulation model is used to gain insights into farm insurance decisions when a budget constraint is in effect. The budget constraint is modeled as it has been revealed through the data on farmers’ insurance expenditures. In the simulation analysis, certainty equivalent values are used to rank farm options subject to the revealed budget constraint. Findings A budget constraint effect within the EUT framework stands out in explaining the observed regional differences. The proposed explanation is consistent with the historical trends on the ratio of crop insurance expenditure to expected crop value, higher premium rates in regions with lower crop insurance uptake, and the limited turnout for the 2014 Farm Bill’s supplemental area-based crop insurance products. Farmers’ crop insurance choices are found to be mostly constrained-optimal. Originality/value This appears to be the first study taking the revealed preferences approach to farmers’ crop insurance choices in a simulation analysis. Some policy implications are drawn and future research avenues are suggested. The findings should be of considerable value to policymakers, academics, bankers, and producers in regard to the design and use of risk management tools.

Depressed demand for crop insurance contracts, and a rationale based on third generation Prospect Theory

“…Standard conceptual economic analysis, invoking expected utility or related theories, holds that risk averters who face financial risks and have actuarially fair risk management contracts available to them will seek to fully offset their risk exposure. However, evidence from the United States and elsewhere is strong that growers do not seek to do so (Bulut, 2018;Che, Feng, & Hennessy, 2019;Du, Feng, & Hennessy, 2017;Huo, Colson, Ramirez, & Liu, 2018;Tadesse, Alfnes, Erenstein, & Holden, 2016). Crop insurance is not unique as an instance of user suboptimization, see, for example, Choi, Laibson, and Madrian (2011).…”

The impact of enterprise unit policy change on the quantity demanded for crop insurance

“…Part 2. In line with Bulut (2018), we make the behavioral assumption that farmers tend to allocate a certain amount of money to spend on crop insurance; and-subject to that given budget-they have the objective of obtaining some overall coverage. From this behavioral assumption, as a response to the policy change on enterprise unit subsidies, we expect the following to hold: (1) an increase in the share of enterprise units within buyup acres because of lower premium rates and higher subsidy rates, provided that such aggregated coverage can be mitigated somewhat; (2) an increase in crop hail coverage uptake to make up for the reduced spot coverage that enterprise units require; (3) a shift out of catastrophic coverage to buyup coverage; and (4) an increase in the share of acres in high coverage levels (75 percent and above).…”

“…For instance, while there were no legislative attempts for a disaster aid during the 2012 drought, which took place in the Midwest (high coverage region), the 2017 hurricanes in Florida and the Carolinas (part of a low coverage region) triggered significant amounts in disaster aid. In analyzing the regional differences in crop insurance uptake, Bulut (2018) raises the hypothesis that a budget threshold may apply to farmers' crop insurance choices. Coble (2017) provides an overview of the RMA participation data from 2009 to 2016 by looking at the farmers' choices for six major row crops and points out that enterprise units have been more popular with corn and soybeans than with wheat.…”

Design principles for agricultural risk management policies

“…As an alternative to an individual-based indemnity programme, Belasco, Cooper and Smith (2020 [46]) examine a weather-based disaster programme where all producers of a crop within a county would be indemnified whenever estimated county yield for that crop fell below a guarantee. The county yield would be estimated using weather data which would allow for timely determinations of indemnities.…”