U.S. taxpayers fare better when the government discounts farmers’ crop insurance premiums rather than relying on unbudgeted disaster aid packages. That’s according to a recent peer-reviewed study that used a novel mathematical model to study an issue that has been difficult to analyze empirically.
The study, published in the Journal of Agricultural and Resource Economics (JARE), was recognized as the publication’s Outstanding Article of the Year for 2017. It was authored by Dr. Harun Bulut, who holds a Ph.D. in economics from Iowa State University and currently serves as a senior economist with National Crop Insurance Services (NCIS).
Bulut’s work specifically focuses on the choice in government policy between crop insurance and ad hoc disaster relief as a way of addressing catastrophic risk in agriculture. This is a choice lawmakers currently face as they debate the 2018 Farm Bill.
Federal crop insurance has become a pillar of U.S. farm policy in recent years and is being considered by policymakers around the world. As it stands, farmers collectively spend $3.5 to $4 billion from their own pockets to purchase insurance protection a year.
Even though it has become the top choice for farmers in mitigating risks, some critics still pan the public’s cost in reducing insurance premiums and are targeting the policy for cuts.
Since crop insurance’s rise, annual disaster bills, which are fully funded by taxpayers and used to be the norm, have been largely reduced. That’s been welcomed news for farmers since the disaster bills of the past were often politically motivated and were slow to deliver relief.
Prior research in this arena offered a variety of reasons for government support of crop insurance. But the research did not take into account the underlying tradeoff between insurance use and ad hoc disaster aid in what economists refer to as an equilibrium model. In particular, econometric evaluations of farmers’ demand response when premium rates rise and fall have been of limited value, as explained in the article.
With a unique approach using mathematical game theory, Bulut was able to demonstrate that policy proposals calling for reductions in premium support may be underestimating the resulting demand response for crop insurance and the increased pressure for disaster aid packages.
Bulut’s work offers a reason for underinsurance in the absence of premium support in that “both disaster aid expectations and overconfidence drive a wedge between the actuarially estimated price and the price that is ‘fair’ from the farmers’ point of view.”
In the mathematical model, the cost arising from insurance premium support is found to be much less than would-be cost from ad hoc disaster aid in the absence of a viable crop insurance option. The findings also imply that disaster aid can be used at a much lower level in the future but may not be eliminated.
Bulut’s work suggests that it will be important for lawmakers to recognize the reduced insurance participation and increased likelihood for ad hoc assistance associated with the proposals being championed by farm policy critics during the ongoing Farm Bill debate.