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Crop Insurance Rates and the Laws of Probability

Published by:
Publication date
Number of Pages
Type of Publication:
Focus Region:
North America
Focus Topic:
Climate / Weather / Environment
Market / Trade
Type of Risk:
Weather & Climate related
Type of Risk Managment Option:
Risk transfer
Bruce A. Babcock, Chad E. Hart, Dermot J. Hayes
Center for Agricultural and Rural Development (CARD)

Increased crop insurance subsidies have increased the demand for insurance at coverage levels higher than the traditional level of 65 percent. Premium rates for higher levels of yield insurance under the Federal Actual Production History (APH) program equal the premium rate at the 65 percent coverage level multiplied by a rate relativity factor that varies by coverage level but not by crop or region. The paper examines whether these constant rate relativities are consistent with the laws of probability in the sense that the implied rates are consistent with a well-defined probability distribution of yields. This topic is relevant because changes in the United States federal subsidy program now encourage producers to increase their coverage level and have increased available coverage to levels for which there is no historical loss/cost data. Even if one accepts that the 65 percent rates are as accurate as they can be, there is no guarantee that the rates at higher coverage levels are accurate unless these rate relativities are also accurate.