Q1.

Challenges for Crop Insurance:

1. Crop insurance demand and participation: To reduce the administration cost and

making the insurance more affordable it is required high farmers participation. An

insurance may fail due to high administration cost. A higher participation rate reduces the

variance of losses as well the reserve needs of insurer.

2. Small farm size and high administration cost: in case of large farm size, administration

cost (For example in Canada 10-15% of premiums) is much efficient for crop insurance.

But often in small size farm administration cost is higher (ie 50% of premiums). The

inadequately defined policy of insurance may lead to costly disputes over crop losses

between the farmer and insurer. Administration cost may increase the due low participation

rate of farmers in crop insurance purchase.

3. Moral hazard and adverse selection: According to chambers, moral hazard problem

occur when a farmer starts to take less care of their crop after the insurance purchase. If a

farmer refuses to use the chemical as a prevention of pests and diseases. They might face

huge crop loss due to disease or pest in saving chemical cost and also save the harvesting

cost and claim the insurance for crop loss.

When some farmer purchase insurance for high-risk crop over the low-risk crop, the insurance

company may face adverse selection problem. The insurer may increase the premium rate to avoid

high crop risk and lead to an increase in the cost of insurance.

Q2. New forms of Agricultural Insurance: Index Insurance
a) Area yield index insurance: Miranda proposed it in 1981. In area yield index insurance

farmers are paid for the losses based on the yield area average index, not on farmer’s losses.

The main advantage of this insurance is farmers don’t have to claim for his crop loss. This

reduces the moral hazard, loss disputes and administration cost as well. It has a major

problem if farmer faces an individual loss, but the area average didn’t then the farmer won’t

receive the indemnity payment for his loss.

b) Weather index insurance: A large portion of crop loss farmer faces due to weather.

Weather index insurance is an alternative to crop insurance. It doesn’t require the

measurement of individual loss; thus, the farmer won’t face the moral hazard problem, and

it will have a low administration cost. It will not face the problem of the adverse selection

process as well. It is very useful for small size farm as it has a reduced administration cost.

Weather index insurance may face the problem of basis risk. Farmer will receive the

indemnity payment if the weather index moves against the farmer. But if farmer face an

adverse weather and a crop loss and weather index don't move then farmer won’t receive

any indemnity payment for his loss.