Crop Insurance Rates and the Laws of Probability
Bruce A. Babcock, Chad E. Hart, Dermot J. Hayes
April 2002 [02-WP 298]
Babcock, B.A., C.E. Hart, and D.J. Hayes. 2002. "Crop Insurance Rates and the Laws of Probability." Working paper 02-WP 298. Center for Agricultural and Rural Development, Iowa State University.
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. In this paper, we examine the consistency of these constant rate relativity factors with the laws of probability by determining the maximum 65 percent premium rate that is consistent with a well-defined yield distribution. We find that more than 50 percent of U.S. counties have premium rates for corn, soybeans, and wheat that are not consistent with the laws of probability for coverage levels up to 75 percent. For coverage levels up to 85 percent, almost 80 percent of corn counties, 82 percent of soybean counties, and 80 percent of wheat counties have rates that are not consistent. Adding the further restriction that at least 15 percent of probability falls between 85 percent and 100 percent of APH yields implies that 92 percent of corn counties, 90 percent of soybean counties, and 95 percent of wheat counties have APH rates that are not consistent with the laws of probability for coverage levels up to 85 percent. These results imply that crop insurance rates under the APH program in most U.S. production regions at high coverage levels exceed those that could be generated by a well-defined yield distribution.
Keywords: crop insurance, premium rates, rate relativities.