What is in this article?:
- Can insurance handle price and yield risks?
- Random nature of yield loss
- As congressional activity heats up for the 2012 Farm Bill, risk management is the central justification for most of the commodity title program proposals.
Random nature of yield loss
Yield on the other hand is more random in nature and depends upon events that are less predictable: weather and disease. A half a dozen counties in central Illinois can experience a yield disaster as the result of a localized drought while neighboring counties can see record yields. It would be rare that all farmers across the US would experience a yield disaster in the same year.
It is this random nature of yield loss that makes crop yields a more appropriate target for crop insurance, especially if different areas are rated for their relative risk of yield loss. This is akin to offering lower fire insurance rates for a brick building with a sprinkler system than a frame building with no sprinkler system. Assuming that farmers engage in good agronomic practices—that is they do not game the system—yield insurance is an excellent way to protect farmers from a weather- or disease-related disaster. If this type of insurance program is properly managed, it is superior to making crop farmers dependent upon a Congressional for an ad-hoc disaster program.
As crop insurance programs have morphed into revenue products, the different types of risk represented by price (systemic) and yield (random) have been ignored. And, as long as prices remain high, the chance of farmers (and government as the insurance underwriter) experiencing problems with combining these two kinds of risks is minimal.
What happens in an era like today is farmers get focused on within-year risk and shallow loss farm programs based on an expected price at planting time which is generally greater than the price at harvest, guaranteeing farmers a profit at times when even the lowest price is well above the cost of production. As a result, the demand for farm programs is for ones that protect against this shallow-loss.
At the same time, it is easy to forget that one of the major functions of farm programs is to provide farmers with a safety net when everything collapses. Shallow loss programs when the anticipated price at planting is well below the cost of production are of little use. All they do is guarantee a loss on the crop.
From our perspective, by ignoring the two different kinds of risks and bundling them in a single program, policy makers risk losing support for farm programs in general. It is very likely that the public will come to view shallow-loss programs in the same way they have come to view direct payments—large payments when farmers are already making a good profit. And this loss of good will on the part of the general public will make it more difficult to design a safety net when prices collapse and farmers are in real trouble.
Daryll E. Ray holds the Blasingame Chair of Excellence in Agricultural Policy, Institute of Agriculture, University of Tennessee, and is the Director of UT’s Agricultural Policy Analysis Center (APAC). Harwood D. Schaffer is a Research Assistant Professor at APAC. (865) 974-7407; Fax: (865) 974-7298; email@example.com and firstname.lastname@example.org; http://www.agpolicy.org.