An Empirical Analysis of the Demand for Multiple Peril Crop Insurance: Comment

Attempts to improve the Federal Crop Insurance Program continue to challenge policy makers. The Federal Crop Insurance Act of 1980 made significant changes that were designed to make multiple peril crop insurance (MPCI) the primary disaster assistance program for U.S. agriculture. However, performance has been unsatisfactory. Low participation and high losses have been major concerns. Current participation rates are around 35% and loss ratios (indemnities divided by premiums) are between 1.25 and 1.40. In the Food, Agriculture, Conservation, and Trade Act of 1990, policy makers addressed crop insurance issues and again called for actuarial soundness. In particular, the act mandated rate increases for crops and areas with poor loss experience. Given this situation, there are two critical research issues: (a) what is the price elasticity of demand for MPCI?; and, (b) how will premium rate increases affect both the risk pool and the overall financial performance of the Federal Crop Insurance Program? The second question reflects a concern that a disproportionate number of the producers who remain in the program following a rate increase will be those whose expected indemnities from purchasing MPCI are high. The two questions are related in that if demand is price elastic, the appropriate policy prescription would call for rate decreases making the second question irrelevant. If, however, demand is price inelastic, then the second question is important. A number of studies investigate factors that influence participation in MPCI (Gardner and Kramer; Nieuwoudt et al.; Barnett, Skees, and Hourigan; Edelman et al.; Hourigan; Calvin; Barnett; Goodwin; and, most recently, Smith and Baquet). However, only Barnett, Skees, and Hourigan; Hourigan; Barnett; Goodwin; and, Smith and Baquet make explicit estimates of the price elasticity of demand. Goodwin's analysis of Iowa corn producers' demand for MPCI makes an important contribution in that: (a) it demonstrates that producers with different expected net returns from the purchase of crop insurance may have different price elasticities of demand; (b) it is the first to address the question of how premium rate increases might be expected to affect the risk pool and the financial performance of the Federal Crop Insurance Program; and, (c) it provides some of the most recent estimates of the price elasticity of demand for MPCI. However, we are concerned that policy makers could be mislead by the policy implications that Goodwin draws from his findings. In particular, we are concerned with Goodwin's assertions that as premium rates increase: (a) the overall loss ratio for crop insurance may increase (pp. 433, 444); and, (b) total premium revenue received from producers with low expected returns from crop insurance will decrease since these producers have a price elastic demand for crop insurance (p. 433). We contend that Goodwin's research does not support either of these conclusions and the first conclusion is mathematically impossible. Barry Barnett is a post-doctoral research fellow and Jerry Skees is professor, Department of Agricultural Economics, at the University of Kentucky. This research was funded in part by the Federal Crop Insurance Corporation and the Economic Research Service of USDA. Review coordinated by Richard Adams.