Insurance is an essential part of the financial infrastructure of a
market economy. By spreading losses among members of a group with
similar exposure, insurance encourages people to take prudent risks
while protecting individuals from ruin in case they are the unlucky
ones. Not all risks are insurable, however. Attempts to insure the
uninsurable create incentives to take excessive risks and burden the
economy with costs to the many that exceed the gains to a few. So-called
“crop insurance,” which has become a central feature of U.S. farm
policy, is a case in point.
Why crop losses are not insurable
Over
time, insurers have developed rules that identify which risks are
insurable and which are not. Crop insurance violates at least three of
them.
Not a pure loss. Insurance is normally limited to situations in which people face a pure loss. For
example, if I insure my house against fire, I either experience a fire,
in which case I suffer a loss, or I do not, in which case I have
neither a loss nor a gain. In contrast, if I build a house for resale, I
may suffer a loss if no one likes it or if the market declines, or make
a profit if someone falls in love with it and pays me a premium price.
The risk of fire is a pure loss, and is insurable; the risk of a
business venture that carries the possibility of gain as well as of loss
is not.
Insurance against crop risks, especially in the popular form of crop revenue insurance,
departs from the pure loss principle. Crop revenue insurance does not
just protect farmers against bad harvests due to natural causes like
drought or floods. It also protects their profits against the economic
risk of low prices, even when a good harvest is the cause of the low
price. In fact, if the premium is low enough and the benchmark price is
high enough, crop revenue insurance provides a guaranteed profit no
matter what happens. >>>Read more
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