Adversity and the Propensity to Fail: The Impact of Disaster Payments and Multiple Peril Crop Insurance on U.S. Farm Exit Rates

This paper investigates the effect of government-provided crop insurance on farm failure rates. By exploiting random variation in weather and the Federal Crop Insurance Reform Act of 1994, which mandated crop insurance coverage for the first time, I employ two natural experiments that identify the causal effect of disaster relief on farm failure rates. I examine the survival smoothing contribution of crop insurance by looking at the relative effect of disaster relief across two regimes, pre- and post-1994. Prior to 1994 ad hoc, ex post disaster payments were the primary form of disaster relief. Shortly after the 1994 Act virtually all disaster relief came through crop insurance indemnities. I find that disaster relief in the form of ad hoc disaster payments slightly reduces the average farm failure rate, while average farm failure rates increase under the crop insurance regime. The relative effect suggests that farm failure rates increase by 1.7 percentage points (about 30-percent) under the crop insurance regime. Excessively generous ad hoc disaster payments and moral hazard provide possible explanations for these findings. These findings suggest that government-provided crop insurance plays an important role in farmer risk management.