Mutual Crop Insurance and Moral Hazard: The Case of Mexican Fondos

Insuring against crop yield risk is an important task in rural microfinance because such an insurance may improve access to capital for smallholders by substituting for collaterals. However, agricultural crop yield risk is even hard to mitigate in developed countries due to problems of asymmetric information. In this paper we investigate theoretically and empirically whether special institutional rules in Mexican mutual crop insurance groups, called Fondos, can reduce problems of moral hazard. After presenting this case of a multiple peril crop insurance, we model a dynamic stochastic control problem extending it to a moral hazard game. We show from a theoretical point of view that institutions in the Fondos system have impact on the farmers' behaviour to avoid or reduce losses. Thus, if farmers can influence the level of losses or the loss probability technologically the institutions can be used to restrict the incentives for moral hazard. In the empirical analysis - by means of panel logistic random effects as well as fixed effects regressions - we show that a certain rule reduces the loss probability in a Fondo. Thus, we have empirically shown both that an institution of the Fondos can reduce moral hazard and that moral hazard exists in this insurance system of a multiple peril crop insurance as in common crop yield risk insurance schemes. From a political perspective, our analysis supports the view that this system of Mexican Fondos may serve as a blueprint for crop insurance schemes in developing countries.