The Economics And Implications Of Ex-Ante Regulations In Addressing Problems Of Moral Hazard In Agricultural Insurance

In this paper we develop a theoretical model of input supply by agricultural producers who purchase crop insurance and so who may engage in moral hazard. We show, through simulations, that a combination of partial insurance coverage combined with a minimum standard for input use may reduce substantially the problems associated with moral hazard. Partial insurance coverage creates an incentive for the producer to increase his use of inputs since the cost of lower output is partially borne by the producer, an outcome which would not be present under full coverage insurance. Partial monitoring of inputs, in the form of a minimum requirement for input use, has a direct effect on the reduction of moral hazard. We show that, rather than being substitute instruments, these are in fact complementary methods of encouraging a more efficient supply of inputs. Moreover, the minimum level of input use that must be required by regulation turns over to be substantially lower than the optimal or actual input level chosen by producers. Since the supply of inputs for crop production occurs in many stages over the pre-planting, planting and growing seasons, the fact that only a minimal input requirement is needed means that the cost of implementing such a regulation can be kept much lower than would be the case for a regulation of complete monitoring of input usage.