Revealing the willingness to pay for income insurance in agriculture

Abstract

In spite of its minor and decreasing share in EU GDP, agriculture still plays a fundamental and strategic role in the economy. This is why EU institutions have supported for decades a series of policies to guarantee a stable agricultural income, including insurance. With different degrees of public support, insurance policies covering an increasing number of risks have been developed across the EU. Eventually, EU institutions have started to encourage the development of income insurance. Income insurance covers more risks and has higher uncertainty and costs than conventional single risk or combined yield insurance. Assessing and enhancing the viability of income insurance demands an in depth knowledge of farmers’ willingness to pay (WTP) for this product. This study develops a methodology to calculate the WTP for different degrees of income protection using a revealed preference model and the certainty equivalent theory. The methodology is applied in a drought prone area in southeastern Spain. Results show that WTP for income insurance in the area is higher than observed insurance premiums. This may play in favor of the development of more comprehensive income insurance systems.

Keywords:

• agricultural insurance
• certainty equivalent
• revealed preference models
• Mediterranean basins

Disclosure statement

No potential conflict of interest was reported by the authors.

Notes

1. The advantages of agricultural insurance over traditional income protection measures include as follows: (i) its ability to encourage the adoption of more sustainable farming practices in order to reduce risk exposure and thus prevent high risk premiums (water saving technologies, the avoidance of plantations in rows following the slope to reduce runoff and flood risk, etc.) (Surminski 2009; Warner et al. 2009); (ii) if properly designed, it does not distort trade (EC 2011); (iii) agricultural insurance is at least partially funded by the private sector, releasing pressure over public budgets (Meuwissen, Huirne, and Skees 2003); (iv) in addition, while uninsured losses drive the subsequent macroeconomic costs of natural catastrophes, sufficiently insured events are inconsequential in terms of foregone output (Von Peter, Von Dahlen, and Saxena 2012).

2. In some MS, agricultural insurance markets are already mature (Spain, France, Italy, Austria), but this is not the case in most MS (Bielza et al. 2009).

3. This institutional constraint exists in the whole EU. As a result, although income insurance is regarded as an attractive option (EC 1999; Meuwissen, Huirne, and Skees 2003), its development has been deemed feasible only in the medium–long run (EC 2001). Nonetheless, this has been challenged by several authors that noted that the historical failure of many insurance systems in the past was largely owed to their static behavior and their reluctance to extend insurance protection to other risks rather than the opposite (see for example AGROSEGURO 2012; ISMEA 2011; Meuwissen, Huirne, and Skees 2003). Actually, there are many MS in which agricultural systems have already reached a maturity that permits the progressive introduction of income insurance. Italy, Austria, France, and Spain have insurance systems where comprehensive combined insurance schemes prevail, comprising a wide and increasing variety of risks (AGROSEGURO 2012; Bielza et al. 2009; ISMEA 2011). In addition, these MS have precautionary clauses that demand a progressive implementation and recurrent testing of novel insurance systems, avoiding a large negative chain reaction if design problems are made evident. In the case of Spain, for example, this clause has been embodied in a law enforced for over 30 years (BOE 1978).

4. Protest bias occurs whenever individuals who oppose or do not approve the survey fail to respond, give invalid but positive bids (outliers), or place a zero value on a good that they actually value (Jorgensen et al. 1999).

5. This is the approach adopted in this study, where the crop portfolio includes all the crops that can be possibly planted by the agent (those planted in the past and also those planted in nearby areas), for which there is available data.

6. In our model, we consider the following constraints: land availability, available water resources, agricultural vocation (crops that have not been planted in the area or neighboring areas before cannot appear in that area in the short run), crop rotation, CAP restrictions, and ligneous crops restrictions (the surface of ligneous crops cannot change significantly in the short run).

7. In the EU insurance system, farmers are eligible for a compensation if the agricultural output observed is below a predetermined percentage of the average historical value (Bielza, Conte, and Catenaro 2008). With large enough data series, this average should be close to the expected value.

8. The ‘Rabin Critique’ (Rabin 2000; Rabin and Thaler 2001) claimed that expected utility theory gave absurd results over large stakes, and the authors prompted economists to recognize expected utility as an ‘ex-hypothesis’. More recently, other authors have put these findings into question, because they ‘lack empirical support’ (LeRoy 2003), are applied to ‘circumstances far removed from the context in which they were conceived’ (Cox and Sadiraj 2006; Rubinstein 2006) and hold only when ‘calibrations are made in a region of the parameter space that is not empirically relevant’ (Palacios-Huerta and Serrano 2006). The trade-off assessed in this study refers to a fraction of the annual income, not a large stake as compared to agent’s capital assets, which in principle makes this research exempt of suffering from the ‘Rabin Critique’.

9. Other attributes were explored (e.g. variable costs avoidance), but they were found irrelevant.

Additional information

Funding

This research is part of a project that has received funding from the European Union’s Horizon 2020 research and innovation programme under the Marie Skłodowska-Curie grant agreement [grant number 660608] (Water Incent – Economic Instruments for Sustainable Water Management in Water Scarce and Drought Prone Irrigated Areas).

This research has also received funding from the EU’s Seventh Framework Program (FP7/2007–2013) [grant number 265213] (EPI-WATER – Evaluating Economic Policy Instruments for Sustainable Water Management in Europe) and [grant number 308438] (ENHANCE – Enhancing Risk Management Partnerships for Catastrophic Natural Disasters in Europe), and from the Italian Ministry of Education, University and Research and the Italian Ministry of Environment, Land and Sea under the GEMINA project.