Small question
On the wiki,
"a plan where the indemnity payment is based on the actual yield versus the insured yield
Example: A corn farmer buys production insurance based on a yield of 10 tons / hectare.
if actual yield = 11 tons / hectare → no coverage is triggered
if actual yield = 8 tons / hectare → coverage would be triggered, and the insurer would compensate the farmer for low production according to the contract terms."
I found this a little counter-intuitive. Does it discourage farmers to produce more so that they can still qualify for insurance?
Comments
Hello,
I would say no in general because of the following:
Let's assume that the market price per bushel of your commodity is $1500 while insurance provides you compensation of $1000 per bushel that's short of your 10 ton target.
Assuming you have 11 tons/hectare -> one hectare generates 11x$1500 = $16500.
Assuming you underproduce and have 8 tons/hectare -> one hectare generates 8x$1500 + 2x$1000 = $14000.
You'd be better off just producing as usual and selling in the market.
The only time this would be profitable would be if your shortfall compensation is greater than the market price which is unlikely because insurers would no doubt try to avoid that as it encourages moral hazard.
Even then, to provide an extreme example where this situation is unlikely; if your maximum capacity for production is 20 tons with a market price of $800/ton while compensation is priced at $1000/ton; you would still be better off producing 20 tons ($16000) vs producing nothing ($10000).
Hope this is clear!
Thank you!