MORAL HAZARD CYCLES IN INDIVIDUAL-COVERAGE CROP INSURANCE

This paper examines the moral hazard implications of individual-coverage crop insurance contracts. Individual-coverage contracts are informationally superior to standard contracts because the farmer's coverage is proportional to his average historical yield. Despite this apparent benefit, the steady-state solution is shown to be characterized by moral hazard cycles, where moral hazard is practiced in alternative periods. The amplitude of the cycle and, thus, the variability in planned production is shown to be larger the lower the degree of production uncertainty, the fewer the number of years used in the averaging process, the higher the coverage threshold, and the lower the level of co-insurance.