The working group on risk management in
Figure 1: Independent versus correlated risk
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| Figure 1: Independent versus correlated risk (Source: Managing Agricultural Production Risk – Innovations in Developing Countries, the World Bank (Lack of statistical independence is not the only problem with insurance in agriculture. Another set of problems is related to asymmetric information — a situation that exists when the insured has more knowledge about his/her own risk profile than does the insurer. Asymmetric information causes two problems adverse selection and moral hazard. In the case of adverse selection, farmers have better knowledge than the insurer about the probability distribution of losses. Thus, the farmers have the privileged situation of being able to discern whether or not the insurance premium accurately reflects the risk they face. Consequently, only farmers that bear greater risks will purchase the coverage, generating an imbalance between indemnities paid and premiums collected. Moral hazard is another problem that lies within the incentive structure of the relationship between the insurer and the insured. After entering the contract, the farmer’s incentives to take proper care of the crop diminish, while the insurer has limited effective means to monitor the eventual hazardous behavior of the farmer. This might also result in greater losses for the insurer. Agricultural insurance is often characterized by high administrative costs. These costs are high, in part, due to the risk classification and monitoring systems that must be put in place to address asymmetric information problems. Other costs are associated with acquiring the data needed to establish accurate premium rates and conducting claims adjustment. However, Indian area yield insurance program is designed in such away that the administrative costs are minimal due to the involvement of multiple agencies and credit link. Download 0.68 Mb. Share with your friends:
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