Marketing Contracts and Crop Insurance

Abstract

Contracts between farmers and intermediaries and crop insurers are important means for farmers to mitigate risks in modern U.S. agriculture. In this paper, we investigate the effect of crop insurance enrollment on contract terms and farmers' participation in marketing contracts. Following Ligon (2003), we set up a mechanism design framework to demonstrate an intermediary's contract design problem, where farmers are assumed to be utility maximizing agents. We depict farmers' optimal choices of insurance coverage using the specification developed by Babcock (2012). Our model shows that improved terms of crop insurance (lower premiums, higher subsidies) make contracts less appealing to farmers as mechanisms for mitigating risk. Therefore, intermediaries may revise their contract offers so that they are more attractive. However, improvements in contract terms are limited by their cost to the intermediaries and will not lead to expanded participation in contracts.