Crop Insurance Basics: Moral Hazard05/26/2016
Moral hazard is a phrase commonly used in the business community that simply means people act or perform differently when they are fully insulated from risk. An entry on the topic in Investopedia.com explained it like this:
We encounter moral hazard every day – tenured professors becoming indifferent lecturers, people with theft insurance being less vigilant about where they park, salaried salespeople taking long breaks, and so on…
The idea of a corporation being too big or too important to fail also represents a moral hazard. If the public or management of a corporation believe that the company will receive a financial bailout to keep it going, then the management may take more risks in pursuit of profit.
The term frequently surfaced during the Great Recession, with the Federal Reserve Chairman even noting, “As we try to make the financial system safer, we must inevitably confront the problem of moral hazard.”
Of course, moral hazard doesn’t just apply to investors. The concept is at the core of insurance products, including crop insurance. A driver with great insurance, a cheap premium and no deductible, for example, might drive more aggressively and be willing to file repair claims on every little scrape or ding.
That’s why auto insurance policies have deductibles and why previous accidents and claims are factored into future premium rates.
Crop insurance customers similarly share in the cost of premiums, receive rates based on past production and shoulder deductibles as a deterrent to risky behavior.
Farmers who know they will lose money by planting a crop not suitable to a specific soil or climate, will not plant that crop. Instead, they plant the best crops for their regions and work hard for a bountiful harvest while purchasing insurance protection to offer some assistance in the event that disaster strikes.
In short, farmers have little moral hazard because they share in the cost of their own safety net. And the American public appreciates this cost-sharing structure.
A recent public opinion poll of 1,000 U.S. voters found that nearly three-quarters of Americans believed that “farmers should help fund farm policies so that taxpayers are not paying the full cost.”
When respondents found out how much of the crop insurance tab farmers paid, they were also pleased. Nearly seven in 10 voters either said that farmers were being asked to pay too much or were paying the right amount of their premiums. Similarly, eight in 10 felt that the average loss deductible of 25 percent that farmers shoulder before receiving aid is about right or even too high.
Sounds like Congress got it right when lawmakers made crop insurance the centerpiece of modern-day farm policy in the 2014 Farm Bill.
Source: National Crop Insurance Services