Crop insurance is good for farmers, but not always for the environment
Congress is now developing a farm bill - large piece of legislation enacted about every five years. One of its essential components is crop insurance that aids defend farmer income in times of volatile production – for instance, when crops are destroyed by droughts or floods.
Crop insurance pays farmers who bring up major commodities, like wheat and corn, when crop yields or revenues decrease below particular point. On average, the federal government pays 62 percent of farmers’ crop insurance premiums.
Researchers work together on a climate policy initiative at the University of Illinois from various angles that include economics, finance, resource use and disaster relief. In their study, they have found that crop insurance affects the environment in ways that are significant but typically ignored.
While it plays an essential role, research has demonstrated that crop insurance promotes overuse of resources – specifically water – and makes the agricultural system less resilient in the face of climate change. Instead, future studies should find ways to encourage farmers to adapt to a changing climate.
Insurance and moral hazard
Crop insurance is the second-largest title in the Farm Bill, after nutrition aid. The Congressional Budget Office has proposed spending on these crop insurance programs at US$78 billion over the next 10 years, which represents 9 percent of total farm bill funding.
Insurance alters farmers’ incentives, which in turn might alter their behavior. When farmers know they will get an insurance payout if their crop fails, they may take fewer steps to lower that risk, or decide to grow riskier crops. Here are some theoretical examples.
First, being insured should discourage farmers from irrigating their crops as much as they otherwise would. Watering is expensive, and the potential for insurance payouts in the event of crop failure lowers the expected benefits of watering.
Insurance companies know this, so policies usually need farmers to show that they have irrigated a “normal” quantity of water in order to receive payouts. Paradoxically, this approach can encourage farmers to use water just to qualify for crop insurance.
Holding insurance could also influence water use by impacting farmers’ choices of what to plant. Since insurance lowers the cost of failure, it may lead farmers to plant crops with highly variable payouts. If yields are high, farmers reap the benefit; if they are low, farmers don’t bear all of the costs. And if the “risky” crops are more water-intensive, then water use increases.
Indeed, as we can see, crop insurance does result in more irrigation and therefore more water use. One reason is that it leads farmers to grow more water-intensive crops, such as cotton. This response is particularly pronounced across the U.S. South, where farmers have tapped groundwater supplies to irrigate cotton.
Using more water is not an issue if it is consistent with choices farmers would make in well-functioning markets where risk was absent. For instance, if some farmers were not growing cotton just because it was too risky and the price of water reflected its local scarcity, then lowering farming risk by offering crop insurance would benefit society.
However, there is a general agreement that agricultural water in many locations is underpriced, which makes increases in water use problematic, especially in water-scarce locations. Farmers already use too much water due to its underpricing, so any additional policies that lead to more water use would compound this market failure.
Crop insurance could also impel farmers to shift to new crops that are nutrient-intensive, which would boost fertilizer use. More nutrient applications cause more nutrients to wash into rivers and streams. Every year, nutrient runoff from Midwest farms flows down the Mississippi River into the Gulf of Mexico, making a massive “dead zone” where fish can no longer live because of poor water quality.
Nevertheless, a 2016 research that analyzed this issue using farm-level information demonstrated that, in fact, crop insurance did not affect nutrient use. This is great news, since it shows that crop insurance does not contribute to nutrient runoff in our national waterways. It is not clear why crop insurance boosts water use but not fertilizer use, although it's believed the answer is price differences between these inputs.
Crop insurance and climate resilience
Still another worry is that farmers with crop insurance might not take enough precautions against extreme weather, since crop losses will be covered. Without insurance, farmers who think that they are no longer can grow a certain crop at their location might grow something else or move production elsewhere.
To avoid this moral hazard issue, crop insurance is “experience rated,” which means it is more expensive for farms that have experienced large losses before. In principle, farmers whose premiums increase after they experience large losses due to extreme weather should take steps such as turning to more resilient crops or shifting to new locations.
However, a 2015 study that examined the impact of crop insurance on corn and soybean farming found that yields in areas with more crop insurance were more sensitive to weather fluctuations. In other words, subsidies for crop insurance appear to build a disincentive for farmers to defend their crops from the consequences of extreme weather events.
This says that crop insurance is making our agricultural system less resilient to future changes in the climate than it would otherwise be. Crop insurance also is likely to boost future payouts to farmers – which ultimately are subsidized by taxpayers – in the wake of floods and droughts. For instance, the Midwestern corn belt drought of 2012 cost taxpayers $13.4 billion.
Questions for the next farm bill
Neither house of Congress opted to make important changes to crop insurance in the farm bill, although some Senators had thought of suggesting amendments to make the biggest and richest U.S. growers pay a bigger share of crop insurance premiums. It is believed that insurance protects farmers’ livelihoods in times of crop failures, but its less-understood effects on their decisions about resource use deserve more research. Modifying crop insurance to lower incentives for unsustainable farming practices could be an great way to ensure the resilience of our future agricultural system.