Political Economy of Crop Insurance Risk Subsidies under Imperfect Information

We consider a political economy where government cares about risk-averse farmers’ loss of income and yet incurs political cost if it provides monetary support to farmers. Government evaluates three options: 1) ex-post disaster aid; 2) ex-ante insurance option with perfect information; 3) ex-ante insurance with imperfect information (farmers are over-confident about their risk). It is assumed that marginal political cost is high enough so that the possibility of monetary support to farmers in the absence of economic loss is ruled out. In comparing 1) and 2), we find that government prefers farmers manage their risks through fairly priced insurance In comparing 1) and 3), if the information problems prevent risk-averse farmers to take up full insurance under actuarially fair rates, government prefers to subsidize farmers’ insurance ex-ante rather than providing disaster aid ex-post (subject to political cost) for a wide range of parameter values.