Risk in United States agriculture: Insurance, forward contacts, adverse selection and moral hazard

Endogenous adverse selection cross-subsidized equilibrium. Rothschild and Stiglitz (1976) showed unobserved heterogeneity causes welfare loss due to adverse selection. We establish necessary conditions when information disclosure that removes unobserved heterogeneity might reduce welfare, in an endogenous adverse selection separating equilibrium. Welfare may rise under disclosure bans with a small proportion of high risk types and moderate rise in premium for low risk types. In this case, either a private or public provider of insurance may be optimal. If the necessary conditions do not hold, mandatory disclosure is optimal.;Endogenous adverse selection: Evidence from U.S. crop insurance. Adverse selection tests in the tradition of Chiappori and Salanie (2000) examine correlation between contract choice and risk, given variables observed by the insurer. Non-zero correlation is evidence that inefficiency is due to unobservables. If the goal is to eliminate the inefficiency, such a conclusion falls short. A study of endogenous adverse selection requires the analyst to posit the presently unobserved, but potentially observable source of adverse selection. We test if the U.S. crop yield insurance market is characterized by a zero-subsidy endogenous adverse selection equilibrium, caused by use of forward price contracts. Using data for corn and soybean producers, we find some evidence since use of forward contracts is estimated to result in a 6% increase in risk in one state. This is substantial when compared to the benchmark increase in risk of 1% to 2% for differentially rated producers who use higher risk crop rotation practices.;Optimal insurance under self-protection and insured background risk. Real world insurance may not exhibit the optimal design predicted by models in the tradition of Raviv (1979). Crop yield insurance policies in the U.S. exhibit the, not necessarily optimal, full insurance feature. For a producer who optimally chooses a quasi-fixed input and who may hedge production, we assess the welfare effects of changes in coverage and coinsurance. When a sub-optimal policy without coinsurance is offered, a decrease in coverage at given premiums can strengthen incentives to counteract the social welfare loss that occurs due to increased insurer losses (budget deficits) in the absence of coinsurance.