A SIMULATION ANALYSIS OF THE INDIAN CROP INSURANCE PROGRAM (INDIA)

The general objective of this study was to analyze the viability of the pilot crop insurance program in India. The major focuses of this study were: to review the literature against crop insurance on theoretical grounds; to do a Monte Carlo simulation of the Indian program to study the effects of various factors affecting demand and supply of crop insurance; and to analyze insurability under alternative conditions under the individual yield approach, which is used in most insurance programs in the world, and the homogeneous area yield approach as used in India.;The demand curve for insurance can be established using the expected utility theorem and by assuming that farmers are risk averse. Because the integral involved in the estimation of expected utilities cannot be solved analytically, expected utilities and insurance costs at various levels of guaranteed yields were simulated.;It is concluded that for reasonable values of risk aversion and of correlation between farmers' and area yields, the subsidy required under the homogeneous area yield approach is less than that under the individual yield approach. If it is also assumed that the yield distribution used by the insurance company is the same as that of the farmer, then an insurance subsidy of Rs 29 per hectare would be required for a guaranteed yield level equal to 70% of the mean yield. If the administrative expenses are higher then the subsidy may be still higher. Insurability under alternative values of these parameters for various wealth levels is also discussed under both approaches.;Crop insurance programs for multiple risks suffer from problems of moral hazard and adverse risk selection. One method of avoiding these problems is to estimate premiums and indemnities on the basis of area yields. However, if the correlation between a farmer's and area yield is less than 1, the compensation pattern may be erratic and this may lead to a decline in the demand for insurance. Thus even though it may be possible to sell insurance at a lower price by using this approach, the price that a farmer may be willing to pay would be even lower still and a subsidy may therefore be required.