Managing Catastrophic Risk in Agriculture through Ex Ante Subsidized Insurance or Ex Post Disaster Aid

Abstract

We consider a political economy in which government cares about risk-averse farmers’ loss of income but incurs political cost if it provides monetary support to farmers. Farmers’ expectations of government disaster aid and overconfidence (optimism bias) regarding their risk prevent farmers from purchasing full insurance under actuarially fair rates. Considering this conclusion, government prefers to subsidize farmers’ purchases of insurance ex ante rather than solely relying on disaster aid ex post. The resulting subsidy rate depends on the political environment, the degree of systemic risk, the distribution of farmers’ risk preferences, and the nature and distribution of farmers’ risk perceptions.