Forward Contracts And Crop Insurance: Should Premiums Be Adjusted For Risk Management Practice?

Current premium rate-making methodology for the government-sponsored Multiple Peril Crop Insurance (MPCI) program adjusts premiums for farms engaging in certain cropping practices. These practices are production methods such as irrigation, fallow and double-cropping. Actuarial evidence has shown that such practices can separate farms into distinct risk classes. We suggest that risk-management tool is another category of practice which could be considered in setting premium rates. The present analysis shall focus on one risk management tool: cash forward contracts. Making this assessment requires that we use a key actuarial concept called loss cost ratio. Preliminary evidence (from sam ple moments of yield distributions) suggests that indeed the loss cost ratio may be lower in the presence of forward contracts when corn, wheat and soybeans are the insured crops.