How Australian farmers deal with risk

Abstract

PurposeIn Australia broadacre crops can be insured against hail and fire damage and some other perils but not against losses caused by drought, flood or frost. The purpose of this paper is to investigate the private provision of crop insurance in Western Australia.Design/methodology/approachA farm survey was conducted with the cooperation of dryland farmers belonging to Western Australian grower groups. The willingness to pay for hail insurance is modelled as a function of risk aversion, risk of crop failure and government assistance; and the effect of expected crop yield in t/ha on the crop area is investigated.FindingsThe empirical analysis shows that the coefficient of relative risk aversion is 2.7. An increase in the variability of crop yield by 20 per cent, which may be caused by future climate change, would raise the willingness to pay for crop insurance one‐to‐one by 20 per cent. Adverse selection plays a minor role because almost all farmers buy full coverage for hail insurance and associated risks. A future supplier of multi‐peril crop insurance must, however, consider the potential for ex ante moral hazard because the size of the crop area depends on the expected crop yield in t/ha.Social implicationsThe Global Financial Crisis has provided a stark reminder that society crucially depends on the efficient and fair allocation of risk. Climate change threatens the livelihood of farmers and food security. Private multi‐peril crop insurance, which has yet to emerge, would improve the welfare of rural populations and the efficiency of farming.Originality/valueFew empirical studies deal with the private provision of multi‐peril crop insurance because the market for multi‐peril crop insurance fails worldwide and private insurance does not exist. In this study, Australian crop insurance serves as a proxy to gain an understanding of multi‐peril crop insurance.