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Abstract

This study focuses on how subsidized crop insurance affects the farm portfolio. Crop insurance programs may change the investment decision of farmers due to risk reduction or premium subsidies. First, actuarially fair insurance reduces the risk of farmers, holding expected return constant. Second, premium subsidies encourage farmers to purchase crop insurance and increases the expected return to the risky crop. Yet, outside of crop insurance, farmers have self-insurance mechanisms available, such as crop diversification. I derive conditions for when actuarially fair insurance and premium subsidies lead to more investment in the risky higher-return crop, while allowing for self-insurance. The effect of premium subsidies are decomposed into an encouragement (indirect) effect and a relative profitability (direct) effect. These effects are explained by the interaction between market insurance and self-insurance, and the interaction between a risky crop and a safe crop. I discuss each effect as a combination of a wealth effect and a substitution effect. The framework provides a novel view of the evaluation of subsidized crop insurance programs.

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