Catastrophic risks and insurance in farm-level decision making

Keywords: risk perception, risk attitude, catastrophic risk, insurance, farm characteristics, farmer personal characteristics, utility-efficient programming, arable farming, dairy farming

Catastrophic risks can cause severe cash flow problems for farmers or even result into their bankruptcy. To cope with catastrophic risks farmers need to apply risk management strategies. Insurance is a frequently used instrument to cover catastrophic risks. The main goal of the research is to analyse the actual farmer’s behaviour (descriptive approach) and to model the impact of catastrophe insurance purchase (prescriptive approach). Concerning insurance decisions to cope with catastrophic risks, the impact of farmer personal and farmer characteristics is important to consider. In this research, the impact of farmer’s personal risk characteristics on catastrophe insurance purchase was mainly addressed. These characteristics are the farmer’s personal risk perception and his risk attitude.
The descriptive approach evaluated the impact of farm and farmer personal characteristics on actual insurance purchase in arable farming as well as in dairy farming. The first part of the descriptive analysis focused on the purchase of several general types of insurance (i.e., damage, disability, health and liability insurance and a combination of previous insurance covers). In the second part, more specific insurance covers were analysed (hail, storm, brown rot, hail-fire-storm insurance for buildings, disability insurance, and insurance against epidemic animal disease outbreaks). The results showed that farm and farmer’s personal characteristics (including risk perception and risk attitude) had a significant impact on actual (catastrophe) insurance purchase.
In the prescriptive analysis, the decision making problem describing how arable farmers can cope with catastrophic yield risks was modelled. The analysis focused in more detail on risk perception and risk attitude. For this purpose the results obtained from single-crop two-state risk models were compared with the results obtained from multi-crop multi-state models (utility-efficient portfolio approach). The preferred options whether the decisions to insure and not to insure in terms of utility accounted either for farm income or terminal wealth. The analysis showed that if a farmer makes decisions only in terms of an income-based utility function he is more prone to purchase catastrophe insurance. Those decision-makers who perceived that a risk would relatively seldom occur were less inclined to insure and self-insurance would be preferable. However, if insurance decisions are made only on the basis of the single-crop two-state approach, they may differ from portfolio results because of alternative risk reducing options such as a diversification are not taken into account.