Crop insurance

2012: the Midwest drought costs the US federal crop insurance program some seventeen billion dollars in indemnities, its record at the time. Crop insurance runs into the problem built into weather perils. A drought or a frost hits a whole region at once, not one isolated farm, so risk pooling, which assumes independent risks, does not work. Adverse selection is strong, because the most exposed farmers are the keenest buyers. Moral hazard is real too: after partial damage, the insured is the one managing the crop. Everywhere, then, the market is organized around public support, whether that means subsidizing the premium, reinsuring the extreme layers or compensating uninsurable perils as a last resort. Two forms coexist, and they answer different problems. Yield cover pays the shortfall against the farm's historic yield, which takes an assessment farm by farm. Index cover pays on an external measurement, rainfall or a satellite vegetation index. It removes the assessment and the moral hazard, but the farmer then carries the basis risk.