Moral Hazard Analysis for Crop Yield Insurance Using Loss Prevention Model

Farmers play the most critical role in agricultural production, and to keep producing, they must safeguard themselves against the associated risks. Offering an insurance plan designed to fulfil this coverage requirement is crucial. Among agricultural insurance products, crop yield insurance has a unique role since it aims to maintain agricultural production at a specific level, which promotes ecosystem sustainability. The study addresses scenarios of asymmetric information due to the insurer's need for more complete knowledge about the farmer's efforts. It provides solutions for optimal loss prevention efforts and suggests bridging the gap between observable and unobservable efforts. Comparing optimal contracts with observable and non-observable efforts, the marginal benefit in premium reduction is omitted for non-observable efforts. This highlights moral hazard, leading to inefficient crop insurance pricing. The results are generated using the expected utility theory. The certainty equivalent approach is also used to illustrate the results numerically and graphically.