Evaluating the marginal risk management benefits of the supplemental coverage option

Abstract

Purpose

The purpose of this paper is to evaluate the risk management benefits provided by the supplemental coverage option (SCO) insurance plan which was created in the 2014 Farm Bill. Specifically, the marginal expected utility benefits are compared with the potential additional subsidy cost introduced by the new program for a stylized example of a corn producer.

Design/methodology/approach

The paper uses a stylized simulation model examines the preferred insurance program choice for a typical Midwestern corn farmer. The expected utility of the farmer is calculated under their preferred insurance program choice both with and without the availability of the SCO program, and compared to the case where crop insurance is not available. Scenarios are examined for a range of farmer risk aversion levels, different levels of correlation between farm-level and county-level corn yields, and case with and without insurance premium subsidies.

Findings

The SCO program is found to enter into the preferred insurance program choice for risk averse farmers. As risk aversion increases, farmers are estimated to prefer higher coverage levels for individual products along with SCO coverage. While the availability of existing crop insurance programs are shown to substantially increase the expected utility of farmers, the marginal impact of adding SCO to the crop insurance program is relatively small. Furthermore, the additional expected benefits generated by SCO are shown to include both risk management and expected return components. With subsidies removed, the estimated marginal benefits provided by SCO are reduced significantly.

Practical implications

The findings of this paper can help inform the policy debate for future farm bills as agricultural support programs continue to evolve. The results in this paper can also be used to help explain farm-level decision making related to crop insurance program choices.

Originality/value

This paper contributes to the literature by documenting a new, federally supported risk management programs made available to farmers in the 2014 Farm Bill and evaluates the marginal benefits the SCO program offers US crop producers.

Citation

Paulson, N., Schnitkey, G. and Kelly, P. (2016), "Evaluating the marginal risk management benefits of the supplemental coverage option", Agricultural Finance Review, Vol. 76 No. 3, pp. 411-424. https://doi.org/10.1108/AFR-03-2016-0022