Justification forgovernmentinvolvement

In the case of low-frequency, high-consequence loss events, however, government intervention maybe justified. As explained in the Section 21.2 on production/weather risk management, research suggests that many decision makers tend to underestimate their exposure to low-frequency, high-consequence losses - a tendency that is reinforced when the decision-maker believes the government will provide assis-

tance in the event of a disaster, ttus, producers thinking in this way will be unwilling to pay the full costs of insurance products that protect against these losses, ttose who do buy insurance against low-frequency, high-consequence losses often cancel the policy if they do not receive an indemnity for an extended period, ttus, it seems that successful agricultural insurance products must be constructed so that they make indemnity payments with reasonable frequency, for example, once every seven or ten years. On the supply side, insurers will typically load premium rates heavily for low-frequency, high-consequence loss events where considerable ambiguity surrounds the actual likelihood of the event. Together, these effects create a gap between the prices farmers will pay for catastrophic agricultural insurance and the prices insurers will accept, ttus functioning private sector markets fail to materialize, or, if they do materialize, they cover only a small portion of the overall risk exposure, ttis type of market failure is commonly cited as justification for government interventions to facilitate provision of products or services not otherwise provided (or provided in sufficient quantity) by private markets.

Subsidies for catastrophic reinsurance are a type of government intervention that can facilitate the provision of insurance for low-frequency, high-consequence loss events. Hardaker et al. (2004), provide the following arguments for such an approach:

• Governments already provide disaster relief, even though providing assistance through reinsurance might be more efficient;

• tte financial involvement of a government may address the moral hazard problem: many catastrophes can either be prevented or magnified by government policies or lack thereof. For example, governments that are financially responsible for some losses might provide incentive for putting appropriate hazard management and mitigation measures in place;

• A government's financial involvement in reinsurance may reduce political pressure to provide distorting and often capricious ad-hoc disaster relief;

• Governments can potentially provide reinsurance more economically than can commercial reinsurers. A government's advantages, including its deep credit capacity and unique position as the country's largest entity, enable it to spread risks more broadly. If governments are to intervene in agricultural insurance markets, the social benefits of reducing the inefficiencies brought on by risk must outweigh the social cost of making agricultural insurance work.

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