The Impact of Crop Insurance on Indonesian Rice Production

This study builds a theoretical model of the yield-based MPCI crop insurance policy for a risk averse rice farmer in Indonesia and presents the comparative statics analysis of policy variables on yield through the coupling, wealth, and insurance effects. Moreover, Using yield data from 1979 to 2014 for the Tuban Regency, this study applies numerical optimization to the model and simulates the effects of different policies on input use, certainty equivalents, indemnity payment, and premiums. The theoretical analysis shows that no coupling effect exists for change in the coverage level, while a coupling effect exists for change in the subsidy implying that farmers can impact the size of their payments by adjusting inputs and thus yield. For wealth effect, if the price market higher than the average cost of production, the wealth effect is ambiguous. If the price market smaller than the average cost of production, the wealth effect for the coverage levels is ambiguous, while the wealth effect for subsidy levels is negative, indicating a marginal increase in the subsidy reduces input use. For insurance effect, the analysis shows a positive sign for coverage level, revealing that an increase in the coverage level triggers the farmer using more inputs. On the other hand, the insurance effect for subsidy levels generates a negative sign, where higher subsidy cause the farmer to reduce input use. The numerical analysis shows that MPCI crop insurance indicates a moral hazard. At coverage levels of 30% and above, the farmer does not expect to receive any indemnity payment. However, for coverage levels at or above 40%, the farmer expects indemnity payments, which triggers a reduction in input use as the farmer tries to maximize both insurance payments and market revenue simultaneously. For certainty equivalent, farmers prefer the highest coverage level. For expected indemnity and insurance payment, farmers receive the highest payment for the largest high coverage level and subsidy. Hence, the result indicates that MPCI insurance with high coverage levels and low premium subsidies is suggested to Indonesian government since such policy results improving the farmers’ wellbeing while mitigating moral hazard facing the insurance provider