The Role of Area-Yield Crop Insurance Program face to the Mid-Term Review of Common Agricultural Policy

Abstract

The mid-term review of Common Agricultural Policy increases the complexity of the decision-making process of farmers. The subsidies are substituted for a single decoupled income payment. The farmers decide what crops and livestock will produce based on climate, soils conditions and agricultural market signals and not based on subsidies granted to each one of the crop and livestock activities. The area-yield crop insurance program might have an important role on increasing production and facing natural catastrophes. This paper studies the introduction of the area-yield crop insurance program to reduce the risk originating from the variability of farmers’ income and to compare this alternative with other agricultural policy alternatives in the context of the mid-term review of Common Agricultural Policy. The comparison of the introduction of the area-yield crop insurance program with other agricultural policy alternatives is made through an approach using concepts of the Cumulative Prospect Theory, because besides defining that the results are appraised in agreement with changes in relation to the initial wealth, this theory treats in a differentiated way gains and losses. A discrete sequential stochastic programming model with five states of nature is developed to study agricultural policy alternatives. The objective function is constituted by a set of functions (the value function and the probability weighting function) differentiated for gains and losses, in that the total value of the game is given by the sum of the positive and negative components. The value functions and the weighting probabilities are elicited by the Trade-off and Certainty Equivalent methods for a group of farmers in the Alentejo dryland region of Portugal. The set of constraint restrictions describes the environment in which the Alentejo farmers develop their crop and livestock activities in all their components: production, financial, marketing and taxes. Model results show the introduction of the area-yield crop insurance program with full decoupling of income payments from agricultural production under the mid-term review of the Common Agricultural Policy has positive effects in the agricultural production. This new Agricultural Policy guarantees a minimum farm income, while the area-yield crop insurance program allows making face to the agricultural production variability and avoids the abandonment of the farming activity in the Alentejo dryland region.