ALTERNATIVE MODEL FOR CROP INSURANCE A CASE OF ONION CROP (ALLIUM CEPA) Abstract

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1 International Conference On Applied Economics ICOAE ALTERNATIVE MODEL FOR CROP INSURANCE A CASE OF ONION CROP (ALLIUM CEPA) SAIKUMAR C. BHARAMAPPANAVARA 1, MALLIKARJUN S. HASANABADI 2, DR. JAYASHREE A. HANDIGOL 3, AND DR. R.A.YELEDALLI 4 Abstract Agriculture is liable to heavy losses through natural uncertain calamities, which are beyond man s control. Crop insurance is a means of counteracting the uncertainties involved in crop production. The study found that at the existing coverage level increase of the premium amount will help the insurance agency to get the high premium collection. Similarly, the increase in the indemnity also helps the farmers to get more amount as compensation. Thus the alternative model suggested will fully compensate the loss of yield incurred by the farmers. The area yield insurance is costlier compared to premium calculated with normal curve technique. Hence the premium calculation through normal curve method will be the best method. Key words: Premium, Indemnity, Insurance. JEL codes: Q130 or Q140 1 Introduction It has been observed that in the Indian sub-continent, fluctuations in crop yields have mainly been due to the in clemencies of weather. The farming involves numerous risks such as natural, social and human. But the principal characteristics, which distinguishes farming from most other business is its great dependence on nature. Agriculture is liable to heavy losses through natural uncertain calamities, which are beyond man s control. Uncertainty of crop yield is one of the basic risks, which every farmer has to face. The yield uncertainty arises from the excessive dependence on the vagaries of nature, which prevents farmers from maximizing production. Crop insurance is a means of counteracting the uncertainties involved in crop production. Crop insurance is a device through which the uncertainty faced by an individual is transferred to an agency or insurer through their participation in large number for which they pay a premium. i.e., the total risk is shared by all the participating farmers. Ray (1960) defines insurance as a social device which aims at reducing the uncertainty of loss through combination of a large number of similar uncertainties and through the use of accumulated funds, distributing the burden at loss, should there be any over space and time. Onion crop in particular is highly sensitive to weather conditions, pest and diseases and it requires heavy expenditure during the production period and the farmer is not assured of good quality and disease free crop which is essential for obtaining reasonable yields sufficient to recover expenses. Hence, insurance is considered to be important for onion crop and the present attempt was made with an objective of formulating an alternative model for crop insurance. 1.1 Study Area In India, Karnataka state is the 2 nd largest onion growing state with a share of 23.8 % of total onion grown ( ). Hence the Karnataka state is chosen for the study keeping in view the limitations of researcher. In Karnataka State, Dharwad district was selected for the present study. The main reason behind selecting Dharwad district was, it stands first in onion crop production in terms of area (38,112 ha) and Production (114,847 tonnes) in the year The data were collected from both primary and secondary sources. The primary data were collected from randomly selecting 120 farmers (60 insured and 60 non-insured) from six villages. The secondary Data on yield of onion for five years for was obtained from the District Horticulture Office of Dharwad district. 2 Methodology 2.1 Normal curve theory techniques Insurance actuaries employ many techniques in determining premium rates and indemnities. In the present study the normal curve technique was used and due to data constraints a few modifications were made while adopting this method. The details of the normal curve technique employed are discussed below. Similar technique was adopted by IYENGAR (1989). This method was first developed by BOTTS and BALES (1958). This technique is being presently adopted by the Federal Crops Insurance Corporation (FCIC) of the United States of America and Manitoba Crop Insurance Corporation (MCIC) of Canada. The frequency distribution of the yields on individual form over the area should be relatively normal in distribution. This is a crucial assumption, which has to be fulfilled before using this technique. The premium rates and the indemnity payable depend on the coverage level. The total indemnity (I) payable in a given year, I = (C Yi).. (1) The average annual loss cost is (L) = 1/N (nc - Yi).... (2) But since R = 1/n yi, then Yi = nr Therefore, nc Yi = nc nr = n (C R) 1 Doctoral Research Fellow, DAAD Scholar, Dept. of Agricultural Economics & Social Sciences, Division of Resource Economics, Berlin Institute for Co-operative Studies, Humboldt University of Berlin, Germany. 2 Assistant Manager, Syndicate Bank, Belgaum. 3 Associate professor, Dept. of Agricultural Economics, University of Agricultural Sciences, Dharwad. 4 Associate professor, Dept. of Agricultural Economics, University of Agricultural Sciences, Dharwad.

2 86 International Conference On Applied Economics ICOAE 2010 The average annual loss cost or pure premium rate for the particular year = n (C R)/N. (3) Substituting A = n/n in equation... (3). Therefore, A (C R) or AC AR L = AC AR.. (4) It can be demonstrated that the average value of R in a truncated normal distribution is d R = Y (5) A Where d is the height of the ordinate at C in the frequency distribution of yields and is the standard deviation of the yields. Substituting (5) in (4) L = AC AR d = AC AY A = AC AY + d L = A (C Y) + d. (6) This formula gives the premium rate for any given year in commodity units. If only A, Y, C, d and are known, the following conversion needs to be made in order to obtain L. C can be converted to the standard normal variable Z using the formula, C - Y Z = After obtaining Z, the values of A and d can be obtained from statistical tables (Murray, 1972). The pure premium can be intimated by substituting the value for A, C, Y, d and in equation (6). The pure premium rate was calculated using the formula, L = A (C Y) + d Where L is the pure premium. A, d is height of the ordinate at c and is standard deviation of yields were calculated for the different coverage levels (75%, 80%, 90% and 100%) of the long term area average yields. The pure premium rates and the indemnity payable were calculated for insured farmers. The total indemnity payable was obtained by the formula; I = n(c R) Different approaches were used for fixing the coverage level. 1. The coverage level was fixed as a percentage of the long term area average yield. 2. The cost of cultivation was considered, while fixing the coverage level. The coverage level was fixed at a level sufficient to cover the cost of cultivation expenses. 3. The price of onion was considered while fixing the coverage level. The price per quintal of onion was varied and the different coverage levels were obtained. The coverage was calculated by using the formula Cost of cultivation C = x 100 (Long term average yield) (Price per unit of output) The methodology was in line with the techniques adopted by Abada (1987) in his paper on possible measures for determining coverage, premium and premium rating. In his study, he opined that whichever basis is used, the sum insured in all cases will be always below the actual value of the harvested crops under normal conditions. 2.2 The Area Yield Insurance Plan The pure premium was calculated by averaging the amount by which the yield in each year falls below the coverage level selected. 3 Results and Discussion 3.1 The goodness of fit test and the frequency distribution of observed and expected yields It is natural for the individual farmers yield to vary from the mean yield. But the yields should be normally distributed, if the normal curve technique is to be employed. Therefore, in order to check for normality the yields obtained were fitted into a normal curve and tested for normality by using chi-square test. The test was conducted for one year kharif crop and for the other years, normality was assumed. The frequency distribution of the observed and the expected yields of onion for the year 2004 kharif along with chi-square values are presented in Table 1. It could be seen from the table that the chi-square values are not significant and hence the condition of normality is satisfied The pure premium was calculated by using normal curve technique using the formula, L = A (C Y) + d

3 International Conference On Applied Economics ICOAE Where L stands for the pure premium. A for the crop loss probability, d for height of the ordinate and for standard deviation of yields. All these were calculated for the different coverage levels (50%, 60%, 70%, 80%, 90% and 100%) of the long term area average yields. This formula gives the pure premium in commodity units. The pure premium as a percentage of quantum coverage is called as the premium rate. The pure premium which is in commodity units was converted into monetary units by multiplying the pure premium in commodity units with price received by the farmers. In the present study, the commodity unit was quintal per hectare and this was multiplied at the rate of Rs. 250 per quintal of onion. The coverage levels were fixed on varied grounds and the premium rates were calculated for all the different types of coverage levels. The coverage level and yield quantum was depicted in Table 2. The coverage levels were chosen arbitrarily at 50 per cent, 60 per cent, 70 per cent, 80 per cent, 90 per cent and 100 per cent of the long term average yield of onion. commodity units, rate of premium and pure premium in monetary units were calculated. The results obtained were presented in Table 3. As the coverage level was increased from 50 per cent, 60 per cent, 70 per cent, 80 per cent, 90 per cent and 100 per cent, the pure premia in commodity in terms of quintals per hectare also increased from 3.60 to 4.42, 10.12, 15.57, and and the same in monetary units per hectare amounted to an increase from Rs to Rs. 1105, Rs. 2530, Rs , Rs and Rs The rate of premium correspondingly increased from 5.14 per cent to 5.26 per cent, per cent, per cent, per cent and to per cent. The coverages were calculated considering the cost of cultivation, price per unit of output and the long term average yield. The existing coverage level for onion is 60 per cent and is based on the yield coverage rather than cost of cultivation and price. If the operating expenses of Rs per hectare incurred by the farmers were to be compensated, it is sufficient to cover 60 per cent per hectare (Table 2). This method reflects the sensitivity of coverage levels to the cost of cultivation. It is interesting to observe that if the cost of cultivation is increased by 20 per cent in the future period without any change in price of onion, the maximum coverage desired will be 73.1 per cent as against the yield based 60 per cent coverage level. At present the premium rate is arbitrarily fixed at 3.45 per cent of sum insured, which amounts to Rs. 315 per hectare and the coverage level of 60 per cent is considered, according to premium calculated by normal curve method at 60 per cent coverage level the premium rate comes to 7.38 per cent of the quantum coverage of 84 quintals per hectare and pure premium in monetary units amounts to Rs per hectare (Table 3). Thus, we can see that the AIC is facing loss mainly due to the low premium charged for a same coverage. The pure premia were calculated for coverage levels at different levels of cost of production. The results were presented in Table 4. With an increase in the cost, it was found that coverage levels and correspondingly the pure premia also increased. With an increase in the cost of production from Rs per hectare to Rs , Rs , Rs and Rs per hectare, the pure premia in commodity units in quintals per hectare increased from 6.20 to 7.23, 8.29, 9.66 and correspondingly, the rates of premium increased from 7.38 per cent to 8.19 per cent, 8.97 per cent, per cent and per cent. The pure premia in monetary units increased from Rs per hectare to Rs per hectare, Rs per hectare, Rs per hectare and Rs per hectare. Considering the coverage levels at different prices per unit of output, pure premia were calculated and the results are presented in Table 5. As the price per quintal was increased from Rs. 200 to Rs. 250, Rs. 300, Rs. 350, Rs. 400, Rs. 450 and Rs The pure premia in commodity units in terms of quintal per hectare decreased from to 6.20, 3.57, 2.33, 1.64, 1.24 and 0.97, correspondingly the pure premia in monetary units decreased from Rs per hectare to Rs per hectare, Rs per hectare, Rs per hectare, Rs per hectare, Rs per hectare and Rs per hectare. In India 60 per cent, 80 per cent, 90 per cent coverage level corresponding to low risk, medium risk and high risk areas will be available for all crops based on coefficient of variation in yield of 10 years under National Agriculture Insurance Scheme. According to this measure premium worked out to be low Rs. 315 per hectare, when the normal curve technique was adopted and the cost of cultivation and price of onion is considered the insurance scheme will be more successful in terms of its profitability. In Karnataka 60 per cent of the long term average yield of last 10 years based on coefficient of variation in yields. According to this measure premium worked out to be Rs per hectare, when normal curve technique was adopted. But instead of fixing the coverage level at 60 per cent based on coefficient of variation in yields, if they consider the cost of cultivation of onion as well as price of onion at a coverage level of same 60 per cent the pure premium in monetary units will amount to Rs per hectare Indemnity Indemnity is the compensation payable to the insured farmers for a crop loss due to insured causes. The indemnities calculated for various types of coverage level at 50 per cent, 60 per cent, 70 per cent, 80 per cent, 90 per cent and 100 per cent are shown in Table 6. As the coverage levels were increased, the indemnity in quintals per hectare correspondingly increased from 46.4 to 49.8, 61.1, 68.2, 78.2 and Correspondingly indemnities in monetary units were also increased from Rs. 11,615 per hectare to Rs. 12,450 per hectare, Rs. 15,275 per hectare, Rs. 17,050 per hectare, Rs. 19,570 per hectare and Rs. 22,275 per hectare. The indemnities for different coverage levels revealed that as the coverage levels were increased the indemnifying quintals also increased. The results indicate that for the existing coverage of 60 per cent, the indemnity per hectare in monetary units was Rs. 7,600 when only threshold yields were considered but when the coverages were calculated based on cost of cultivation and prices with the help of normal curve technique the Indemnity in monetary units per hectares at 60 per cent coverage was Rs. 12,450 per hectare (Table 6). Thus the existing coverage level is definitely costlier to GIC. Hence, it is better if the coverage levels based on cost of cultivation and price was considered which will be able to fully compensate the loss of yield with higher indemnity and liability to farmers. For the coverage level fixed on the basis of cost of cultivation, the indemnity calculated and the results are presented in Table 7. For existing cost of cultivation of Rs. 21,079 per hectare, the coverage level was 60 per cent and for this coverage level indemnity was 49.8 quintals per hectare. When the cost was increased from Rs. 21,079 per hectare to Rs. 22,133 per hectare, Rs. 23,187 per hectare, Rs. 24,241 per hectare, Rs. 25,595 per hectare. The indemnity in quintals per hectare also increased from 49.8 to 53.2, 55.5, 58.8 and 64.4 correspondingly indemnity monetary units per hectare at Rs. 250 per quintal of onion also increased from Rs. 12,450 per hectare to Rs. 13,300, Rs. 13,875 per hectare, Rs. 14,700 per hectare and Rs. 16,100 per hectare.

4 88 International Conference On Applied Economics ICOAE 2010 The coverage levels were calculated by varying the prices per quintal of onion. For the different coverage levels corresponding to different prices the total indemnity was calculated and the values obtained are presented in Table 8. It was noticed that with an increase in the price of onion from Rs. 200 per quintal to Rs. 500 per quintal, the coverage level decreased from 75.2 per cent to 30.1 per cent correspondingly the indemnity in quintal per hectare decreased from 68.6 to 16.9 and indemnity in monetary units per hectare also decreased from Rs 17,150 per hectare to Rs per hectare. Similar results were observed by BABCOCK ET AL. (2004) conducted a study on actuarial fairness of crop insurance rates with constant rate relativities and suggested that this overpricing may explain why large premium subsidies were required to induce farmers to move from low-deductible to high-deductible policies beginning in Similarly Table 9 shows the pure premium in monetary units at different coverage levels as coverage level increased from 60 per cent to 100 per cent, the pure premium in monetary unit also increased from Rs. 2,200 at 60 per cent coverage level to Rs per hectare at 100 per cent coverage level. The Table 10 gives the comparison of premium between premium calculated by normal curve method and premium calculated by area yield insurance. The pure premium calculated through normal curve method at 60 per cent level was 6.42 quintal per hectare and the pure premium calculated through area yield insurance method was 8.8 quintal per hectare and in both the methods as coverage level increased the pure premium also increased. In normal curve method, pure premium in monetary units was increased from Rs per hectare at 60 per cent coverage level to Rs per hectare at 100 per cent coverage level and similar trend was observed in the area yield premium. But, between the two methods the normal curve method is the best in terms of pure premium in monetary units because the pure premium is lesser in case of normal curve method. When the premium rates calculated compared between premium calculated through normal curve method and area yield insurance method the premium in monetary units calculated through normal curve technique were found to be lower compared to premium calculated through area yield insurance method (Table 10). The results reveal that the area yield insurance is costlier compared to premium calculated with normal cure technique. Hence the premium calculation through normal curve method will be the best method which will be recommended to Agriculture Insurance Company for calculation of the premium for onion. Similarly AHSAN et al. (1982) provided a simple and more general theoretical framework of agricultural insurance as an alternate model. The forging analysis shows a possibility of increasing the pure premium to Rs per hectare with coverage of 60 per cent for compensating the existing cost of cultivation. Therefore, the Government, Agriculture Insurance Company as well as other agencies concerned with crop insurance should take a serious step for incorporating the above method of pure premia calculation. 4 Conclusion In the nutshell, based on the Present study the alternative model for crop insurance was suggested by way of providing the method of calculating the coverage premium and indemnity using normal curve technique. The coverage was calculated considering the cost of cultivation, price per unit of output and the long term average yield. For the corresponding coverage premium, indemnity and liability were calculated. The existing coverage level for onion is 60 per cent and this is based on the long term average yield alone. This coverage level is sufficient to cover the operating expenses of Rs. 21,079 per hectare of the insured farmers at the price of Rs. 250 per quintal of onion received by the farmers. The premium was found to be Rs per hectare as against existing premium of Rs. 315 per hectare. The results indicated that for the existing coverage level of 60 per cent, the indemnity was 12,450 per hectare as against existing indemnity of Rs per hectare when only the value of average yield was considered. At the existing coverage level increase of the premium amount will help the insurance agency to get the high premium collection. Similarly, the increase in the indemnity also helps the farmers to get more amount as compensation. Thus, the alternative model suggested will fully compensate the loss of yield incurred by the farmers. Comparison between normal cure method and area yield insurance in premium calculation reveals that the area yield insurance is costlier compared to premium calculated with normal curve technique. Hence, the premium calculation through normal curve method was identified as the best method and further following recommendations were given, 1. The calculation of insurance premium with the help of normal curve technique will help insurance company to get realistic premium rates. 2. The cost of cultivation and price of the commodity should be taken into consideration during calculation of coverage level as against the coefficient of variation in the yields alone, which is beneficial to Agriculture Insurance Company and farmers. Table 1. Frequency distribution of observed and expected yields and goodness of fit test of insured farmers Class limits Mid value Observed frequency Expected frequency Total Non significant at 5%

5 International Conference On Applied Economics ICOAE Table 2. Fixed coverage level Particulars level coverage Cost of cultivation per hectare excluding the fixed cost 60.0% 84.2 q Table 3. Pure premia for different coverage levels coverage commodity unit Rate of premium (%) monetary Rs. 250/q (Rs.) Table 4. Pure premia for coverage levels at different levels of cost of cultivation Cost coverage commodity units (q) Rate of premium (%) monetary Rs. 250/q (Rs.) Table 5. Pure premia for coverage level at different levels of prices Price level level (%) coverage in commodity units (q) Rate of premium (%) in monetary Rs. 250/q (Rs.) Table 6. Indemnity at different coverage levels level (%) coverage Total indemnity (q) Indemnity per hectare in commodity units Indemnity in monetary units (Rs./ha) Table 7. Indemnity at different levels of cost of cultivation of onion Cost coverage Total indemnity (q) Indemnity Indemnity in monetary 250 (Rs./ha) Table 8. Indemnity at different level of prices for onion Price level coverage Total indemnity (q) Indemnity per unit area Indemnity in monetary 250 (Rs./ha)

6 90 International Conference On Applied Economics ICOAE Table 9. Pure premia at different coverage levels under area yield insurance method Indemnity limit (q) rate (%) monetary 250 Rs./q (Rs./ha) Table 10. Comparison of premia between normal curve method and area yield premium 5 References under normal curve under normal curve in monetary units (Rs./ha) nder AY premium monetary units under area yield premium (Rs/ha) ABADA, J.C., 1987, Determination of coverage, premium and indemnities. Rep. No. 8. Crop Insurance in Asia. Asian Productivity Organization, Tokyo. AHSAN, S.M., ALI, A.G. AND KURIAN, J.N., 1982, Towards the theory of agricultural insurance. American Journal of Agricultural Economics, 64 (3) : 520. BABCOCK, B.A., HART, C.E. AND HAYEES, D.J. 2004, Acturial fairness of crop insurance rates with constant rate relativities. American Journal of Agricultural Economics, 86 (3) : BOTTS,.R. AND BOLES, J.N., 1958, Use of normal curve theory in crop insurance rate making. Journal of Farm Economics, 40 (3) : IYENGAR, H., 1989, An economic analysis of crop insurance for paddy in Bangalore rural district. M.Sc. (Agri.) Thesis, University of Agricultural Sciences, Bangalore. MURRAY, R.S., 1972, Theory and Problems of Statistics in SI Units. McGraw Hill International Book Company, New York.

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