COSTLY YIELD VERIFICATION, MORAL HAZARD, AND CROP INSURANCE CONTRACT-FORM

The theories of hidden-action, both moral hazard and costly state veri fication, are drawn on to analyse crop insurance contract structure. T he hidden-action moral hazard model allows few clear predictions regar ding optimal contract form. In particular the conditions under which a ctual contracts are optimal are not clear. Posing crop insurance as a problem of costly yield verification, however results in optimal contr acts with familiar properties - a deductible indemnification if and on ly if yield is verified, and indemnification only when yield is low Ho wever these contracts require full insurance across low yield states, while actual contracts typically involve co-insurance. This model is t hen generalised to incorporate hidden-action moral hazard, and it is s hown that optimal contracts then require co-insurance. Thus, this mode l reflects the essential features of actual contracts, suggesting that recognising the incentives for misreporting and for insurers to econo mise on yield verification costs will potentially result in a better u nderstanding of crop insurance.