The Demand for Specialty-Crop Insurance: Adverse Selection and Moral Hazard

estimate the demand for insurance do not exist (Barnett, Skees, and Hourigan; Hojjati and
Bockstael; Calvin; Goodwin, Coble et al.). However, the fact that many growers have an interest
in fruit and vegetable insurance suggests this is not due to a lack of demand, but a lack of a
mechanism to achieve a market equilibrium (Blank and MacDonald). In the absence of an active
market, contingent valuation (CV) methods have proven valuable in eliciting potential
participants’ willingness to pay for a good or amenity (McFadden). This study employs a CV
approach in estimating the potential demand for specialty-crop insurance.

The objective of this paper is to develop an empirical test for moral hazard that uses the
definition of inefficiency ventured above. The first section presents an alternative objective
function for an agricultural producer that considers both the level and the variance of output.
Next, the paper presents a definition of inefficiency that uses this risk and return objective
function. The stochastic production function method is then extended to include this new
definition of inefficiency and moral hazard. Finally, an empirical example of the demand for
insurance among U.S. fruit and vegetable growers both demonstrates the value of a CV approach
to insurance valuation and tests several hypotheses of the determinants of insurance demand.

A Model of Production with Moral Hazard and Adverse Selection

Suppose that growers face a production technology similar to QKS where output is a function of
a vector of variable inputs (X), fixed inputs (Z), grower effort (6), and an additive error term that

Y = f(x, z,θ) + ε where ε = (v,μ).

allows for both the random influences of the environment (v ), and managerial skill (//):

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