By Lauren Moody, Lauren Lee, Ruth Ma, Chadd Hennig, and Sahar Sadati.
Supervised by Kai Chan, December 2021.
What would you do if you knew you couldn’t fail?
Such a question likely sparks a flurry of creative, untamed, even reckless answers. When failure is impossible, risk-taking becomes desirable. Even when failure is still very possible, a reduced cost of failure disincentivizes risk aversion and adaptation — an example of “moral hazard”. Moral hazard effects, while seemingly benign, can undermine even the most well-intentioned policies. A prime example of this can be seen in subsidy programs like Canadian crop insurance.
In September 2021, the United Nations released a report describing how 87% — or 603 billion CAD — of government agricultural subsidies are price-distorting or harmful to human and ecological systems. Examining the role that subsidies play in incentivizing detrimental agricultural practices is critical given agriculture’s role as a significant driver of biodiversity and climate crises. As human populations continue to grow, agricultural production systems must rise to the challenge of feeding humanity while simultaneously restoring — not degrading — natural systems. Reforming financial incentives (see Lever 1: Change Incentives) is a key lever in transforming our agricultural systems to be aligned with sustainable futures, but in Canada, agricultural subsidies are often overlooked as tools for change.
Canadian agricultural subsidies are determined and distributed through the Canadian Agricultural Partnership (CAP), a 5-year policy framework representing $3 billion in investments by federal, provincial, and territorial governments with the aim of strengthening Canadian agriculture and supporting Canadian farmers. Under CAP, several risk management programs protect farmers against losses, the largest of which is Crop Insurance.
Crop insurance policies are determined by provincial government corporations, but all Canadian crop insurance is universal in reducing the financial costs suffered by farmers due to crop losses. Farmers pay annual premiums (which are 60% government-subsidized) to insure 50-80% (insured yield) of what they would produce in a normal year (historically averaged yield). In the event of significant crop losses, governments will pay farmers the difference between the farmer’s insured yield and their actual crop yield.
Crop insurance programs have high participation rates in Canada and other industrialized countries because they represent a major opportunity for perceived risk reduction, and farmers (like most of us!) are risk-averse. However, in the face of intensifying climate impacts, participation in crop insurance programs may increase risks for farmers due to intrinsic perverse effects. Intensifying climate impacts (i.e. crop losses from more frequent and severe droughts and climate events) are projected to lead to increases in insurance claims from farmers and subsequently increases in government payouts. The government must take preemptive and transformative actions (see Lever II: Reforming Management Systems) now to reduce future damages and corresponding high costs for taxpayers.
We analyze the perverse effects of crop insurance - and consequently propose transformative solutions - through two primary pathways:
(1) Pathway 1: Incentivize Intercropping
(2) Pathway 2: Reduce Moral Hazard through Premium Credits and Debits for Risk-Reducing Practices
Canadian crop insurance programs implicitly incentivize monocultures, which have less crop diversity. Thus, they are less resilient to extreme heat events, droughts, and pests, which lead to lower crop yields. Intercropping — when multiple crops are grown together — is an alternative farming approach with numerous ecological benefits, including increased resilience to environmental disturbance. However, many provinces do not insure intercropped fields, forcing farmers to plant monocultures; otherwise, their crops cannot be insured.
Some provinces have existing intercropping insurance programs, but most actively restrict or disincentivize intercropping. For example, BC and Alberta allow intercropping for grains, but not for vegetables or berries. Alternatively, some crop insurance programs limit intercropping by area; Saskatchewan’s Diversification Option only allows <30% of total insured acres to be intercropped. Such policies disincentivize beneficial intercropping practices.
Our first solution pathway proposes implementing and improving the most promising components of current provincial crop insurance systems that incentivize intercropping. We propose expanding BC’s Grain Basket Coverage Program to insure multiple crop types like vegetables, fruit trees, pulses and oilseed, with lower annual premium rates (the amount farmers have to pay to maintain coverage) as an additional incentive. To prevent farmers from intercropping ecologically-similar high-profit crops (functionally, monocultures) that will not reduce climate risks, we propose creating preset provincially-determined combinations of insurable intercropping systems. By seeding pre-determined intercropping combinations, farmers can achieve both reduced insurance premiums (lowering costs) and improved climate resilience in their crop systems.
Crop insurance also poses indirect perverse effects. In the face of intensifying climate impacts (such as droughts and pest infestations), farmers must adapt to mitigate crop losses. However, because the cost of crop failure is reduced by insurance, so is the incentive to take actions that reduce the likelihood of failure. This creates a moral hazard situation since participation in crop insurance is utilized as a risk-reduction strategy instead of actual risk-reduction strategies that improve resiliency. Thus, farmers participating in crop insurance programs become more vulnerable to extreme heat events, more susceptible to droughts, and less resilient to climate volatility.
Our second solution pathway proposes building financial incentives directly into the crop insurance program by providing discounted premium rates for farmers who adopt sustainable agricultural practices and increased premium rates for farmers who use harmful farming practices which increase their risk of crop failure. We would use Saskatchewan’s existing system where farmers earn premium discount credits or surcharge debits according to their perceived risk.
Instead of being deemed “low risk” because they have zero or relatively low claims, we would reward farmers for taking steps to reduce their long-term risk, shrinking the current moral hazard effect. Farmers who implement cover cropping and crop rotation practices — which boost climate resilience via improved soil health, in addition to other ecological benefits — would receive additional credits that can be accumulated toward discounts on their premium rates. While this would require federal and provincial governments to subsidize a larger share of insurance premiums in the short run, long-term insurance payments to farmers will decrease due to the benefits of improved soil health and increased climate resiliency.
Surcharges on premiums (increases in costs paid for insurance coverage) could be used to disincentivize monocultures, which as explained by Pathway 1, increases a farmer’s risk of crop loss. However, monocultures are by far the most common farming practice. Instead of punishing most farmers, we propose only applying surcharges (accumulated as debits over time) to the insurance premiums of high-risk large monoculture farms over a given size. Farmers would only have surcharges applied to their premium rates if they meet these “high-risk” criteria (sufficiently large size and monoculture crops) and have not implemented one of the following best management practices to reduce their risk: cover cropping, crop rotation, hedgerows, buffer strips, or native plant strips.