The Potential for Moral Hazard Behavior in Irrigation Decisions under Crop Insurance

The design of federal crop insurance has attracted the interest and attention of many
economists and policymakers in the United States. Moral hazard is a frequently cited concern, as
insurance may reduce the incentive for farmers to manage properly their agricultural operation.
Moral hazard could play a role in irrigation decisions by incentivizing a farmer to choose a
riskier irrigation management strategy, potentially affecting the long-term sustainability of water
resources. We use numerical simulation to determine if insurance coverage affects incentives on
seasonal irrigation use. Results show that the potential for moral hazard at current costs and
policy parameters is low, but that there is potential for moral hazard behavior when the cost of
irrigation is high. Hence, conservation policies that increase the cost of irrigation cost (e.g., a
water tax) may amplify the potential for moral hazard. In most cases, crop insurance provides a
secondary effect that reduces irrigation use in addition to the direct water tax effect, although this
reduction comes at increased taxpayer expense. However, it is possible that irrigation use
increases under crop insurance. Therefore, there is a need for the explicit consideration of the
unintended side effects of crop insurance on farmers’ irrigation water use decisions, particularly
in regions experiencing water scarcity and rising marginal costs of irrigation.