Subjective Risks, Objective Risks and the Crop Insurance Problem in Rural China

China's infant crop insurance industry faces two, not mutually exclusive, challenges. The first challenge is operational and arises from the lack of historical crop yield data at the farm household or village level. The second problem relates to a possible disconnect between objective measures of historical yields that is required for actuarial pricing in the supply of insurance and the subjective perceptions of future risk that is required to establish demand. This may require a substantial subsidy from the Chinese government in order to encourage participation. This paper examines both issues, including the form of subsidy, through use of the beta-PERT distribution. The PERT distribution has the advantage of defining proximal (second best) distributions based on farmers’ recall of historical low, high and typical yields to cover objective risk measures, and subjective distributions through projections of low, high and most likely future yields. Direct elicitations of objective and subjective PERT parameters from 730 farmers in Shaanxi were collected in the fall of 2010. We find that 82.3 per cent of farm households have perceptions that their pro-forma corn yields in 2011 would be higher than their historical memory, while 71.63 per cent perceived the distribution of risks in 2011 to be lower than the historical average. In addition, we find that when we regress farmers’ interest in crop insurance it is the skewness of subjective risk that matters, and perception of downside risk is largely dictated by perceived mean and standard deviation. As a result we argue that the need for subsidising crop insurance premiums is a consequence of the dissonance between subjective and historical risks.