Addressing basis risk in agricultural margin insurances

Purpose: After several reforms of the common agricultural policy, domestic product prices and farm incomes have become more volatile in the EU. Risk-averse farmers are therefore seeking income stabilizing measures. Margin insurance is among the feasible options but is not yet established in the EU. The purpose of this paper is to explore such an insurance under EU conditions for a major crop. Design/methodology/approach: The paper explores conditions for a viable margin insurance. It presents a modeled-loss trigger for a margin insurance scheme using wheat production in Austria as the case study. Findings: While margin insurance products are widely used in the USA, such products are not available in the EU. Basis risk seems to be an important reason. An exploration of wheat production in Austria shows that heterogeneity among farms is relevant. The authors demonstrate an approach aiming to lower basis risks. Research limitations/implications: This paper presents a technically feasible approach to handle the basis risk of a margin insurance under EU conditions. Before such a product can be placed on the market, further research on systemic risk is needed. Market research is necessary to fine-tune the details of the product to meet the actual demand of farmers. Further empirical validation of the modeled losses is needed. Legal implications are not explored in this paper. Practical implications: The insurance product presented here demonstrates a concept that is established in the USA under EU conditions. It is motivated by several shortcomings of income risk mitigation approaches in the EU. Social implications: Income risk may be seen as a problem of social policy. The approach shows that it can be addressed by market-oriented instruments. Originality/value: To the authors’ knowledge, this paper is the first to propose a tool to handle basis risk for margin insurance products in agriculture in the EU. A special feature of the proposed approach is that it is not limited to a single product such as wheat.