OPTIMAL INSURANCE PRICING FOR A NOVEL FARMING CONTRACT MECHANISM

This paper analyzes the optimal production and pricing decisions in a novel contract mechanism consisting of an insurance company, a farmer and a futures company. We call the novel farming contract mechanism as "insurance + futures" mechanism (IFM). The key feature of IFM is to fully guarantee the farmer's profits, motivate the insurance company to participate in the mechanism and control the risk of VaR (Value-at-Risk) faced by the futures company. We study the optimal production quantity for the farmer, the optimal premium rate for the insurance company and the optimal strike price for the futures company. The effects of parameters on the optimal decisions of the production quantity and strike price are analyzed. Our analyses provide managerial insights on the contract terms of IFM through the numerical illustrations including agricultural production of wheat, corn, soybean. We find that the farmer's profits in IFM are higher than the uninsured case. The expected return of the insurance company is positively correlated with the standard deviation of futures basis. We suggest the insurance company to purchase the futures options with a higher standard deviation of basis for hedging risk.