We develop a new insurance model that shows how catastrophic risk affects the nature and existence of a crop insurance market equilibrium. A reservation preference level is used to characterize long‐run equilibrium when catastrophic risk makes insurance companies risk responsive. Catastrophic risk is shown to increase premiums, reduce farmer coverage levels and, under some conditions, lead to a complete breakdown of the crop insurance market. Reinsurance can help facilitate an equilibrium and/or increase participation, particularly if the reinsurance is subsidized. The analysis has important implications for the design and management of crop insurance and reinsurance programs.
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Duncan et al. (2000) studied this question.