An empirical procedure was developed to analyze the cost effectiveness of alternative crop insurance products in terms of increasing producer net returns and minimizing variation in net returns. Results indicate that CAT was the overwhelmingly preferred MPCI option for all scenarios. The ranking of the other MPCI options was consistently 50/100, 60/100, and 75/100 in all scenarios. The CRC options, with the exception of one scenario, ranked 50, 60, and 75 percent, respectively.

Cotton production contributed an average of $5.27 billion per year to the United States economy from 1988 through 1994 (National Agricultural Statistics Service [NASS], 1999). More than 14.5 million acres of cotton were planted in the U.S. in 1999, with more than 13 million acres harvested and about 16 million bales of cotton produced. Texas accounted for about 42 percent of planted acres, about 39 percent of harvested acres, and over 31 percent of total cotton production in 1999 (Texas Agricultural Statistics Service [TASS], 2000). Cotton production, like any other agricultural enterprise, is inherently risky. Cotton producers are subject to unpredictable, random shocks, such as adverse weather, pest infestations, and other natural disasters, such as drought and flooding. Supply uncertainties, coupled with inelastic demand for many agricultural products, lead to price movements that are generally more volatile for farm products than those commonly experienced in other sectors of the economy (Goodwin and Smith, 1995).

In the past, producers have relied on the federal government for protection from price and yield variability. This protection came in the form of a federal crop insurance program, ad hoc disaster payments, and deficiency payments. Deficiency payments were made when the price level of the commodity fell below the target price set by the federal government. The target price acted as a floor price, guaranteeing a level of returns per unit of a commodity. However, significant changes have occurred in U.S. farm policies. The most recent of which are embedded in the Federal Agricultural Improvement and Reform (FAIR) Act of 1996. The elimination of deficiency payment provisions by the 1996 FAIR Act has affected expected returns and the income variability faced by producers (Skees et al., 1998). The lack of deficiency payments to compensate for commodity price variability, coupled with the flexibility of producers to switch crops from year to year, have increased revenue risks for producers. Although the federal government has attempted to reduce its role in providing price and income support, there has been an increasing emphasis on crop and revenue insurance (Skees et al., 1998). Pressure to reform crop insurance products has resulted because of low participation, poor actuarial performance, and the existence of ad hoc disaster payments (Skees et al., 1998). These issues were addressed by the Crop Insurance Reform Act of 1994, which prohibits ad hoc crop disaster programs, unless the funds are appropriated from other agricultural programs. The 1994 act also directed the Federal Crop Insurance Corporation (FCIC) to develop a pilot crop insurance program to provide farmers with coverage against reduced income as a result of reduced yields and/or prices (Miller et al., 2000). Although the movement of agricultural policy in the United States toward less government involvement has left producers exposed to higher levels of production and marketing risk, there are many risk management practices that are available to producers to help substitute for government programs.

Some of these practices are forward contracting, hedging with futures and options, and crop insurance. The general objective of this study was to develop and illustrate the application of an empirical procedure to evaluate the cost effectiveness of various crop and revenue insurance products as risk management tools for Texas cotton producers.