Crop insurance and irrigation behavior: The conditional role of pumping costs

Abstract Excessive water use for irrigation can accelerate the depletion of water resources, undermining agriculture's resilience to weather‐related shocks. Understanding how farmers make water use decisions is essential for developing effective water management policies. This study investigates the effect of crop insurance participation on water use in the High Plains Aquifer region, using crop‐specific irrigation data and unit pumping costs for groundwater extraction. We examine the question of moral hazard in input use, analyzing how water use responses to insurance participation vary with changes in groundwater pumping costs. To address endogeneity between water use and insurance participation, we employ an instrumental variable approach using base premium rates that are determined before farms make production and insurance decisions. We find that insurance participation increases per‐acre water use, but the magnitude of this effect declines as pumping costs rise. At the average pumping costs, a one percentage point increase in insurance participation leads to a 0.4% increase in per‐acre water use. At the 95th percentile of pumping costs, the marginal effect of insurance participation is negligible and close to zero. Our results suggest that water pricing policies should account for indirect effects through insurance participation to avoid the inefficient use of water resources.