Index Insurance to Manage Weather Risk: A Long-Run Experiment

Despite gradual improvements in irrigation, almost 65% of the Indian agricultural sector still depends on erratic and unpredictable monsoons. High variability in income and consumption results, especially because rainfall risk co-varies among households that live near each other. Traditional informal risk-coping mechanisms that help insure against idiosyncratic risks do not work well with covariate risks like drought and flood. Index-based weather insurance is an innovative financial instrument, which can be used by farmers to hedge against erratic monsoons. Such a product pays farmers when rainfall exceeds or falls below pre-determined triggers, which are based on historic rainfall data as well as crop and soil considerations. Despite theoretical advantages of index-based rainfall insurance, take-up as a standalone product has remained surprisingly low among smallholder farmers. In the project “Index Insurance to Manage Weather Risks: A Long-Term Experiment” we investigate the effectiveness of rainfall insurance as a tool to help farmers manage risk. The research also examines whether farmers purchase the optimal amount of risk coverage and attempts to identify the factors, which limit or facilitate adoption of new financial products. The policy brief highlights five main policy implications of the research: Pricing matters – rainfall insurance demand is highly price-sensitive Individual trust in the insurance provider is important Financial education can increase adoption Diversifying weather risk induces farmers to shift to high-return cash crops Policy design is improving.