Index Insurance In the absence of crop insurance, farmers are less likely to specialize in agriculture, more likely to grow multiple crops and less likely to add the optimal inputs these crops As a result, international groups such as the World Bank are interested in creating crop insurance coverage in developing countries There is enormous interest in this topic outside the US

An example of index insurance

Index insurance does not require historic farm level yield data and does not expose the company to moral hazard or adverse selection Losses are poolable on a global basis This would eliminate the need for deep pocket reinsurers such as the US Federal Government The first challenge is to link weather to a particular farm

The simplest method sets the value of rainfall at out-of-sample locations equal to the rainfall recorded at the nearest observed site Another method, estimates rainfall as a weighted average of surrounding observed values, in which the weights are inversely proportional to the squared distances from the unobserved site

NOAA Data

Kriging techniques form a predictor that is equal to a weighted average of the data in the sample. The weights used in the average estimated from the data Kriging techniques have been shown to provide predictors that are both statistically unbiased and efficient Kriging produces a smoothed rainfall surface, fit all existing data and which maintains the spatial correlation structure IDW produces point estimates The two methods provide similar values at each point

Rates Rainfall distributions were found to have a gamma distribution Rain was then linked to yields using plant growth models so that the farmer could buy protection against a rain event that would trigger yield loss Premium rates allowed the insurance company to break even over a 5,000 year period Historic analysis over 60 years showed that the program would also have been fairly priced during that period

Climate.com Company sells index insurance in the US Must compete against heavily subsidized competition, premium rates seem high Recently began selling competing, subsidized products May eventually ask for a subsidy Enormous value in other countries Monsanto purchase?