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?