Weather Index Insurance
In a very simple term, Weather Index Insurance helps farmers to protect/insure their crops against weather risk. This is the type of insurance that is available in areas where traditional agriculture insurance is not available.
INDIA is an Agriculture dominated country, so agriculture-related insurance is crucial for Insurance companies.
Our respected PM Shree Narendra Modi launched Pradhan Mantri Fasal Bima Yojna on 18 February 2016.
In INDIA there is already an Agriculture Insurance product available, Weather Index Insurance is not exist in INDIA currently.
Although let's learn about Weather Index Insurance for knowledge.
Weather Index Insurance is a tool that farmers can use to help manage risk. It pays out the claims based on an index, such as rainfall, measured at a local weather station or by satellite, rather than based on a consequence of weather, such as a farmer’s crop yield.
It helps in dealing with various covariate risks such as drought and excess rainfall. In comparison with traditional agricultural insurance, Weather index insurance has lower premiums due to reduced administrative costs.
The simplified nature of the product will help in reaching more households and result in penetration of the insurance industry.
Advantages of Weather index insurance
Removal of adverse selection- In crop insurance, the farmers who were at higher risk were more likely to take insurance which resulted in adverse selection. On the other hand weather index insurance is based on the same terms for all farmers in a defined area, removing the problem of adverse selection for the insurers.
Removal of moral hazard- In crop insurance, the farmers had the ability to influence the claim by their actions, but weather index insurance is purely based on independent weather parameters which cannot be influenced by farmers thereby removing the risk of moral hazard.
Reduced administrative costs- This insurance does not require physical field assessment thereby reduces administrative costs for the insurers. The reduced costs result in lesser premiums hence giving an advantage to the farmers as well.
Crop insurance requires an assessment of farmer’s land which creates disputes based on the subjective nature of the amount of claim. Weather index insurance is based on independent parameters reduces disputes to a large extent.
Disadvantages/Challenges of Weather index insurance
Basis Risk- Basis risk is the difference between the payout made to the farmer and the actual loss incurred by him. This occurs due to a lack of physical assessment of the farmer’s field which the weather index suggests. This risk is less where large areas are affected to the same extent but risks like hail and frost which are localized might not be considered correct.
Lack of data- Reliable data is required for weather index insurance. Data is required for pricing purposes and also for calculating payouts for different parameters. Historical data is required to assess risk in different regions and hence high-quality time series data is needed for this insurance. For example, 30 years of weather data are preferred for suitable analysis.
The indices provided by the weather stations have to be accurate for the best results of the insurance. The data manipulation should be minimal for appropriate values of premiums.
Weather index insurance cannot be applied to all crops and hazards. Risks to crop due to humid conditions and pests are difficult to be covered under weather index insurance.
The farmers need to be educated about the working of weather index insurance so that they can gain the maximum benefit of the new product.
To get a more and efficient benefit from Weather Index Insurance, disaster management strategies need to develop also the risk should be defined clearly.
e.g. drought. In addition to transferring the risk away from the farmer, WII can provide better access to high-value markets, modern technologies, agricultural information, and other financial services.
Written by: Vaishnavi Rastogi (An Actuarial Student)