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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?