Underwriting Area-Based Yield Insurance to Crowd-In Credit Supply and Demand
This paper analyzes the usefulness of two index-based insurance schemes in protecting small farmers from risk.
Recent theoretical and empirical evidence suggests that risk may discourage the supply of agricultural credit and the willingness of small holders to utilize it. One possible solution to this problem is to remove risk from the system by independently insuring it. Conventional crop insurance has, however, proved to be financially unsustainable due to moral hazard and adverse selection problems. The paper analyzes two index-based insurance schemes, one based on a weather index, and the second based on measured average yields. Study findings indicate that index insurance products:
- Do not protect the farmer from all risks;
- Have substantial value to the producer;
- Could crowd-in credit supply from lenders reluctant to carry too much covariant risk in their loan portfolios.
The study shows that insurance based on measured yields is superior to a weather index. The paper also analyzes the feasibility of a public scheme to initially underwrite costs and uncertainties associated with area-based yield insurance.
