Transcript Weather Index Insurance for Risk Management in

Climate contributes to poverty directly
through actual losses in production due to
climate shocks and indirectly through the
responses to the threats of the crisis.
 Direct impact : When a small holders farm is
destroyed due to extreme weather conditions
like drought or flood
 Indirect Impact: The farmers become
excessively risk averse and abandon any new
innovation that could lead to increase in
production.
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Together these factors leads to increase
in poverty .
 Recent studies have shown that extreme
climatic events will increase in frequency
and magnitude.
 The human population is on rise
increasing the pressure and demand on
agricultural sector.
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Weather index insurance is a form of
insurance that is linked to weather index
such as rainfall rather than a possible
consequence of weather, such as crop
failure
 This distinction resolves number of
fundamental problems that makes
traditional insurance unworkable in rural
parts of developing countries
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It reduces the high monitoring and administrative
costs: Unlike the traditional insurance against the
crop failure the insurer doesn't need to visit the farm
to determine the premium or access the damages.
The structure of index insurance is such that it makes
the payout more quickly and efficiently.
It removes the possibility of perverse incentive in
crop insurance where the farmer prefers the crop to
fail to receive the payment.
With the index insurance the payout is not based on
crop failure , so the farmer has the incentive to make
the best possible decision for a good production.
Reliable network of weather stations
 Quality rainfall data
 High density of farmers around each
specified weather stations
 Relatively Uniform weather pattern in pre
defined radius
 Similar soil condition
 Ability to provide training and education
to the farmers
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The Weather Index Insurance doesn't measure
the change in yield rather it measures change in
weather factor like rainfall.
It provides compensation to farmers when the
rainfall during the crop growing cycle is
insufficient to get an optimum yield.
This form of insurance assumes that the weather
factor like rainfall is highly correlated to the yield.
To establish the correlation the yield is plotted
against the rainfall and regression coefficient is
calculated.
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Weather insurance is defined by
– A reference weather station
– The weather index
– Term period of the insurance
– Threshold level
– Structure of the product
– Premium
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Weather Station
XXX
Risk Period
Duration of the Insurance
Index
Rainfall
Trigger level
Level which triggers the Insurance
Payment per unit shift in the index
Slope of the Increment line
Maximum Payout
Total Cost of Production
Condition for triggering payout
Index < Strike
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The Indemnity function defines the
dynamics of the payout.
 It is defined by three parameters
a) Strike Rainfall : The value at which the
Insurance is triggered
b) Stop Loss : The value at which maximum
damage has been done
c)Payout per millimeter of rainfall: Amount
of money to be paid to the farmers per
millimeter of deviation in rainfall from the
strike rainfall level.
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The Graphical demonstration of the Payout is
as follows:
Payout
Max Payout
Payout per mm (slope)
Stop
Loss
Rainfall
Strike
level
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Developing the rainfall index:
– The rainfall index is defined as the cumulative
rainfall in a specified period of time
– Define r(i) = actual rainfall received per day
Then the rainfall index is given by:
•Where R(t) is the Rainfall index in year t.
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This is the method used to calculate the
Risk Premium for the contingent claim
 The price of the claim P is given as:
P = e-r.TEQ[ψ(I)]
 I is a stochastic variable that expires at
time T
 ψ(I) = payoff at expiration
 r: is the risk free rate of interest
 EQ : is the expectation
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Historical weather data are cleaned and
detrended
 Determine the slope of the payoff
diagram
 Determine index value – hypothetical
payoffs for each year
 Calculate payoff average and discount
with rate r
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Basis Risk: The rainfall recorded at a
weather station may not be the same as
that at the farmer’s field.
Availability of quality weather data and
reliable network of weather stations.
Farmers Training and Education: Explaining
them the dynamics of the product and the
risk that the insurance covers.
Farmers ability to pay the premium: Their
economic condition might result in their
unwillingness to buy the insurance
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Identification of potential area and weather
stations
Studying the crop cycle and identifying the
major risk associated with it
Studying the weather factor correlation
with the yield and deciding if the factor is
insurable
Quantifying the risk and finally arriving at
the premium.
Field testing of the contract
Refinement of the contract based on the
farmers feedback
 Training and education
 Marketing the product
 Monitoring
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