Index-based crop insurance as an alternative insurance is based on the level of weather index (correlated to crop yield as well). There are many weather-based indexes that include parameters such as rainfall, frost, temperature, water stress etc.
Currently, the Rainfall Index (RI) is most used weather parameter for the index insurance scheme. The index reflects how much precipitation is obtained relative to the long-term average for a specified area and timeframe. Even though the rainfall index is transparent, the problems of adverse selection and potential moral hazard can be noticed. Namely, the correlation between yield and rainfall is never ideal and payouts usually represent an underpayment, or an overpayment of the damage occurred. Therefore, this index insurance works best where losses are consistent and well associated with the peril.
Recently insurance market has experienced the introduction of new products, based on the soil moisture deficit index. Namely, the water deficit is closely linked to the yield loss due to a drought and soil moisture is an amount of the water available for plant uptake. Therefore, the payouts are close to actual loss on the field. Moreover, farmers are familiar with this index and it is independent of farming practices.
Despite the fact that design of the perfect weather index can be challenging, the insurance industry is constantly discovering the path to affordable index insurance. Supporting factor is that the technology offers many solutions such are: remote sensing of rainfall and vegetation, blockchain automation of payouts and usage of sensors for soil moisture measurements, that help better risk definition and development of new indexes. Big data streams make the indexes more accurate. This could have a major impact on commercial uptake, as the main reason farmers choose not to buy insurance is because of its high costs. Moreover, with technologically redesigned indexes, insurance is going beyond state-of-the-art insurance products, creating the cutting-edge portfolio.
