Index-Based Insurance for Agriculture in Developing Countries

The poor and particularly poor individuals whose livelihoods are tied to agriculture are exposed to substantial levels of risks. Mechanisms employed to cope with these hazards tend to be associated with low productivity and foregone consumption. However, informal insurance is only partially effective and formal insurance often inaccessible due to asymmetrical information problems and high transaction costs. Index-based insurance constitutes a way to overcome these shortcomings. As payouts depend exclusively on an exogenous index, adverse selection and moral hazard are reduced. Major challenges for the implementation of index-based insurance are the availability of adequate data and the existence of a well-performing legal system.