CASE STUDY: RAINFALL INSURANCE IN INDIA

To study formal insurance’s effects on agriculture, Yale professor Ahmed Mushfiq Mobarak
conducted a research project in India. There, he collaborated with a government-run insurer,
the Agriculture Insurance Company of India (AICI). In order to combat the problems of
moral hazard and adverse selection, they offered index insurance based on a factor beyond
the farmer’s control, the arrival of the monsoon rains. If the monsoon was delayed by two
weeks, the farmers received payouts, and if the monsoon was delayed by four weeks, they
received even bigger payouts. Conditioning payouts on the monsoon’s timing also made the
insurance concept easier for farmers to understand compared to traditional index insurance,
which is conditional on the amount of rainfall.

The authors anticipated that farmers may not buy insurance due to basis risk, which is the
imperfect correlation between the actual rainfall the farmer receives and the measured rainfall
at the rainfall station (which is used to determine payout). To determine whether basis risk was
a problem, the authors randomly designated the rainfall station at either the village level or
block level. The block level rainfall stations have lower correlation with farmers’ rainfall as they
are further away. As expected, when the rainfall gauge was placed at the village level, farmers
were more likely to purchase insurance, which indicates that the choice to insure is sensitive
to basis risk.

The study found that about 40 percent of the farmers bought insurance, and that those with
insurance switched to higher-risk, higher-return crop varieties. In particular, the study shows
that rice farmers move away from the drought-resistant varieties that do well in bad years, but
produce less in other conditions, in favor of other seeds that provide better returns, but are
not as drought resistant. This is important from a policy perspective, since shifting to higher-
risk, higher-return varieties can raise income.
CASE STUDY: RAINFALL INSURANCE IN INDIA (CONTINUED)

Even though the index-based insurance used in the study improved on the status quo, it also
highlighted the need for additional regulatory, bureaucratic, and institutional improvements.
For example, currently, the AICI is not allowed to sell insurance directly to agricultural
wageworkers, since they do not own land. These workers may also need insurance against
rainfall shocks, since, during times of drought, landowners do not hire as many workers. Their
need for insurance may be even greater than the farmers’ because their resources are even
less diversified, and they have smaller social networks that can provide informal insurance.
Reforms that would provide these wage workers with access to insurance could enhance
financial inclusion.

To read the full article, please click on this link:

https://insights.som.yale.edu/insights/can-insurance-help-the-poor-manage-risk