Assessment of the Risk Management Potential of a Rainfall Based Insurance Index and Rainfall Options in Andhra Pradesh, India

By Veeramani, Venkat N.; Maynard, Leigh J. et al. | Indian Journal of Economics and Business, June 2005 | Go to article overview

Assessment of the Risk Management Potential of a Rainfall Based Insurance Index and Rainfall Options in Andhra Pradesh, India


Veeramani, Venkat N., Maynard, Leigh J., Skees, Jerry R., Indian Journal of Economics and Business


Abstract

Crop insurance is an alternative risk management technique available to farmers for stabilizing their revenue risk. Schemes based on area yield index are in operation for quite some time. Here a basic mechanism for the operation of rainfall index insurance and rainfall derivatives is developed. Instead of direct premium subsidies that are distorting, premium subsidy is taken as a function of adverse deviation of rainfall from the mean. A sensitivity analysis at different revenue elasticity levels with respect to rainfall was performed. Potential for private insurer's and reinsurer's participation exists with rainfall based index and options.

JEL Classification: G13, G22, Q14.

Introduction

In 2001-02, farmers in the state of Andhra Pradesh, Karnataka, and Punjab committed suicide over recurring crop losses due to drought, pests, and diseases. The crop loss data for the period 1985 to 2002 provided by the General Insurance Corporation's crop insurance cell categorized drought (70 percent) as the major source of crop loss followed by excess rainfall (20 percent) (Parchure, 2002). This shows the enormous dependency of crop production on rainfall. Higher dependency of agriculture on rainfall means that successive failures resulting from monsoons could leave the cash starved farmers in a debt cycle. The sheer size of the population involved in agriculture and the fact that 60 percent of the crop production is done under rainfed conditions highlight the need for income stabilization programmes for the farmers. Traditional insurance programmes are unsuitable for insuring agricultural risk mainly due to the presence of systemic risk. Presence of high correlation between rainfall and crop losses makes rainfall based crop insurance an attractive option for insuring agricultural risk.

Current Insurance Programmes

Crop Insurance was first introduced as a pilot scheme in 1978. Crops covered under the pilot scheme are paddy, wheat, millets, oilseeds and pulses. Until 2000, crop insurance schemes targeted the crop loans distributed by the loaning agency. Practically, insurance was not available for farmers without crop loans. The central and the state governments at a 2:1 ratio shared the crop insurance risk. "Rashtriya KrishiBeema Yojana" is the latest crop insurance scheme available to farmers. The central and the state governments under this programme share crop insurance risk equally. This scheme is fairly structured with different levels of indemnity and it covered all major crops grown in India. Indemnity payments are calculated based on an area yield index. A lower premium rate (approx. 4%) is charged for liability amounts up to 150 percent of the trigger yield. Liability amounts above 150 percent of the trigger yield attract an actuarial premium rate. Under this scheme a 50 percent premium subsidy is provided to small and marginal farmers. Losses up to 200 percent of the premium are covered by the insuring agency and losses above 200 percent are covered by a corpus fund set up by the government.

Area yield index programmes overcome most of the moral hazard and adverse selection problems but presence of basis risk is a major disadvantage of crop insurance programmes based on an index. U.S. crop insurance programme results have shown that the level of participation did not increase even with higher levels of premium subsidies. Higher premium subsidies also provided an incentive for the farmers to take more risky activities (Skees, 1999). Although the crop insurance scheme is effective in increasing the participation level of the farmers (0.7 million in 1992 to 1.3 million in 1999) in the state of Andhra Pradesh, high compensation payments (386 percent of the premium collected) discouraged full scale implementation of the programme. Extending the programme to include non-loaned farmers is met with skepticism as the payment rate for non-loaned farmers averaged 3 times that of loaned farmers (Parchure, 2002). …

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