Index Insurance, Probabilistic Climate Forecasts, and Production

By Carriquiry, Miguel A.; Osgood, Daniel E. | Journal of Risk and Insurance, March 2012 | Go to article overview

Index Insurance, Probabilistic Climate Forecasts, and Production


Carriquiry, Miguel A., Osgood, Daniel E., Journal of Risk and Insurance


ABSTRACT

Index insurance and probabilistic seasonal forecasts are becoming available in developing countries to help farmers manage climate risks in production. Although these tools are intimately related, work has not been done to formalize the connections between them. We investigate the relationship between the tools through a model of input choice under uncertainty, forecasts, and insurance. While it is possible for forecasts to undermine insurance, we find that when contracts are appropriately designed, there are important synergies between forecasts, insurance, and effective input use. Used together, these tools overcome barriers preventing the use of imperfect information in production decision making.

INTRODUCTION

Climate-related risks have profound impacts on agricultural producers around the world. (1) These effects are particularly important in developing countries, where agriculture makes a significant contribution to gross domestic product (World Bank, 2001) and insurance markets are underdeveloped or nonexistent. Recently, microinsurance and probabilistic seasonal forecasts have become available to help farmers manage climate risks in production. Although these tools are intimately related, work has not been done to formalize the fundamental connections between them. (2)

It is well known that climate risk can keep low-income households in poverty traps (see a review by Barnett, Barrett, and Skees, 2007). Lack of assets and risk exposure may lead households to forego activities with high returns, perpetuating their poverty. In response to this challenge, innovative insurance pilots to help farmers in developing countries have been gaining increasing interest (Hellmuth et al., 2009). (3) Recent studies analyze the potential of insurance in helping to escape poverty traps (Kovacevic and Pflug, Forthcoming).

Work in the agricultural economics literature has examined the relationship between insurance and input usage for both farm-level insurance (e.g., Ramaswami, 1993; Babcock and Hennessy, 1996) and index insurance (Chambers and Quiggin, 2000; Mahul, 2001). Focusing on the relationship between insurance and input use, this literature does not address interactions between insurance, climate forecast, and input decisions. Trade-offs between basis risk and moral hazard afforded by index-based products have been analyzed from an insurance company standpoint (Doherty and Richter, 2002).

Seasonal climate is predictable in many regions of the world (Goddard et al., 2001), with the El Nino Southern Oscillation (ENSO) linked to variations of seasonal precipitation (Ropelewski and Halpert, 1987). Work in agricultural and climate science has modeled the impact of probabilistic climate forecasts on production decisions (e.g., Hansen, 2002) but has, with few exceptions (Mjelde, Thompson, and Nixon, 1996; Cabrera, Letson, and Podesta, 2005), ignored the impact of insurance. (4)

Although yields and production practices are impacted by ENSO phases, this relationship is not built into existing insurance products. Insurance implementers acknowledge that climate forecasts may undermine the financial soundness of a product by providing opportunities for intertemporal adverse selection. The advocated strategies are to finalize insurance transactions contracts months ahead of time, before the forecast is informative (see, e.g., Hess and Syroka, 2005; World Bank, 2005), or allow insurance premiums to reflect forecast information (Skees, Hazell, and Miranda, 1999). Implementation of these strategies is undermined by the lack of a clear conceptual understanding about the interaction between seasonal forecast, insurance, and production decisions. Potential opportunities to exploit synergies may be being missed. Since the reinsurance industry uses probabilistic seasonal climate forecasts in pricing (Hellmuth et al., 2009), (5) it is important to understand forecasts and pricing from the perspective of the insurance company that must develop a product that: (1) results in products that provide value to farmers, unlocking consumer demand; (2) reflects fluctuating reinsurance costs; and (3) cannot be undermined through strategic use of forecast information. …

The rest of this article is only available to active members of Questia

Sign up now for a free, 1-day trial and receive full access to:

  • Questia's entire collection
  • Automatic bibliography creation
  • More helpful research tools like notes, citations, and highlights
  • Ad-free environment

Already a member? Log in now.

Notes for this article

Add a new note
If you are trying to select text to create highlights or citations, remember that you must now click or tap on the first word, and then click or tap on the last word.
One moment ...
Default project is now your active project.
Project items

Items saved from this article

This article has been saved
Highlights (0)
Some of your highlights are legacy items.

Highlights saved before July 30, 2012 will not be displayed on their respective source pages.

You can easily re-create the highlights by opening the book page or article, selecting the text, and clicking “Highlight.”

Citations (0)
Some of your citations are legacy items.

Any citation created before July 30, 2012 will labeled as a “Cited page.” New citations will be saved as cited passages, pages or articles.

We also added the ability to view new citations from your projects or the book or article where you created them.

Notes (0)
Bookmarks (0)

You have no saved items from this article

Project items include:
  • Saved book/article
  • Highlights
  • Quotes/citations
  • Notes
  • Bookmarks
Notes
Cite this article

Cited article

Style
Citations are available only to our active members.
Sign up now to cite pages or passages in MLA, APA and Chicago citation styles.

(Einhorn, 1992, p. 25)

(Einhorn 25)

1

1. Lois J. Einhorn, Abraham Lincoln, the Orator: Penetrating the Lincoln Legend (Westport, CT: Greenwood Press, 1992), 25, http://www.questia.com/read/27419298.

Cited article

Index Insurance, Probabilistic Climate Forecasts, and Production
Settings

Settings

Typeface
Text size Smaller Larger Reset View mode
Search within

Search within this article

Look up

Look up a word

  • Dictionary
  • Thesaurus
Please submit a word or phrase above.
Print this page

Print this page

Why can't I print more than one page at a time?

Full screen

matching results for page

Cited passage

Style
Citations are available only to our active members.
Sign up now to cite pages or passages in MLA, APA and Chicago citation styles.

"Portraying himself as an honest, ordinary person helped Lincoln identify with his audiences." (Einhorn, 1992, p. 25).

"Portraying himself as an honest, ordinary person helped Lincoln identify with his audiences." (Einhorn 25)

"Portraying himself as an honest, ordinary person helped Lincoln identify with his audiences."1

1. Lois J. Einhorn, Abraham Lincoln, the Orator: Penetrating the Lincoln Legend (Westport, CT: Greenwood Press, 1992), 25, http://www.questia.com/read/27419298.

Cited passage

Thanks for trying Questia!

Please continue trying out our research tools, but please note, full functionality is available only to our active members.

Your work will be lost once you leave this Web page.

For full access in an ad-free environment, sign up now for a FREE, 1-day trial.

Already a member? Log in now.