Jerry R. Skees

Designing and Rating an Area Yield Crop Insurance Contract

This article documents the design and rate-making procedures used in the development of the Group Risk Plan (GRP)—the new federal crop insurance product that insures based on area yield. The authors of this article worked closely with personnel in the Federal Crop Insurance Corporation and others in developing methodological and practical constraints needed in implementing a workable area yield contract. GRP indemnity payments are made based on percentage shortfalls in actual county yields relative to a forecasted yield. Historical county yield data are used to develop forecasted yields and premium rates. Copyright 1997, Oxford University Press.

Rate Making for Farm-Level Crop Insurance: Implications for Adverse Selection

This research identifies two problems in the new Federal Crop Insurance that may cause adverse selection: (a) the relationship between rate making and expected yields for individual farmers, and (b) the bias introduced in coverage protection when trends are not used to establish expected yields. A theoretical investigation using the normality assumption demonstrates the potential severity of these problems, and empirical results from farm-level data lend further support. As crop insurance changes to individualized methods of protection, these issues will be particularly important for developing rates.

Can Financial Markets be Tapped to Help Poor People Cope with Weather Risks

Poor households in rural areas are particularly vulnerable to risks that reduce incomes and increase expenditures. Most past research has focused on risk-coping strategies for the rural poor, specially on micro-level and household actions. These are risks that can been shared within a community or extended family. These strategies are effective for independent risks, but ineffective for covariate or systemic risks. The authors focus on private and public mechanisms for managing covariate risk for natural disasters. When many households within the same community face risks that create losses for all, traditional coping mechanisms are likely to fail. Such covariate risks are not uncommon in many developing countries, especially where farming remains a major source of income. The authors focus on risks related to weather events (such as excess rain, droughts, freezes, and high winds) that have a severe impact on rural incomes. Weather insurance could cover the covariate risk for a community of poor households through formal and informal risk-sharing arrangements among households that are purchasing these weather contracts. Given recent Mexican innovations targeted at helping the poor cope with catastrophe weather events, the authors use Mexico as a case study. In Mexico, poor households are exposed to systemic risks, such as droughts and floods, that affect the economic livelihood of their region. Catastrophic insurance is useful for small farmers, although commercially oriented small farmers may wish to obtain coverage for less catastrophic events. Weather insurance could meet this need. It pays out according to the frequency and intensity of specific weather events. Because weather insurance depends on the occurrences and objective measure of intensity of a specific event, it does not require individual farm inspection that can be very costly for small farm. The authors argue that a key issue of delivering insurance to small farmers is the existence of producer organizations. In Mexico, the farmer mutual insurance funds provide a good example. These funds provide insurance to their members by pulling together resources to pay for future indemnities and reinsures itself from major systemic risks that could hurt simultaneously all their members.

Poverty Traps and Climate Risk: Limitations and Opportunities of Index-Based Risk Financing

The objective of this paper is to frame the key issues and summarize the current state of knowledge about and innovations in index-based risk transfer products (IBRTPs) as they relate to the management of climate risk for poverty reduction, especially of chronic or persistent poverty. In the past several years, interest in and experimentation with weather index insurance and other IBRTPs has grown rapidly. Though no one should expect that these innovations alone can solve the problem of chronic poverty, index-based financing opens up a range of intriguing possibilities. The remainder of this paper is comprised of five major sections that discuss: 1) how weather risks and climate shocks impact the poor in developing countries; 2) the concept of poverty traps, highlighting how conventional risk management strategies typically do not work well for managing covariate weather risk; 3) the limitations and opportunities of financial innovations using index-based risk transfer products (IBRTPs) for reducing or transferring weather risks and climate shocks; 4) a poverty traps-based typology of IBRTPs; 5) key remaining challenges in developing and implementing index-based risk financing for use in the global struggle to end chronic poverty.

Innovations in Index Insurance for the Poor in Lower Income Countries

This article focuses on innovation in weather insurance designed to fit the special circumstances of the poor in lower income countries where rural and agricultural financial markets are largely underdeveloped. Index insurance is an innovation that circumvents many of the fundamental problems that hamper the development of insurance for weather risks in lower income countries. With index insurance, payments are made based upon an objective and independent index that serves as a proxy for significant losses to crops, livestock, or other property. For example, the index can be based upon extreme rainfall measures that create either drought or flooding. Weather stations or even satellite imagery coupled with computer models can be used to create reliable “indexes” as the basis of payments. This article reviews this innovation by providing the background for its development and the motivation for using the innovation for the poor.

Challenges for use of index-based weather insurance in lower income countries

This article offers some perspective on the progress and challenges of managing catastrophic weather risk in lower income countries through the use of index insurance. Innovations in insurance for natural disaster risk are critically important to help the rural poor improve their lives and to contribute to the overall economic growth in lower income countries. By reviewing lessons learned from various index insurance projects, several conclusions are made about how best to approach weather risk management to benefit the livelihoods of the rural poor. It is important to recognize the limitations of index insurance and that it is not a substitute for crop insurance. However, using index insurance to address catastrophic risk can serve as the foundation for the development of broader financial services by removing one of the major constraints to market development. This in turn can offer households more effective strategies for consumption smoothing in the face of different sources and magnitudes of risk.

Weather Information and the Potential for Intertemporal Adverse Selection in Crop Insurance

This study investigates the potential usefulness of early-season weather information in forecasting corn yields for the Midwest. To the extent that farmers are able to forecast yields prior to sales closing dates for crop insurance, farmers may use such information in deciding which years to purchase crop insurance and which years not to purchase insurance. Such intertemporal adverse selection would result in increased losses for the crop insurance program. Three yield forecasting models were developed using early-season weather information: (1) simple weather forecasts; (2) yield-weather regression models; and (3) yield-weather discriminant functions. This study presents procedures that would allow farmers to predict low corn yields before the purchasing deadline of corn insurance on 95 percent of planted acreage in the Midwest.

El Nino-Southern Oscillation-based index insurance for floods: Statistical risk analyses and application to Peru

Received 23 June 2006; revised 18 June 2007; accepted 3 July 2007; published 17 October 2007. [1] Index insurance has recently been advocated as a useful risk transfer tool for disaster management situations where rapid fiscal relief is desirable and where estimating insured losses may be difficult, time consuming, or subject to manipulation and falsification. For climate-related hazards, a rainfall or temperature index may be proposed. However, rainfall may be highly spatially variable relative to the gauge network, and in many locations, data are inadequate to develop an index because of short time series and the spatial dispersion of stations. In such cases, it may be helpful to consider a climate proxy index as a regional rainfall index. This is particularly useful if a long record is available for the climate index through an independent source and it is well correlated with the

Enhancing microfinance using index-based risk-transfer products

While significant progress in microcredit and microfinance has been made in low‐income countries, lending for small farming enterprises has been limited. This article reviews how innovative index‐based risk‐transfer products (IBRTPs) can be used to transfer the correlated natural disaster risks that often hamper the development of farm‐level microcredit. By linking lending to IBRTPs, access to microcredit can be enhanced while also providing opportunities to offer mutual sharing of the basis risk that remains after correlated risks are transferred into global markets. This opens the way for new thinking about developing agricultural insurance in low‐income countries.

A role for capital markets in natural disasters: a piece of the food security puzzle

Abstract Natural disaster can create significant shocks in food supplies for small country-states. These events are very disruptive to the development process. Market-based means for managing natural disaster risk are emerging. For example, despite the failure of government-subsidized crop insurance around the world, it is now possible to create index-based contracts that would trigger when events that create serious crop failure problems occur. This paper investigates the logic for such contracts and some basic designs using measures of rainfall.