Environmental shocks are drivers of poverty as well as a fact of life in many rural areas of the developing world. In the developed world, agricultural insurance provides protection from such calamities. But conventional insurance products have not reached many rural households in developing countries due to the high costs of gathering information relative to the size of policies demanded and well-known moral hazard and adverse selection issues that complicate product design and pricing.

Recently, there has been much excitement around the use of index-based insurance as an alternative to conventional insurance products that may extend the rural poor’s access to formal insurance coverage in developing countries (Alderman & Haque 2007; Barnett, Barrett & Skees 2008; Mahul & Stutley 2010). Index insurance provides indemnity payments based on a signal that is related to covariate losses rather than actual and observed individual losses. When signals are chosen properly—easy to observe, exogenous, highly correlated with the insured risk—suppliers of index insurance face much fewer costs associated with adverse section, moral hazard monitoring, and validation of claims than they would if they were offering conventional policies.

Read the full blog post by Nathan Jensen, a Postdoctoral Associate at Cornell’s Dyson School working with the Index  Based Livestock Insurance (IBLI) project at the International Livestock Research Institute (ILRI).