Basis Risk Valuation Sensitivity
RCTClinical Trial
Index insurance products eliminate moral hazard and administrative claims verification, but introduce spatial basis risk when reference weather stations are situated far from insured agricultural plots.
Picture this
Imagine buying a fire insurance policy where the heat sensor is installed in the next town over; if a fire destroys your house but fails to trip the distant sensor, you receive zero compensation despite paying your premiums.
What the evidence says
Assigning an insurance contract to a distant rainfall station reduced mean willingness to pay by 29.45 Rupees (p < 0.01), cutting baseline policy valuation (68.4 Rupees) roughly in half.
- Who was studied
- N = 1,978 smallholder farmers across Mahbubnagar and Anantapur districts, Andhra Pradesh, India.
- How
- Incentive-compatible Becker-DeGroot-Marschak (BDM) mechanism eliciting willingness to pay for index policies linked to local versus distant rainfall stations.
What to do
Deploy dense networks of automated weather stations or satellite-derived rainfall indices to reduce distance-induced basis risk before marketing index insurance to smallholder producers.
From the source
"Finally, the coefficient on the indicator for the policy that induces substantial basis risk is negative and very large, roughly halving farmers' willingness to pay for policies."
How Does Risk Management Influence Production Decisions? Evidence from a Field Experiment