What are the advantages and disadvantages of index insurance?
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| Advantages of Index Insurance | Disadvantages of Index Insurance |
| Adverse selection and moral hazard are minimized. The payout is based on an objective index that the farmers or insurers cannot influence. | Basis risk can arise if an individual insured’s loss experience does not correlate with the index payouts. In this case, some households that experience loss may not receive compensation while some who suffer no loss receive insurance payouts. |
| In the long term, once product structures have been standardized and most administrative processes, automated, administrative costs are reduced which offers the potential for lower premiums. For example, an insurance company does not need to conduct pre-inspections on individual farms or to assess individual grower in-field area losses, which is time-consuming and costly. In particular, transaction costs of index insurance can be significantly reduced with meso/portfolio-level approaches (eg.with microfinance institutions and agribusinesses) as opposed to micro-level direct sales to individual farmers. |
There is a lack of high quality weather and yield data in many developing countries. Ideally, 20-30 years of historical weather data is needed to allow product design teams and risk carriers to perform robust actuarial analysis and product pricing.
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| Timeliness of payouts after an event is improved, as an insurance company does not need to assess individual grower in-field area losses. This advantage is particularly true with weather station indexes and satellite indexes. | In most developing countries, there is not an enabling environment for index insurance. The GIIF Team is invested in working with government ministries and regulatory agencies to develop the requisite laws and regulations to govern the index insurance market and to allow it to grow. |
| In the early years of each market, a lot of financial and human capital is required before standardized products and systems can be developed. The products are technically complex and yet they have to be packaged in a way that is understandable by most people. Awareness-raising activities have been a sizeable component of pilot start-up costs in developing countries. |