Index-Based Insurance: Types, Benefits, And Solutions

What Is Index-Based Insurance?

Index-based insurance is an innovative concept for evaluating agricultural risks and payouts using a set index or index combination instead of traditional on-site loss assessment. Costly distribution, claims processing, and other frictional expenses make traditional crop insurance products expensive for both insurers and their clients. Claim processing delays can add months to the time between submitting a claim and receiving payment, which is especially problematic in emerging economies.

In light of this, a new, parametric approach emerged to optimize crop insurance products through the application of reliable current and historical data, advanced agricultural technology, and smart product design. Farmers can ensure their financial security by acquiring parametric insurance against climate change, severe weather events, or other circumstances beyond their control. Here, indicators (such as precipitation, humidity, temperature, or vegetation index) substitute for direct measurements of agricultural loss in an area. A payout is issued to the farmer if the insurance index drops below a set threshold, signaling poor crop development conditions.

Parametric insurance comes in several types:

• The indemnity in area-yield index insurance is calculated using the average yield that was harvested in a given region. The insured yield typically ranges from 50% to 90% of the local average. If the average yield in the area falls short of the insured yield, the policyholder receives an indemnity.
• Crop weather index-based insurance uses the long-term average of a chosen weather parameter at a designated meteorological station or satellite network to calculate compensation. Drought, flooding, extremely hot or cold temperatures, high winds, and hail are all examples of index deviations that can be insured against. When the actual index value either surpasses or falls below a set threshold, indemnification is provided. To calculate index-based compensation, multiply the agreed-upon sum per unit by the realized unit value.
• In satellite index-based insurance, indices are built from satellite imagery time series. This type of index-based coverage integrates knowledge from the fields of climatology, agronomy, economics, and remote sensing to create usable data sets for crop protection. For instance, the International Research Institute for Climate and Society (IRI) and NASA are working together on a satellite index-based project that will have an impact on thousands of index insurance-holding farmers across Africa ^{Mann, B., Stanimirova, R. Using Satellite Data to Improve Index Insurance. International Research Institute for Climate and Society (IRI).}.

How Index-Based Insurance Benefits Farmers

Poor weather, pests, and crop diseases put farmers, especially smallholders, at a significant disadvantage, which often results in a cycle of poverty. Before the advent of index-based insurance, they had very limited options for protecting their crops and income from the effects of natural calamities. The following are some examples of how index-based crop coverage proves beneficial for farmers.

Less Paperwork And Easier Claim Processing

With an index-based approach, intricate claim completion and processing are unnecessary. The use of predefined parametric triggering insurance indicators speeds up and simplifies the payout process and improves the productivity of both farms and insurance agencies.

Prompt Payouts

Claims submitted under conventional crop coverage may require onsite checks and evaluations, adding delays, while index-based claim processing may be almost immediate. The speed of payout distribution is critical here since farmers who have suffered losses need relief money as soon as possible so they can get back on their feet.

Decreased Basis Risk

Basis risk occurs when a farmer’s real losses differ from the index used to determine the payout. Although index-based insurance cannot completely eradicate this risk, it has the potential to minimize it. Index-based coverage plans can better reflect farmers’ actual risks by opting for indices linked to agricultural output and local weather patterns.

Affordability

Index-based insurance is usually more affordable than conventional. By using predefined indices, insurers can provide coverage to more farmers at lower rates.

Improved Risk Management

While traditional risk management systems offer a structured approach to financial risk control, their effectiveness in handling severe dangers and calamities, particularly in developing nations, is low ^{WEATHER INDEX INSURANCE FOR AGRICULTURE: Guidance for Development Practitioners. (2011). The International Bank for Reconstruction and Development / The World Bank.}. With index-based insurance, farmers can be more strategic in their production planning, applying inputs, and making investments if they have some sort of failsafe in case of crop failure due to severe weather risks, pests, or diseases. Agricultural index-based insurance encourages the development of more effective approaches to managing risk in agribusiness and supports the long-term viability of farming.

Easier Access To Credit

Index-based insurance for agriculture helps farmers have easier access to credit. Having parametric insurance coverage in place makes lenders more comfortable providing loans to farmers. As a result, more farmers will be able to take advantage of the services offered by financial institutions like banks and credit unions.

How Parametric Insurance Benefits Insurers And Financial Institutions

Insurance companies and banks benefit from index-based crop insurance since it lowers their administrative costs and credit risks, boosts repayment capacity, attracts new customers, and encourages ecologically conscious agriculture. Let’s take a closer look at each of these advantages.

Reductions In Administrative Costs

In index-based insurance, payments are linked to specified indices, eliminating the need for in-depth on-site audits. This allows index-based coverage providers to cut overhead while also speeding up the claims process and improving overall efficiency.

Limiting Financial Risks

Lenders in the agriculture sector face a serious risk due to the uncertain nature of crop production and the associated possibility of financial losses. With index-based crop insurance, farmers can protect themselves financially in the event of a crop failure. As a result, banks and other lenders will feel more comfortable extending financing to farmers.

Diversification Of Product Range

Financial institutions can expand their product lines with index-based crop insurance. They have an opportunity to increase their customer base and diversify their product offerings by catering to the specific coverage needs of farmers.

Workflow Optimization In Key Departments

With index-based insurance, key departments can streamline their operations for greater productivity, lower costs, and higher levels of client satisfaction in the following ways:

• Underwriting department. Index-based insurance data, like the satellite data EOSDA supplies, facilitates the examination of client applications. It is no longer required to rely on questionable sources and double-check the facts with official figures to confirm a field’s productivity. With the help of EOSDA Crop Monitoring, you can easily gather the reliable data you need to evaluate crop productivity.
• Claims department. Within an index-based approach, the claim can be processed without sending out scouts to verify the crop’s condition. With features like weather analytics and vegetation indices, precision agriculture platforms have you covered from every angle.
• Risk management department. Index-based insurance allows for better risk assessment. If there are no yield statistics for the region, historical satellite images and meteorological records may provide the insurer with the missing data.

Promoting Sustainability At The Farm-Level And Global Scale

The only sustainable approach to managing and even decreasing poverty rates is a system based on resilience that incorporates index-based crop insurance to protect farmers against hazards ^{How Agricultural Index Insurance Can Promote Risk Management and Resilience in Developing Countries. Feed the Future Innovation Lab for Markets, Risk and Resilience, University of California, Davis.}. Farmers are better equipped to make strategic decisions about resource allocation and agricultural practices when the financial risks they face due to weather or other external causes are mitigated. This way, index-based coverage promotes sustainable farming and aids the long-term goals of financial institutions.

Using EOSDA’s Capabilities To Improve Parametric Insurance Solutions

If your company is looking to expand its product line through the use of parametric insurance or other index-based services, EOSDA is here to help. From ready-made solutions to advanced data and custom software capabilities, we have it all to suit your specific needs in the field of index-based insurance.

Historical Weather Data Spanning Various Parameters

Our platform and API give you access to weather records dating back to 1979, allowing you to more accurately estimate the risk associated with adverse weather events on a certain farm. For agricultural weather-index insurance against hail, drought, flood, crop fire, and cold, we provide you with details on a variety of factors, including the following:

• Accumulated precipitation, precipitation type and probability are factors to consider for determining the payout threshold in a rainfall or drought index-based coverage plan.
• Minimum and maximum temperatures, as well as mean temperatures over the past decade, can be used in weather index-based insurance for agriculture to predict the risk of cold or heat stress in plants, drought, and crop fires.
• Using historical hail information, you can trace where hailstorms have occurred and where they are most likely to strike in the future.
• Knowing the snow line and the probability of snow cover will be particularly useful when using an index-based method to insure winter and perennial crops.
• Heavy rain, incessant rain, snow, wind, and thunderstorm warnings may indicate when the insured event happens.

Diverse Vegetation Indices For Different Insurance Cases

EOSDA offers more than 15 satellite-based vegetation indices, which you can use to craft your index-based insurance programs for farmers. Since EOSDA is an independent service provider not tied to any insurance companies, you can rest assured that the information you receive is accurate and unbiased. Instead of being modeled, the provided data for index-based planning reflects the actual state of the insured fields and is processed and analyzed in near real time.

Choose tools that will be best suited for each insured case by considering the crops grown, their development stage, local climate, terrain, and many more factors. Get immediate alerts when insured events occur, verify claims, and facilitate the calculation of payouts by using different indices at different plant growth stages, for instance, MSAVI at the start of the growing season, NDVI during the active crop growth stage, and NDRE during crop maturity.

Too high or too low of an index value may indicate an issue that can be compensated if the cause is beyond the farmer’s control. Armed with index-based data about vegetation, you can avoid moral hazards and discard invalid or fraudulent claims.

Turnkey Solution For Insurers And Insured Farmers

With EOSDA Crop Monitoring, a ready-made precision agriculture platform, both the insured farmer and the insurer can always have full access to all the index-based data necessary for decision-making.

How does this benefit insurance companies? The platform warns farmers about potential problems in their fields in near-real time. So if the farmer took the appropriate safeguards to minimize losses, the insurer would pay very little to nothing. And if the farmer did hardly anything to rectify the situation, there’s no basis for a compensation claim.

This way, the platform serves as a signal for action in case of any undesired crop changes and a supplementary tool in determining index-based insurance payout by illuminating the farmer’s in-field actions and their impact on the development of the crop.

Insure A More Sustainable Agricultural Future With Parametric Approach

Index-based crop insurance equips farmers to secure their livelihoods and follow sustainable agriculture practices by offering timely and individualized coverage against unpredictable weather events and other uncertainties. A more financially stable and technologically advanced agricultural sector can better withstand the effects of climate change.

Expand your index-based product line by meeting the demand for sustainability with the help of EOSDA’s tailored solutions. With their assistance, farmers and financial institutions have all the information they need to make data-driven decisions that will result in higher yields in the long run. For instance, the Yield Prediction solution provides insurers with accurate yield predictions for each customer to minimize financial risks. And the Remote Harvest Dynamics Monitoring solution enables them to obtain index-based reports on the actual state of crops, cross-validate information, and spot discrepancies.

Contact our knowledgeable sales team at sales@eosda.com to explore additional details on index-based crop insurance and start planning for a more secure agricultural future.

Published: 26.07.2023