Basis risk in the pasture, rangeland, and forage insurance program: Evidence from California

Abstract

AbstractAgricultural producers who are reliant upon rangelands and pasturelands are some of the most vulnerable to weather‐related risk given their dependence on climate‐sensitive resources. Index‐based insurance products, like the Pasture, Rangeland, and Forage Insurance Program, are considered to be an adaptation strategy for mitigating climatic risks. Given that indices are imperfect predictors of losses, residual (basis) risk persists. This study quantifies basis risk and assesses insurance contract quality for nearly 63 million acres of rangelands in California. Basis risk can be summarized by considering false negative probabilities—the probability that an insured producer suffers a loss without receiving an indemnity payment. On California rangelands the false negative probabilities associated with one (both) of insured time intervals failing to indemnify a loss are 31% to 46% (14%–25%). When indemnities were paid, in 36% of the cases the payments are not sufficient to compensate for forage‐related losses; the average shortfall in indemnity‐related compensation ranged from $1.74/acre to $2.73/acre depending upon the location and underlying value of forage.