Index insurance benefits agricultural producers exposed to excessive rainfall risk

Abstract

Managing the risks of climate variability on crop production is central to ensuring financially viable farming systems and sustainable food production. Insurance provides a mechanism to manage and transfer climate risks. However, traditional multi-peril crop insurance (MCPI) is often too expensive and so other methods, such as index insurance, are being explored as a cheaper way to insure farmers against climate induced crop losses. Here we investigate the potential financial benefits of index insurance (protecting against excessive rainfall) for agricultural producers, namely sugar cane farmers in Tully, northern Australia. We used 80 years of historical climate and yield data to develop an excessive rainfall index. The index was developed and tested using generalized additive regression models (allowing for non-linear effects) and quantile regression, which allows relationships with lower quantiles (i.e. low yield events) to be assessed. From the regression models we derived relationships between the excessive rainfall index and sugar cane yield losses that were converted to insurance fair premiums (i.e. premiums that cover expected losses). Finally, we used efficiency analysis, based on Conditional Tail Expectation (CTE), Certainty Equivalence of Revenue (CER) and Mean Root Square Loss (MRSL), to quantify financial benefits to farmers if they purchased excessive rainfall index insurance. The regression model predicted sugar cane yields well (cross-validated R2 of 0.65). The efficiency analysis indicated there could be financial benefit to sugar cane farmers if they were to use excessive rainfall index insurance. Index insurance (based on the assumption of a fair premium) could make farmers better off by $269.85 AUD/ha on average in years with excessive rainfall (i.e. years with rainfall over the 95th percentile). Index insurance could offer a viable method for managing the financial risks posed by excessive rainfall for sugar cane producers in northern Australia. We are not aware of any other study demonstrating the potential benefits of excessive rainfall index insurance in the literature, but our results suggest this type of insurance may be viable for sugar cane producers, and other crops, in parts of the world where extreme rainfall poses a risk to the financial sustainability of production.