Insurance paid on the basis of rainfall is cost-effective and complements caste-based support networks.

Agriculture is a particularly risky business. Unpredictability in crop output stems from pestilence, price volatility in markets, and natural disasters. In India, it is estimated that about 90 per cent of the variation in production levels is caused by changes in rainfall levels and patterns.

To cope with this variability, innovative, index-based weather insurance products have come to the fore. Payouts are based on a publicly observable index, such as local rainfall.

Tying payouts to rainfall implies that the insurance company is not affected by any particular farmer’s actions or risk profile. It also eliminates the need for in-field assessments, in the process lowering the cost of providing insurance.

While the market for such insurance products has not really developed in rural India, this does not imply that poor farmers are currently uninsured. Rural populations are dependent on their caste, or jati-based networks to manage risk.


Rural households informally insure each other through gifts and loans to cope with both agricultural risks and household-specific risks, such as death, illness, or theft. Such pre-existing informal risk sharing may affect the market for index insurance.

To understand these interactions, a collaborative research team from Centre for Micro Finance at IFMR, Agricultural Insurance Company of India, and Yale University, conducted a field-based study in which they marketed a monsoon insurance product to approximately 5,000 farmers in the States of Tamil Nadu, Andhra Pradesh and Uttar Pradesh.

The product was designed to be very simple — it pays out increasing amounts with greater delays in the onset of the monsoon.

This research studies the demand for, and effects of, offering formal index-based rainfall insurance. It randomises offers of insurance to a group of farmers. The nature and extent of their pre-existing jati-based informal risk-sharing was carefully measured by the researchers. Another unique feature of this study was that the weather insurance product was marketed to households engaged in agricultural labour activities, in addition to land-owning cultivators.

This is important because the income of agricultural labour is just as dependent on seasonal weather patterns, but this group has traditionally been excluded from insurance marketing.

In Andhra Pradesh and Uttar Pradesh, there was almost an equal demand for the insurance product among cultivators and agricultural labourers (43 per cent and 40 per cent, respectively). This is in spite of the fact that farmer households on an average typically earn 25 per cent higher incomes. The demand demonstrated reflects a largely untapped market of customers traditionally excluded from the formal insurance market. These results hold particular relevance for households involved in both small-scale farming operations and agricultural labour activities.


In response to a question on why the households that rejected our offer chose not to purchase the insurance product, the primary barrier cited was current liquidity constraints (i.e. insufficient current cash holdings). Other demand constraints commonly cited were: ‘not trusting insurance’; having a premium price which was ‘too expensive’. These responses were not significant, together comprising only 13 per cent of responses.

One way to combat household liquidity constraints would be to market the insurance to farmers during seasonal periods when their income is high, for example, at the end of the rabi season.

In fact, marketing campaigns targeted during the rabi season could significantly benefit farmers for two reasons. First, as farmers would have ‘cash on hand’ from the sale of rabi crops, their liquidity constraints would be reduced.

Second, since this would also be the time when farmers take planting decisions concerning kharif crops, they could consider their insurance coverage while making their investment choices. This is significant, as knowledge of owning insurance can potentially alter their choices regarding which crops to cultivate.

The study also finds that farmers are less willing to purchase insurance when the automatic weather station (AWS) measuring the rainfall to calculate payouts is farther away.

When the AWS is situated far away from the farmer’s own plot of land, the rainfall measured by the insurance company may not closely track the rainfall conditions in the farmer’s village. This imperfection in the product is known as “basis risk”. Basis risk lowers the demand for insurance.

In our study, constructing some AWSs in the specific villages where the insurance product was marketed led to increased demand.

This suggests that the value of index insurance products could be significantly improved by building more AWSs where the index (rainfall, or the onset of monsoon) can be reliably measured.

Finally, the study indicates that when particular jatis (or sub-castes) are already good at providing informal coverage against village-level rainfall shocks (e.g. because the jati is diversified, and many jati members are engaged in non-agricultural occupations), members of those jatis are less likely to purchase the rainfall insurance product.

The informal network and the formal insurance product are substitutes in that case. On the other hand, where the jati network is particularly good at providing support following household-specific losses (such as death, illness, theft), members of those jatis are more likely to purchase index insurance, especially when that insurance product carries more basis risk (and can therefore fail them when they sometimes need help). Here, informal risk-sharing of a certain type can complement the market for index insurance.

In summary, index insurance is a positive market innovation that can lower the transaction costs of selling the product and calculating payouts. But it also introduces new challenges, such as basis risk.

Pre-existing informal risk-sharing arrangements, such as jati networks in India, clearly condition the demand for such products, and can limit the detrimental effects of basis risk. Finally, we see clear evidence of demand for insurance among agricultural labour households, a group that has traditionally been excluded from the insurance market.

The detailed results of this study can be found at

(The authors are with Institute of Financial Management and Research, Chennai.)

(This article was published on November 12, 2012)
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