One of the more promising proposals for reforming the federal crop insurance program calls for both premium rates and indemnities to be based not on the producer's individual yield but rather on the aggregate yield of a surrounding area. Area-yield crop insurance can provide more effective yield-loss coverage than individually tailored insurance, without most of the adverse selection and moral hazard problems that have historically undermined the actuarial performance of the federal crop insurance program.

Unlike conventional insurance, which indemnifies policyholders for verifiable production losses arising from multiple perils, index insurance indemnifies policyholders based on the observed value of a specified “index” or some other closely related variable that is highly correlated with losses. Index insurance exhibits lower transaction costs than conventional insurance, potentially making it more affordable to the poor in the developing world. However, it also offers less effective individual risk protection. This article provides a review of recent theoretical and empirical research on index insurance for developing countries and summarizes lessons learned from index insurance projects implemented in the developing world since 2000.

Without affordable reinsurance, private crop insurance markets are doomed to fail because systemic weather effects induce high correlation among farm-level yields, defeating insurer efforts to pool risks across farms. Using an empirical model of the U.S. crop insurance market, we find that U.S. crop insurer portfolios are twenty to fifty times riskier than they would be otherwise if yields were stochastically independent across farms. We also find that area yield reinsurance contracts would enable crop insurers to cover most of their systemic crop loss risk, reducing their risk exposure to levels typically experienced by more conventional property liability insurers. Copyright 1997, Oxford University Press.

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