The Economics of Weather
Weather Insurance and Derivatives
How weather-based crop insurance pays farmers based on rainfall or temperature readings, and how firms hedge weather risk with weather derivatives.
Weather risks can be insured.
Weather-based crop insurance
- Pays based on rainfall or temperature readings, not assessed damage.
- India’s Restructured Weather Based Crop Insurance Scheme (RWBCIS) offers this.
Advantages
- Fast payouts.
- Less fraud and fewer disputes.
Basis risk
A farmer’s field may suffer even when the weather station records normal rain: this is basis risk.
Weather derivatives
Firms like power companies buy derivatives that pay out if temperatures are unusually warm or cold. The Chicago Mercantile Exchange lists weather futures.
More stations
More weather stations reduce basis risk.
The rainfall payout
When rainfall in a block falls below a threshold, insured farmers automatically receive payouts.
Thinking weather insurance always matches losses
Basis risk can cause mismatches.
Key takeaways
- Weather insurance pays based on readings.
- Payouts are fast.
- Basis risk is a drawback.
- Firms hedge with weather derivatives.
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