Evaluating Alternative Drought Indicators for Risk Management via Index Insurance

Weather and climate indicators, if relevant to risk analysis and management, can improve response and resilience to environmental extremes. Weather-based index insurance is a promising strategy for hazard mitigation in agriculture and other areas. Basing payouts on an indicator avoids many costs associated with loss-based insurance and has potential to expand risk protection to a wider demographic. Index insurance is efficient only if the indicator correlates with loss. Indicators for drought are mostly based on precipitation, even though drought indices based on multiple factors that would, theoretically, provide more accurate indications of impacts exist. Therefore, we analyze the feasibility of using drought indices as the basis for insurance coverage by incorporating several into an existing rainfall index plan and simulating historical payouts. Using a variety of autoregressive and multi-scalar indices, we demonstrate that they have the potential to reduce the risk of both non-payment during drought and payment during non-drought.