Can revenue index insurance outperform yield index insurance?

Abstract

Index insurance programs in developing countries have focused almost entirely on agricultural production risk (i.e., yield) while largely avoiding output marketing risk (i.e., price). This omission may miss an important constraint on smallholder investment and may partially explain underwhelming demand for yield-based insurance policies. Here, we explore the viability of an area-revenue index insurance policy and how its performance may compare to that of an area-yield index insurance policy. Using data from Ghana, we estimate reduced-form regression analysis and calibrate a simulation model, generating several important results. We show that there is a negative correlation between farm investment and covariate price risk. Moreover, our simulation predicts that in many market contexts, area-revenue index insurance suffers from less basis risk, exhibits higher demand, and is more effective at crowding in advanced input adoption compared to area-yield index insurance. Our results also demonstrate important contexts in which area-yield index insurance outperforms area-revenue index insurance. We therefore find that revenue insurance may be a valuable and impactful product in Ghana but would not outperform area-yield index insurance in all contexts.