With index-based insurance, payouts are related to an “index” that is closely correlated to agricultural production losses, such as one based on rainfall, yield or vegetation levels (e.g. pasture for livestock).
To ensure that a given claim is legitimate, time and resources must be allocated to adequately audit the losses or damages incurred from an event.
Production relies on natural conditions, such as rain, temperature, and sunlight, which cannot be controlled easily by poorer farmers, other than by those with access to irrigation or plastic tunnels in the case of horticultural crops.
This can reduce some administrative and implementation costs, and also has the potential to limit payouts caused by fraud or poor farming practices.
Index-insurance could be used to cover the potential economic losses that might occur with water supply disruptions and similar perils that are heavily influenced by weather conditions.
The use of index insurance by financial institutions and farm input suppliers who extend credit to low income farmers in developing countries may be a more cost-effective use and enable such bulk buyers of insurance to hedge against default by farmers and thus continue to deal with those who have a high risk of defaulting.
Reducing basis risk by incorporating newly upcoming data sources is of central interest in current research.
[12] Offsetting that, ICTs, particularly smartphones, are reducing costs, while increasing use of satellite measurements for the purposes of index development has also been effective.
[8] Subsidies can reduce index insurance premiums to be moderately viable on the market, but there is still low uptake of the product amongst smallholders.
One method of combating this procrastination is by collecting insurance premiums directly after growing seasons when farmers would have the highest capacity to pay.