Weather Derivatives – A Need for Indian Farmers?

Weather affects the performance of many industries/ sectors. The notable examples are agriculture and energy. The weather sensitivity sometimes results in huge financial losses. Financial engineering thus came up with solutions like weather insurance and weather derivatives.

Weather Insurance products have been targeted at and sold to the farmers of India - but the success of these remains questionable. The reason for the failure could be attributed to lack of clarity/ awareness about the product, infrastructural issues and inherent issues with the category of insurance products.

Weather derivatives, in comparison, are a new class of products. Though, they are virgin to Indian soil, these have been successful abroad. Weather derivatives are regarded a better, low-cost, sustainable alternative system of agriculture risk management. These contracts can be designed with good deal of flexibility to help farmers manage drought risk by making a payment when rainfall in a given period goes below a certain pre-agreed level. Besides the developed countries, these contracts are already in operation in some developing countries, too, for instance, Morocco, Mexico, Ukraine, Mangolia, and Romania due to their numerous advantages. The derivatives cover events with highly probability or low risk - which insurance does not cover. Also, the problems of adverse selection and moral hazard are not seen in derivatives.

This paper aims to compare and contrast the concepts of weather insurance and weather derivatives. Taking a cue from the episode of weather insurance, the article suggests ways that might lead to the success and widespread acceptance of weather derivatives in India.