Despite their compelling logic, index insurance contracts that transfer risk from smallholder farmers and pastoralists have met with sometimes indifferent demand and low uptake by the intended beneficiary populations. While discouraging the ever‐mounting evidence that risk plays an important role in the creation and perpetuation of rural poverty demands further efforts to solve this problem. This paper explores whether, when and how index insurance can enhance the functioning of agricultural credit markets and enhance farmers’ expected income even as it reduces the variance of income.