Paper: Improving the Quality of Index Insurance with a Satellite-based Conditional Audit Contract

While index insurance offers a compelling solution to the problem of covariant risk among smallholder farmers in developing countries, most weather-based contracts have suffered from poor quality. This paper demonstrates that a contract based on satellite data combined with a second-stage conditional audit has the potential to improve index insurance quality.

The analysis is based on a welfare-based metric for quantifying index insurance quality and use this to identify an optimal audit trigger. Using plot-level panel data of 323 smallholder rice farmers in Tanzania, the simulation results indicate that demand for the conditional audit contract is 36% under reasonable assumptions, while demand for a satellite-only contract is 22%. Overall, these results indicate that in data-scarce environments where area-yield contracts are infeasible, a satellite-based conditional audit contract may be superior to standard index insurance contracts.