The optimal drought index for designing weather index insurance

Climate change increases the need for better insurance solutions that enable farmers to cope with drought risks. We design weather index insurance using drought indices based on precipitation, soil moisture and evapotranspiration as underlying drought index and compare their risk-reducing potential for winter wheat producers in Eastern Germany. In general, we find that all drought indices can reduce financial risk exposure. However, the largest risk reduction can be achieved if the underlying drought index is tailored individually for each farm. This implies that insurers should offer insurance with farm-specific underlying drought index.

Automated summary

Climate change increases the need for better insurance solutions for farmers to cope with drought risks. Weather index insurance based on different drought indices can reduce financial risk exposure for winter wheat producers in Eastern Germany. Tailoring the underlying drought index individually for each farm can achieve the largest risk reduction, implying insurers should offer farm-specific underlying drought index insurance.