A Minimum Quality Standard to Ensure Index Insurance Contracts Do No Harm

However, this is only true of high-quality contracts. The quality of an index insurance contract is a hidden trait, and the quality of index insurance products is unregulated. This gives households no way to tell whether a contract will leave them worse off than if they had no insurance at all. The AMA Innovation Lab has used standard economic and statistical tools to develop a measure of index insurance quality that can be used to establish an objective Minimum Quality Standard (MQS) for index insurance. This measure calculates an index insurance contract's market price, average risk, potential payouts, and farmer income/consumption into a comparable expected utility value. Comparing the value of having index insurance and having no insurance at all establishes whether a specific contract meets what is called a "Minimum Quality Standard." The purpose of insurance is to leave farmers better off than if they had no insurance at all. A Minimum Quality Standard based on the simple comparison of the index insurance quality measure's expected utility value provides a clear and objective definition of when—at a minimum—a contract is likely to leave farmers better off. A good contract should of course exceed this minimum standard and make farmers much better off than if they had no insurance. Using the tool requires historical data on the index measure and yields that are needed to develop an index insurance contract, as well as historical data on household income/consumption. The stakes for index insurance quality are high. When an index insurance contract fails, a farmer faces a crop loss in addition to the money spent on insurance. The situation is especially dire if having insurance motivated her to take out a loan to invest in higher productivity. In a bad year, she would lose all her income and have no way to repay the loan. Without a certification for quality, it can take years before a catastrophe makes the difference clear. By then it's too late. Establishing how to objectively measure index insurance quality and defining a minimum standard is only the first step. Because there is no inherent incentive for high-quality contracts, the next steps involve the broad adoption of a certification to ensure that index insurance products available to smallholder agricultural households meet a Minimum Quality Standard. Examples of systems that could work involve a body of technical specialists who conduct objective tests for levels of quality that meet government or donor regulatory requirements.