Crop Insurance as a Risk Management Strategy in Bangladesh

Methodology to develop an index in that case is possible by providing a weight factor for
each of the hydro-climatic variables as follows;
Index = (Rainfall deficit / Target rainfall)*(Runoff deficit /Target runoff)
Or, = 0.3*(Rainfall deficit/Target rainfall) + 0.25*(Runoff deficit /Target runoff)
+ 0.25 (GW level fall/Target GW level)
Quantifying the Loss
Once the index has been identified, it must be calibrated to capture the financial impact of the
specified weather exposure as measured by the index. Two approaches are possible at this
stage: identifying the financial exposure per unit of the defined index, and/or establishing the
limit, the total financial protection, required per risk period, that is, the maximum payout
necessary in a worst-case scenario. The approach chosen depends on the nature of the
underlying index and weather event. If the weather exposure is event driven, for example,
such as a Category 5 hurricane hitting a particular location or a cold winterkill event
destroying an entire wheat crop, the latter approach is more appropriate. If the weather
exposure is of a cumulative nature, such as drought the former approach should be chosen.
Unit Exposure
In designing an index, expert scientific agrometeorological assessments, either in conjunction
with crop model output or with verification using historical yields, used to be employed that
best proxies the weather sensitivity of the crop in question. After developing weather indexes
to capture the impact of adverse weather conditions on a specific crop’s yield, it is
straightforward to calculate the financial impact of these events for producers. Having
identified the index, the crop yield, Y, or volume, V, variability per unit of the defined index, I,
can be defined, as follows:
∆Υ = ∆V / H = a(I) ∆I
where, a(I) is some function of I that relates the index to the yield Y, and H is the planting
area of the crop. In order to calibrate an appropriate weather contract, the variation in crop
yield must now be converted into a financial equivalent that mirrors the producer’s exposure.
This can be done, for example, by considering a producer’s production and input costs per
hectare planted or by considering his expected revenue from the sale of the crop at harvest.
Producers with fixed-price delivery contracts or those using price risk management
instruments to protect themselves from market fluctuations in the price of their crop at
harvest time know the financial value of each kilogram or metric ton they produce and hence
can quantify the financial cost of a shortfall in production. If a grain producer, for example,
knows he will receive $X per metric ton of crop, the following relationship must hold for his
change in revenue:
A good weather hedge must offset the negative ∆ �Revenue fluctuation in the event of a drop
in yield from budgeted levels if a producer is to protect his earnings. In order to perfectly
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