Agricultural weather index insurance (WII) has been introduced in pilot or experimental form in many countries. However, the effective demand for WII is often limited by the impact of the basis risk. Thus, the purpose of this paper is to propose a new type of double trigger product, named “supplement” type, to reduce basis risk and improve the performance of the standalone WII.
Two measures of performance are introduced by the certainty equivalent income of expected utility theory. Through the Monte Carlo experiments and empirical study, this paper compares the performance of three types of double trigger products.
The findings indicate that the supplement type can significantly improve the performance of the single weather index product. First, it covers the downside basis risk and the catastrophic basis risk when the standalone WII fails to do so, especially in case of extreme losses. Second, it is superior when the correlation between the weather index and the yield index is not so strong, and can further enhance the performance of insurance even when the weather index and the yield index are highly correlated, for which the standalone WII could perform well.
The supplement type double trigger product proposed in this paper as an enhancement version finds a more preferable way to improve the standalone WII with relative lower complexity.
