Developing decision rules for the Rainfall Index insurance program: An application to Pennsylvania producers

This study analyzed a pilot insurance program for pastures, rangeland, and forage called Rainfall Index (RI-PRF). It is designed as a risk management tool to insure against declines in the accumulated rainfall index within a geographic grid. Although conceptually RI is an easy to understand risk management tool, it also represents a complex set of choices of coverage levels and index intervals that can be confusing for producers who have seldom used crop insurance before. Overall, the producer's decision process will consist of the following: (1) should I insure? (2) If I insure, which index intervals should I insure? and (3) If I insure, what level of coverage should I choose? Because the RI insurance policy is not available nationwide, success with this pilot program is critical to its expansion. The expected benefit to forage and livestock producers from this study is to simplify the process of evaluating the multitude of decisions under RI.;To generate the probability density functions required for the Monte Carlo simulation, a mean-reverting time series process was the approach used to modeling the rainfall indices. A VBA macro program was written to calculate the premium costs and conduct a Monte Carlo simulation of the potential indemnity payments due when the rainfall index falls below a given trigger grid index. The model was evaluated using the historical rainfall index data from a representative grid in ten counties in the state of Pennsylvania as case studies: Beaver, Clearfield, Erie, Greene, Lancaster, Tioga, Venango, Wayne, Westmoreland, and Wyoming.;For seven of the 10 counties, the choice with the highest mean net indemnity per acre, regardless of the coverage levels, was to insure for the entire year (January-December). The results also indicate that the mean net indemnities increase as the number of index intervals insured also increase. Moreover, the period from March to May should be insured regardless of the total number of index intervals to insure. Conversely, choices with the lowest net indemnities were frequently observed for interval combinations occurring in the fall and winter (September through January).;Additionally, the findings suggest that at higher coverage levels, the producer can expect higher mean net indemnities, but also higher standard deviations. Choosing a coverage level involves weighing a tradeoff between a higher coverage levels and a higher total premium. These results indicate that less risk-averse producer may be more comfortable with a higher level of coverage, while more risk-averse producer may prefer to purchase lower level of coverage. Crop insurance loss ratios and producer benefit-cost ratios demonstrated that lower coverage levels generate higher mean net indemnities for every dollar that producers paid in premium cost. A risk analysis was conducted to at least partially assess tradeoffs between coverage level and index interval choices under risk. The optimal or expected indemnity maximizing choice from the frontier is dependent on the risk aversion of the producer.;Finally, current subsidies make RI insurance protection more affordable by reducing the premium costs charged to the producers. As result, it is expected that subsidies will increase higher participation rates. Moreover, subsidies may influence the decision to insure more months and increase coverage levels, providing more flexibility for the producer to manage risk. However, participation in the RI insurance program would be much less attractive if the premium costs are not subsidized...