Evaluating the Effectiveness of Weather Index Insurance: Empirical Assessment Framework and Policy Recommendations for Fair Premium Subsidies

Extreme weather threatens crop yields and farmers’ incomes. Weather index insurance (WII) provides direct compensation based on weather indices, aiming to stabilize agricultural production. However, its feasibility remains in question, with basis risk being a major obstacle to widespread adoption. Previous studies suggest that improving “weather-yield” models and contract design can enhance WII effectiveness by reducing basis risk. This study evaluates the effectiveness of WII in mitigating farmers’ income risks due to extreme weather events. Using middle-season rice yield data and meteorological observations from Anhui province, China, it develops WII products based on various “weather-yield” models and assesses their impact on income risk reduction through basis risk and expected utility analysis. Furthermore, to improve insured farmers’ expected utility while minimizing government subsidy costs, the study proposes a refined fair premium subsidy plan. It also examines the role of government subsidies in WII, suggesting that subsidies should only cover the portion of the fair premium linked to yield losses caused by weather fluctuations. These findings can be extended to other crops in regions prone to extreme weather, laying the foundation for the improvement and broader implementation of similar insurance schemes.