Behavioral weather insurance: Applying cumulative prospect theory to agricultural insurance design under narrow framing

Abstract

Experience across many countries shows that, without large premium subsidies, crop insurance uptake rates are generally low. In this article, we propose to use the cumulative prospect theory to design weather insurance products for situations in which farmers frame insurance narrowly as a stand-alone investment. To this end, we introduce what we call “behavioral weather insurance” whereby insurance contract parameters are adjusted to correspond more closely with farmers’ preferences. Depending on farmers’ preferences, we find that a stochastic multiyear premium increases the prospect value of weather insurance, while a zero deductible design does not. We suggest that insurance contracts should be tailored precisely to serve farmers’ needs. This offers potential benefits for both the insurer and the insured.