4 investments resulting from weather and catastrophic events, without requiring the traditional services of insurance claims assessors.”<sup>4</sup> Historical hazard and inventory damage data are used in the design of index insurance products, which trigger pay-outs at specific frequency and severity levels.<sup>5</sup> Thus, index insurance makes the claims settlement process quicker and more objective. These characteristics help address some of the constraints in the offering of agricultural insurance, as the product can be made more affordable and effective for smallholder farmers, while also being commercially viable for insurance companies.

The potential for better uptake makes well-designed index insurance products easier to commercialize, and an easier case for reinsurance access in developing countries (Carter et al. 2014). Index insurance has been piloted in around 15 developing countries at the individual farmer level, while around 20 countries have offered it at an institutional/geographic level (Carter, Janvry, et al. 2017).

Despite the success of index insurance at the pilot level, countries have struggled to enjoy its sustained benefits – for several reasons. One of them is basis risk. Basis risk results from discrepancies between the measured insurance index and the losses actually experienced from adverse events by the insured, i.e. “imperfect correlation between the insurance index and the shocks that it is meant to protect against” (Carter, de Janvry et al, 2017).<sup>6</sup> Rainfall has been the most commonly used trigger for weather-based index insurance. In case of rainfall indices, product design can be further complicated by the existence of other sources of water for cultivation, such as irrigation. Hydrological drought is a result of the reduction in water supply in rivers, streams and groundwater due to rainfall deficits.<sup>7</sup> In times of hydrological drought, farmers face the risk of limited water supply leading to a ‘water supply gap’ that may have negative effects such as increasing production cost or crop failure. However, agricultural insurance coverage against such hydrological drought is limited due to its systemic character, where large losses over vast areas can be experienced (Pérez and Gómez 2014).

Given the increasing dependence on irrigation in agriculture, developing robust insurance products for hydrological droughts has evinced increased interest. Though the existing literature and experience are

> 4 https://olc.worldbank.org/content/introduction-index-insurance.

> 5 For useful technical guidance on index product design, please refer ‘Risk Modeling for Appraising Named Peril Index Insurance Products: A Guide for Practitioners’ by Mapfumo, Hybert & Dugger (2017). 6 Index Insurance for Developing Country Agriculture: A Reassessment (Michael Carter, Alain de Janvry, Elisabeth Sadoulet, Alexandros Sarris Annual Review of Resource Economics 2017 9:1, 421-438).

> 7 It emanates from a meteorological drought which is the lack of precipitation over a large area and for an extensive time period. Meteorological drought combined with high evaporation rates can lead to reduced soil moisture and thus agriculture drought, where soil moisture is insufficient to support crops. Subsequent groundwater recharge and reduced streamflow lead to hydrological drought (Tallaksen & van Lanen 2004).