Weather index insurance, also known as index-based insurance or index-linked insurance, is a unique tool primarily used in agriculture. Here’s how it works:

Concept:
Unlike traditional insurance that pays indemnities for actual losses incurred (which can be costly to assess), weather index insurance pays out based on an index—such as rainfall or temperature—measured at a local weather station or via satellite.
It doesn’t rely on specific consequences (like crop yield) but rather on predefined weather thresholds.

Advantages:
Reduced Transaction Costs: No need for field visits or damage assessments; payouts are based on objective indices.
Increased Accessibility: Lower premiums make it more accessible for smallholders in developing countries.
Incentive Alignment: Farmers still have an incentive to make decisions that promote crop survival.

Example:
Drought Index Insurance: Protects against losses due to below-average rainfall. If a drought occurs and meets the contract terms, the farmer receives compensation.