Can remotely-sensed vegetation health indices increase the hedging-effectiveness of index insurance? – Insights from Germany

Purpose - Satellite-retrieved vegetation health (VH) indices are under active consideration to be integrated into weather index insurance to reduce the basis risk and increase the attractiveness to farmers. The objective of this study is to obtain a deeper understanding of the hedging effectiveness (HE) of the satellite-retrieved VH indices. Design/methodology/approach - By using winter wheat yield records from 79 farms in Northern and Eastern Germany over 20 years, we designed index insurance based on three satellite indices to explore their HE: the Vegetation Condition Index (VCI), the Temperature Condition Index (TCI) and the Vegetation Health Index (VHI) with a spatial resolution of 1 × 1 km. As the benchmark, a meteorological index related to precipitation is employed. Findings - The results indicate that, on average, the TCI and VHI outperform the benchmark index in a statistically significant way. However, considerable differences across regions are observed. In particular, the highest HE, and therefore basis risk reduction, was found for regions with sandy soils in Eastern Germany. Practical implications - Insurers can be advised to accelerate the research and development of satellite-based index insurance in Eastern Germany. By considering our insurance design, products with low transaction costs and therefore comparatively low loading factors can be offered to farmers. Originality/value - To the best of our knowledge, this is the first study that uses a large sample to explore the HE of index insurance based on satellite-retrieved VH indices by focusing on different regions in a country.