Drought Index-Based Insurance for the US Cattle Ranching Industry

Williams, Travis Matthew

Graduate Thesis Or Dissertation

Drought Index-Based Insurance for the US Cattle Ranching Industry Public Deposited

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Citeable URL: https://scholar.colorado.edu/concern/graduate_thesis_or_dissertations/vt150j599

Abstract

The recent availability of federally-subsidized rainfall-index insurance for US grazing livestock producers provides a previously absent level of financial support that has long been common in the crop production industry. This development is important for the economic well-being of the small-scale rancher who faces the ever-present risk of drought. When drought hits the ranch, forage-production is reduced, expensive supplementary feed becomes necessary, and often the rancher must sell cattle into a flooded local market. In recent years, particularly severe national-scale droughts have caused large economic losses for agricultural producers, renewing interest in drought risks mitigation strategies. Over these years, weather-based index insurance has become increasingly popular for the mitigation of such risks because it is designed to avoid many of the pitfalls that make loss-based insurance inefficient. By basing loss on an indicator and not experienced loss, expenses associated with profit-seeking behavior by policyholders can be significantly reduced. This feature promises to lessen operation costs, decrease premiums, and expand possible coverage to a larger number of people, but will only be effective to the degree that the index accurately indicates loss. The Pasture, Rangeland, and Forage (PRF) rainfall-index insurance program assumes that rainfall is highly correlated with the rangeland forage. However, cumulative rainfall is only one factor of many that determines rangeland health, creating a risk of non-payment. The existence of a myriad of drought indices specifically designed to monitor the impacts of drought begs the question; why not indicate drought-induced loss with a drought index? A drought index would provide the same efficiencies as the rainfall index while potentially reducing the risk of non-payment when there are losses. In this study, various drought indices are assessed for their ability to indicate the economic impacts of drought in the US live-cattle market, and subsequently tested as experimental alternatives to the rainfall index in the PRF. The results demonstrate that they explain similar amounts of variance in cattle weights at live-auctions as the rainfall index but incentivize appropriate growing season protection and have the potential to significantly reduce the chances of missed payouts during drought without creating actuarially unmanageable payout patterns.

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