Risk Management & Insurance.

The case is BASIX (Abridged), case 9‐213‐035, Harvard Business School. Below are two links you can
try – make sure the title has the “(Abridged)” and that the file is 15 pages long (there is a different,
much longer version we will not use).
Dear team, thank you for our brief discussion of the 2004 insurance product that BASIX designed
for rural farmers in India growing castor. I agree that product may provide us with some ideas. I
would like to discuss this with the board, and I would like you to respond to several questions that
will help me in that discussion. If the board is receptive, I will follow up with you for additional
analysis. Below are the questions I would like you to address—please be brief in your responses.
Please do not include supplemental materials or additional analysis at this time…only include brief
answers to the questions below in a memo to me (graphs may be on additional pages if you wish).

  1. Describe the risks faced by the potential buyers of the 2004 BASIX insurance product.
  2. Without insurance, how did farmers usually cope with the risk they faced?
  3. Why was a private insurance product even necessary? Wasn’t government‐provided insurance
    available (what were the problems with government insurance, if so)?
  4. Please explain how the revised 2004 BASIX insurance product was designed to work.
  5. Please include a graph (paste it into your word document) for “Phase I” of the revised 2004
    product. The vertical axis should be the payout of the insurance to a farmer, and the horizontal
    axis should be the amount of rainfall (mm).
  6. Like me, some of the board members are familiar with options (calls and puts), and they are likely
    to feel that if we offer a similar product, some of the firm’s more sophisticated investors would
    find an option‐like approach to understanding this sort of product informative. In other words, a
    financial engineering perspective may be useful (and option pricing could then later be used to
    help price the product).
    Based on your description to me of the revised 2004 product “Phase I” during our meeting, last
    night I sketched out a combination of options that might replicate this payoff scheme: buy 15 put
    options that each have a strike of 60 mm, sell 15 put options that each have a strike of 20 mm,
    and buy one “binary, all or nothing” put with a strike of 20 mm and a payoff of 900 rupees (the
    binary put pays out 900 rupees if the rain index is strictly below 20, and pays out 0 otherwise). I
    didn’t have much time to check my work….the strike prices of 60 and 20 are obvious, but are the
    other numbers correct (the 15, 15, and 900)? Please check and let me know (and If not, please
    correct my work and state to me the correct combination of options—rewrite the entire strategy,
    i.e., rewrite the italicized statement above).
  7. Similar to #5, please draw a graph for Phase II.
  8. Similar to #6, please design an option scheme to replicate the payoffs for Phase II (rewrite the
    italicized language in #6 to replicate Phase II).
  9. Similar to #5, please draw a graph for Phase III.
  10. Similar to #6, please design an option scheme to replicate the payoffs for Phase III (rewrite the
    italicized language in #6 to replicate Phase II).
  11. “Traditional” insurance would pay a farmer for the losses on crop failure incurred (if any). How
    did the insurance that BASIX designed for 2004 differ from traditional crop insurance?
  12. Do you feel the 2004 product would have subjected farmers to “basis” risk?
    13.Compared to traditional insurance, how does the proposed insurance differ in terms of the issues
    of moral hazard and adverse selection? (Are these problems more or less severe, and why?)
  13. The product seems a little complicated to explain to rural farmers, many of whom have little
    formal education. Do you have ideas how we could best market a similar product successfully but
    in a cost efficient way?

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