Index-based financial risk-transfer mechanisms (referred to as index insurance in the rest of the paper) are being tested for poverty reduction and climate-change adaptation. Case studies are showing that these mechanisms may be able to dramatically reduce both the direct and indirect impacts of climate shocks in some sectors, reducing vulnerability and enabling investment and growth. They are not suited to cover the entire range of risks faced by these sectors, and they do not supplant the need for good policy and practice. But index insurance could, if negotiated and managed properly to target key risks, provide a missing piece of the puzzle in the global effort to eradicate extreme poverty.
As with any tool, these mechanisms must be developed carefully if they are to fulfill their potential without unintended negative effects. Of the existing index insurance projects, few have reached the stage of actual financial transactions and most are small scale pilot projects or one-year test period projects at the national scale. While there is evidence that these projects can work at this limited scale, there are many challenges which need to be overcome if index insurance is to contribute to the eradication of poverty at large scales.