Design of optimum private insurance schemes as a means to reduce water overexploitation during drought events. A case study in Campo de Cartagena (Segura River Basin, Spain)

Water is a key input in the production of many goods and services and under certain conditions can become a critical limiting factor with significant impacts on regional development. This is the case of many agricultural European Mediterranean basins, where water deficit during drought events is partially covered by illegal abstractions, mostly from aquifers, which are tolerated by the authorities. Groundwater overexploitation for irrigation has created in these areas an unprecedented environmental catastrophe that threatens ecosystems sustainability, urban water supply and the current model of development. Commercial drought insurance systems have the potential to introduce the necessary incentives to reduce overexploitation during drought events and the high costs of the drought indemnity paid by the government. This paper develops a methodology to obtain this socially desirable basic risk premium based on concatenated stochastic models. The methodology is applied to the agricultural district of Campo de Cartagena (Segura River Basin, Spain). Results show that the basic premiums in a hypothetic commercial drought insurance market would be reasonable and the expected environmental outcomes significant.