This study sets out to explore the concept of risk management within the framework of the agricultural financial markets in developing countries. The framework provides opportunities for innovative agricultural insurance tools. Microinsurance and index-based indemnification mechanisms have been recognized as potential instruments for transferring risks by providing cover, or indemnification, against losses in a disaster event. This insurance product provides an easily accessible insurance cover for small-scale assets at affordable premiums while keeping transaction and other costs low. By protecting the poor from disaster losses and providing incentives for risk reduction, microinsurance is increasingly recognized as an important part of risk management. However, it was to be tested in Sri Lanka. The main objective of this study was to examine the possibility and suitability of introducing index-based microinsurance for the small-farmers in paddy crop cultivation in the context of production risk caused by natural disasters.