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1 Case Study on Weather Insurance. Introduction Theory suggests households should diversify idiosyncratic risk. Yet, most individuals (and countries)

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Presentation on theme: "1 Case Study on Weather Insurance. Introduction Theory suggests households should diversify idiosyncratic risk. Yet, most individuals (and countries)"— Presentation transcript:

1 1 Case Study on Weather Insurance

2 Introduction Theory suggests households should diversify idiosyncratic risk. Yet, most individuals (and countries) hold idiosyncratic risk even when publicly observable / exogenous: –e.g. exposure to house price risk, local weather fluctuations, commodity prices, regional income growth etc. –Sometimes hedging markets have simply not developed, in other cases they exist but are not widely used. Shiller (1998): It is odd that there appear to have been no practical proposals for establishing a set of markets to hedge the biggest risks to standards of living

3 Introduction Research Question: Why dont more households participate in formal markets when available? We study participation in a retail-level rainfall insurance product offered to rural Indian households. –Test theories of insurance demand using a randomized evaluation in Gujarat Setting where diversification benefits appear particularly high: –Nearly 90% of households in our study area cite rainfall shocks as most important risk faced by the household.

4 Outline Motivation Product Description Setting, Sample, and Research Design Determinants of Adoption Conclusion and Future Research

5 Motivation Agriculture is the primary activity of 2/3 of India (and 40% of the world) Rainfall is an important determinant of yield and revenue Lasting, successful, unsubsidized crop insurance is practically non-existent –National Agricultural Insurance Scheme has been disappointing

6 Motivation (cont…) Is it strange why enough people dont buy it? –Households use a range of ex-ante and ex-post mechanisms to smooth consumption and labor Saving, intra-household transfers, grow safer crops etc. –Some evidence that these are: Insufficient, especially for poor households. Costly, in the sense that they trade-off risk for lower return. Poor hedges against shocks that are aggregate to all households in a village, such as a drought. Demand for weather insurance if the product can be used to hedge risk more cost effectively.

7 Outline Motivation Product Description Setting, Sample, and Research Design Determinants of adoption Conclusion and Future Research

8 Product Description Index-based Insurance on rainfall –Payouts based on rain measured at local rainfall station, relative to different thresholds –Sold within 30km of station by partner NGO –Coverage period spans from June 1 to August 31 Expected payouts range from 50% to 57% of premium Catastrophe insurance Policies underwritten by IFFCO-Tokio

9 Expected Payouts

10 Key Benefits of Product Reduces transaction costs Data collection is relatively cheap Objectivity of index construction Historical rainfall data can be used to set prices Divisible (policies as cheap as Rs. 44) and easy to purchase Fast settlement and payment

11 Key Limitations Basis Risk ( Rainfall imperfectly correlated with income and consumption) –Correlation between rainfall and crop yields –Correlation between rainfall at gauge and plot Expensive, in part due to small scale. Payout 50-57% of unsubsidized premium Complicated to understand and evaluate

12 Outline Motivation Product Description and Simple Calibration Setting, Sample, and Summary Statistics Determinants of adoption Conclusion and Future Research

13 Gujarat Setting and Sample 100 villages in three districts (Ahmedabad, Anand, Patan) Part of a five-year impact evaluation study Fifteen households interviewed in each village SEWA (NGO) sells IFFCO policies

14 Education and Financial Literacy Low level of financial literacy (as good as guessing) Limited understanding of insurance product

15 Uptake and persistence Significant correlates of insurance uptake –Wealth –Financial literacy and probability skills (measured through a series of questions in the survey) –Household has other types of insurance products –Surprisingly, aversion to risk does not increase uptake Of the households who purchased the policy in 2006, 40% purchased the following year –Indicating that rainfall insurance has yet to receive widespread acceptance amongst farmers

16 Outline Motivation Product Description and Simple Calibration Setting, Sample, and Summary Statistics Determinants of Adoption Conclusion and Future Research

17 Field experiments Design of treatments guided by potential barriers to adoption: Theoretical determinants of willingness to pay –Price (relative to actuarial value) –Aversion to risk –Not enough cash on hand –Perception of basis risk –Size of risk Non-standard – financial literacy, trust in the provider, religious cues in marketing materials

18 Experiment: Price Motivation: Financial services expensive to provide in poor areas Insurance premium ranges from Rs Rs. 86 (USD 1 – USD 2) Sample: 1,415 households Intervention: Randomly assign discounts to households Offer discount of Rs. 5, 15, or 30 for first policy purchased –Expected payout ranges from 54%-181% Price elasticity of demand on order of 0.8 (significant at 1%) 53% of households decline policy with expected gross return of 181% return over four months

19 Experiment: Trust Motivation –Households may be less inclined to purchase products from unfamiliar sources Sample: 2,391 households Interventions –1: Including religious symbols and cues on flyers –2: Emphasizing the SEWA brand through videos Results –Intervention 1 Muslim households are 33% less likely to purchase a policy when the flyer includes Hindu symbols (significant at 5% level) Hindu households are 10% less likely to purchase a policy when flyer includes Muslim symbols (significant at 5% level) –Intervention 2 Surprisingly, SEWA Brand emphasis has main effect of zero despite evidence from other studies that branding is significant

20 Outline Motivation Product Description and Simple Calibration Setting, Sample, and Summary Statistics Determinants of Adoption Conclusion and Future Research

21 Conclusions –Adoption of innovative products may be slow –Overall uptake was 26% among households receiving a video or flyer Insurance demand is sensitive to price Non-standard factors such as trust are important. First experimental evidence for role of trust in financial market participation

22 Policy Recommendations Increase density of rainfall gauges Foster competition in the market Combine rainfall and crop-yield insurance Combine product with a loan Group policies


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