1. for internal use only Presentation by Shahid Vaziralli, Center for Microfinance, IFMR January 12, 2011 Barriers to Household Risk Management: Evidence from India Shawn Cole Xavier GineJeremy Tobacman (HBS)(World Bank)(Wharton) Petia TopalovaRobert TownsendJames Vickery (IMF)(MIT)(NY Fed)

2. 2 for internal use only 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. 3 for internal use only Introduction  Research Question: Why don’t 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. 4 for internal use only Outline  Motivation  Product Description  Setting, Sample, and Research Design  Determinants of Adoption  Conclusion and Future Research

5. 5 for internal use only 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. 6 for internal use only Motivation (cont…)  Is it strange why enough people don’t 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. 7 for internal use only Outline  Motivation  Product Description  Setting, Sample, and Research Design  Determinants of adoption  Conclusion and Future Research

8. 8 for internal use only 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. 9 for internal use only Expected Payouts

10. 10 for internal use only 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. 11 for internal use only 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. 12 for internal use only Outline  Motivation  Product Description and Simple Calibration  Setting, Sample, and Summary Statistics  Determinants of adoption  Conclusion and Future Research

13. 13 for internal use only 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. 14 for internal use only Education and Financial Literacy  Low level of financial literacy (as good as guessing)  Limited understanding of insurance product

15. 15 for internal use only 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. 16 for internal use only Outline  Motivation  Product Description and Simple Calibration  Setting, Sample, and Summary Statistics  Determinants of Adoption  Conclusion and Future Research

17. 17 for internal use only 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. 18 for internal use only Experiment: Price  Motivation: Financial services expensive to provide in poor areas  Insurance premium ranges from Rs. 44 - 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. 19 for internal use only 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. 20 for internal use only 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

21. 21 for internal use only 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

22. 22 for internal use only FIN