Innovative Financial Services for the Poor: Managing Rainfall Risk Report on a Field Project with SEWA Shawn Cole Harvard Business School

Acknowledgements SEWA  Leadership, cooperation, and guidance USAID/BASIS  Funding IFMR/CMF  Funding, Technical Assistance, Research Support Terrific implementation and implementation team  Dozens of SEWA members; Aparna Krishnan, Monika Singh, Nilesh Fernando of CMF HBS DFRD  Financial support

Today’s Talk Weather Insurance Description Project Overview Why Randomized Trials? Results Looking towards the future

An Urgent Need Two-thirds of India’s population is rural Hundreds of millions are very poor, with very limited ability to come with monsoon risk NGO, Government help insufficient Result: Stress, suffering, farmer suicides, reduced educational investments, costly diversification, under-investment

Price and Output Risk are Aggregate Shocks Cannot turn to friends, family, neighbors Asset prices (e.g., livestock) may be depressed Monsoon correlated with Indian economic growth (e.g., ability to borrow)

Financial Innovation: Rainfall Insurance Financial derivative on local rainfall  Costs Rs , pays Rs First sold in India in 2003 (Andhra Pradesh) Pioneered in Gujarat by SEWA in 2005 Indian monsoon risk uncorrelated with global financial markets: in principle, insurance rates should be very low Subsequently copied in dozens of countries

Product Description Coverage during Kharif (monsoon) Payout designed to correlate to economic loss from deficit / excess Limitations on how complex product can be  Transparency  Pricing ICICI, IFFCO, and AIC Policies  Policy starts after mm accumulated  Three phases: sowing, flowering, and harvest  Each phase pays out or not separately

The Promise Low-cost, scalable intervention Implement in other developing countries, as well as at the developed world Absence of such products has puzzled academics for decades

Key Benefits  No adverse selection  No moral hazard  Easy to price  Divisible: policies as cheap, but individuals may purchase many  Easy to purchase (private company and government provide)  Fast claim settlement

Research: The Challenge Selling a custom-designed financial derivative to individuals with primary education and no experience with formal financial contracts “If I purchase the insurance, and the rains are good, so the policy doesn’t pay out, do I get a refund of my premium?”

Key limitations  Basis Risk  Water needs perhaps not linear  Distance between plots and gauge  No cover for pests, prices, etc  Complicated  Potentially expensive  Limited re-insurance market

Research Programme SEWA and CMF Researchers  Identified 1,500 households in 100 villages  From , offered weather insurance in ca. 50 villages  Periodic household surveys  A host of ‘marketing’ experiments

Research Agenda Impact Evaluation:  (How much) better off are agricultural laborers and farmers who obtain weather insurance Developing Sustainable Product  Most effective ways to sell  Optimal design of product  Pricing of products  Willingness to pay

Study Context SEWA  NGO in Gujarat  SEWA members: very poor, limited education, limited landholdings  Ongoing project: BASIX  AP MFI, pioneered weather insurance  Groundnut farmers, landowners, high level of trust with BASIX  2006, 2009 Large-Scale Project  Ca. 3,500 households visited, involving up to 50 staff

Randomized Evaluation Methodology Select sample population Randomly assign ‘treatment’ and ‘control’ groups Evaluate outcomes following intervention Similar to drug trials Very expensive and time-consuming Key advantages Randomly assign ‘treatment’ and ‘control’ groups Avoid selection problem Estimate ‘average’ effects on population Produce extremeley credible results (cf, drug trials)

Initial Product Take-Up “Low” Approximately 5% of households in a village purchase insurance in Andhra Pradesh Purchasing households tend to purchase only one policy Makes it difficult to offer the product in a sustainable fashion: marketing cost spread over few purchasers

Research Questions: What are the important barriers to adoption? Price Expected Return Liquidity Trust Product Education / Financial Literacy

Research Methodology Understanding demand for product crucial to success Can’t simple ask people: what is your elasticity of demand? Experimental approach: offer each household a random discount, measure how purchase decision varies In cooperation with insurance providers Similar to medical studies

Logic: Expected returns an important determinant of demand, at least in theory; but households have limited ability to calculate expected return Method: Randomly assign discount coupons to different households to measure price elasticity of demand (cf. Capital One) Result: A 10% decrease in price increases product demand 6.5 percentage points Analysis: Even when product is positive NPV (183% gross return), only 47% purchase Key Results: Price

Key Results: Product Awareness Logic: Most households unaware of rainfall insurance; indeed, most have never entered a formal financial contract Method: (Costly) door-to-door marketing visits Result: Increases purchase of the product substantially: 13% Analysis: Not a cost-effective marketing tool (unless respondent becomes a subscriber)

Key Results: Product Education Logic: Households unfamiliar with index insurance Method: Additional education module as part of household visit Result: No increase in take-up Analysis: Surprisingly, education not effective

Key Results: Trust Logic: Insurance is a promise of a future contingent payment; ICICI/Lombard relatively unknown Method: BASIX representative, known to household, accompanies insurance salesperson and endorses product Result: Increases product demand 6.5 percentage points Analysis: May help explain success of AIC product

Key Results: Liquidity Logic: Insurance purchase decision made during planting, competing with other inputs (fertilizer, seeds) Method: Randomly assign cash compensation for survey of Rs. 125 to households (price of policy Rs. 100-Rs. 150) Result: Larger cash compensation increases take-up by 35 percentage points Analysis: Dramatic effect: suggests timing of insurance sales important; loans for policies might be effective; possible priming effect

Key Results: Willingness to pay Sustainability of product depends on willingness to pay Difficult to elicit willingness to pay with hypothetical questions Innovative field experiment measuring willingness to pay:  Given scratch card with a price sought  Asked to indicate willingness to pay  Number written down  Scratch off result: if reported number is above scratch card price, then purchase is made; if number below price, no sale

Key Results: Willingness to pay for 1 policy

Key Result: Willingness to pay for 4 policies

Conclusion and Discussion Product has tremendous theoretical merit and practical promise Attractive alternative to crop insurance Substantial barriers to adoption Difficult to effectively educate consumers Consumers have difficulties evaluating product Liquidity constraints bind Technological improvements my substantially improve product Developing reinsurance market may improve pricing Group negotiations for policies quite desirable

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