SSRN Electronic Journal · 2012 · 243 citations · 28 references
BusinessAgricultural EconomicsEconomicsAgricultural InsuranceEconometricsInsurance EconomicsAdverse SelectionInsurance PolicyRisk AversionRural InsuranceAgricultural Index InsuranceFarmer Demand For InsuranceFormal InsuranceInformal InsuranceInformal Sector InsuranceModeling Basis RiskRainfall Index InsuranceShocks In Index Insurance
Unpredictable rainfall poses a major risk to agricultural activity, and farmers in developing countries often rely on incomplete protection from informal risk‑sharing networks. The study investigates how offering formal index‑based rainfall insurance influences demand and outcomes among farmers in rural India where informal risk‑sharing networks are well characterized. The authors conduct a randomized experiment that varies index insurance offers and the placement of rainfall gauges to assess the interaction between formal insurance and informal networks. The results show that informal networks lower demand for formal insurance only when they indemnify aggregate risk, that idiosyncratic coverage boosts benefits under basis risk, and that index insurance allows households to assume more risk even when informal insurance exists.
Unpredictable rainfall is an important risk for agricultural activity, and farmers in developing countries often receive incomplete insurance from informal risk-sharing networks. We study the demand for, and effects of, offering formal index-based rainfall insurance through a randomized experiment in an environment where the informal risk sharing network can be readily identified and richly characterized: sub-castes in rural India. A model allowing for both idiosyncratic and aggregate risk shows that informal networks lower the demand for formal insurance only if the network indemnifies against aggregate risk, but not if its primary role is to insure against farmer-specific losses. When formal insurance carries basis risk (mismatches between payouts and actual losses due to the remote location of the rainfall gauge), informal risk sharing that covers idiosyncratic losses enhance the benefits of index insurance. Formal index insurance enables households to take more risk even in the presence of informal insurance. We find substantial empirical support of these nuanced predictions of the model by conducting the experiment (randomizing both index insurance offers, and the locations of rainfall gauges) on castes for whom we have a rich history of group responsiveness to household and aggregate rainfall shocks.
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