Case Study on Weather Insurance

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Case Study on Weather Insurance

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”

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.

Outline

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

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

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.

Outline

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

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

Expected Payouts

IFFCO-Tokio Policies

Year Station Premium Rs.% of

premiumGujarat

2007 Ahmedabad 44 25 57%2007 Anand 72 n.a. n.a.2007 Patan 86 43 50%

Expected payout

Normal Rain

607.4783.6389.9

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

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

Outline

• Motivation• Product Description and Simple Calibration• Setting, Sample, and Summary

Statistics• Determinants of adoption• Conclusion and Future Research

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

Education and Financial Literacy

• Low level of financial literacy (as good as guessing)• Limited understanding of insurance product

Highest level of education:Primary school or below 42.0%Secondary school 28.7%High school 11.6%College or above 17.6%

Average Score, Financial Literacy 35.8%

Average Score, Insurance Questions 68.2%

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

Outline

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

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

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

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

Outline

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

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

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