DOES THE OFFER OF WEATHER INSURANCE IMPACT THE RISK TAKING OF FARMERS IN UNDERDEVELOPING COUNTRIES?

Responsible Researcher: Eduarda Miller de Figueiredo

Paper Title: Informal Risk Sharing, Index Insurance, and Risk Taking in Developing Countries

Authors: Ahmed Mushfiq Mobarak and Mark R. Rosenzweig

Intervention Location: India

Sample Size: 4,667 families.

Sector: Agriculture

Variable of Main Interest: Risk taking

Type of Intervention: Offer of weather insurance

Methodology: Experimental Design

The aim of this study was to understand the complex interactions between informal risk sharing, formal insurance and risk taking. Since formal insurance markets have low penetration in agrarian areas of developing countries, as families in these areas have the habit of sharing risks. By using a risk-indexed insurance model based on the cooperative risk-sharing model, the authors realized that with the purchase of rain insurance, farmers increased their risk acceptance.

Policy Problem

In agrarian areas of developing countries, the penetration of formal insurance markets is surprisingly low, despite the fact that agriculture is highly susceptible to climate fluctuations. What happens is that the majority of rural families participate in informal risk sharing, so, according to the authors, farmers seem to sacrifice profitability to reduce risk.

Implementation and Evaluation Context

The aim of this study was to understand the complex interactions between informal risk sharing, formal insurance and risk taking. To do this, the authors used random offers of rain insurance contracts to a set of families living in indigenous villages, which have data on the rich characterization of the nature and extent of informal risk sharing in a readily identifiable and exogenous network: subcaste, or jati .

Jatis are risk-sharing networks that span villages and districts in India, where data has shown that most loans and transfers to households are from caste members, and most informal loans and transfers to households and other caste members have origin outside the village. Therefore, Jatis have the potential to indemnify the aggregate risk of rainfall at the village level and thus such risk sharing can directly replace formal insurance.

Policy/Program Details

The 63 REDS villages in the sample contained 118 Jatis with at least 50 families. Of these, 42 REDS villages were randomly selected to receive insurance marketing.

To ensure pure control group of families not receiving any insurance treatment, first the sample was stratified by caste, thus members of 25 castes were randomly selected not to receive any insurance offer. Afterwards, stratification was carried out by occupation, with half of the insurance offers going to farmers and the other half to families dedicated exclusively to agricultural work. In the end, around 4,667 families received the treatment, in which around 40% of all families acquired some insurance.

The product offered provided a cash payout to buyers if the rains were delayed beyond the expected monsoon onset date determined by the Agricultural Insurance Company of India Lombard (AICI). The price of insurance ranged from 1.6-4 dollars.

The target of climate insurance programs is farmers and the provision of climate insurance induces them to take more risks, which can increase the wage risk borne by landless people who depend on agricultural wage labor. Mobarak and Rosenzweig (2013) study the general equilibrium effects of providing rain insurance to farm families and landless workers. Along these lines, Jayachandran (2006) examined how the provision of financial services to landless families that allowed income smoothing affected the labor supply. Thus, such families would work more when rainfall is low, having more leisure time when rain is abundant, with wages varying between these two periods. Such a situation, according to the research, would increase the volatility of income for salaried workers, reducing the volatility of profits for farmers. In this study, discussed here, the repercussion effects in the labor market of the offer of insurance to the landless on the income of cultivators will also be examined.

Method

Data from the NCAER Rural Economic Development Survey (REDS) 2007/2008 was used, which allowed randomization between and within caste-based risk-sharing groups.

Mobarak and Rosenzweig (2012) place a risk-based indexed insurance model on Arnott and Stiglitz's (1991) cooperative risk-sharing model, demonstrating that:

• a) Basis risk, or the imperfect correlation between losses and insurance payments due in part to the remote location of rain gauges, reduces uptake of index insurance;
• b) When the contract does not carry base risk, the demand for insurance based on indicators is independent of the extent of informal coverage of losses (family specific);
• c) Risk sharing and index-based insurance can be complements when there is basis risk, because the Jatis network will cover households' idiosyncratic losses exactly when the index-based contract fails.

To test such predictions, the authors use data from the REDS survey on interhousehold transfers in response to village-level rainfall shocks and household-specific adverse shocks to construct informal risk-sharing indices that measure how well each caste in the sample indemnifies against idiosyncratic losses and aggregate countershocks.

Main Results

To assess whether and how variations in informal household loss compensation empirically affect risk taking, they explored the idea that among farmers who take more risks, crop production, input use, and profits should be more sensitive to changes. rains. Using REDS data, the authors therefore find that in Jatis with higher individual loss compensation, profits per acre are less sensitive to rainfall, while in Jatis where compensation depends more heavily on weather shocks, profits were more sensitive to rainfall variations.

Using a random variation in the provision of meteorological insurance, when evaluating the effects of rain insurance and informal loss compensation on risk taking, the authors found exactly the same relationships as in the REDS data. Agricultural production increases dramatically with rainfall for farmers with random offers of weather insurance, therefore demonstrating that however much caste groups in India are evidently successful in mitigating risk, this comes at a substantial cost, i.e. more risk-averse production, with lower average returns. Therefore, with the purchase of rain insurance, it allows farmers to increase risk acceptance.

When assessing the labor market spillover effects of offering insurance to the landless on the income of cultivators, the results suggest that if landless families are aware of the impact of insurance on risk and wage levels, they Households will be more receptive to climate insurance when farmers also purchase insurance.  

Public Policy Lessons

By examining the interrelationships between informal insurance arrangements, the demand for formal weather insurance, and risk-taking among farmers and landless families in an environment where there is widespread risk-sharing, the authors realized that with the purchase of formal insurance farmers have increased risk acceptance.

References

MOBARAK, Ahmed Mushfiq; ROSENZWEIG, Mark R. Informal risk sharing, index insurance, and risk taking in developing countries. American Economic Review , vol. 103, no. 3, p. 375-80, 2013.