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October 18, 2012

New Paper Highlight: How Does Risk Management Influence Production Decisions? Evidence from a Field Experiment (Shawn Cole, Xavier Giné and James Vickery)

By Elise Corwin and Timothy Ogden

Intuitively, insurance should be highly appealing to poor households for two reasons—they face a lot of risks, and have few resources to effectively deal with negative shocks. But microinsurance hasn’t taken off. That leads to two main questions: Does microinsurance provide the benefits that we theoretically think it does? And if so, how do we overcome the barriers that are preventing people from buying insurance?  Of course, the answer to the second is quite dependent on the answer to the first.

A new paper by Cole, Giné and Vickery presented at Innovations for Poverty Action’s recent Impact and Policy Conference in Bangkok tries to uncover some answers on the real world impact of microinsurance not just in terms of protection from an actual shock. One possible benefit of microinsurance is that it allows poor households to make different choices because they have to worry less about the impact of a shock.

This particular study aimed to see whether insurance against the risk of rainfall fluctuations affects investment and production decisions by farmers in India. These farmers have a choice regarding what they choose to plant: lower risk, lower yield crops versus higher risk, higher return crops. Without any kind of security blanket, subsistence farmers may be less likely to invest in more profitable crops since the risks are too high. Even if they do invest some in the higher profit they may not be willing to spend as much on fertilizer or other inputs to maximize their returns if all goes well.

The randomized evaluation assigned insurance to half the farmers in the sample (total sample included 1,500 households) at the start of the monsoon season. The insurance policy is “index insurance;” payouts are linked to an observable rainfall index. Previous studies have had difficulty linking access to insurance and outcomes. The authors note that this may be due to relatively modest take-up and the fact that policies are usually designed to pay in the case of rare adverse events. Low take-up makes it hard to detect effects. Payout against a rare event may not be enough to change the behavior of households. If someone gave you free insurance against a truck crashing into your house, it’s unlikely that you would do much different tomorrow. While it’s nice to be insured against something negative happening, the risk you are now insured against is probably not one of the ones you worry about most.

Cole, Giné and Vickery get around these challenges by randomly giving free policies—since they are studying the effect rather than the demand, “free” is a useful place to start. Second, they previously asked farmers about the greatest risks they faced—and rainfall came up top of the list.

What did they find? Providing insurance to farmers does in fact lead to them shifting from less risky, lower profit crops to more risky (and more profitable) crops and to investing more in their crops. That’s an important confirmation that risk is playing an important role in these farmers’ decision making, and therefore that changing the risks they face (via insurance or otherwise) can change outcomes. It’s also important that the farmers quickly changed their investments when they received the insurance. Of note,  the authors also looked for differences in outcomes based on wealth and those who had previously purchased insurance, but found only weak effects of the former, and no effect of the latter. Chalk this up as a victory for the theory of microinsurance.

This paper builds on the authors’ previous work. If you’re interested in learning more see Giné et al (2008). The authors also plan to continue this research to learn what happened in 2009 after India experienced its worst monsoon since 1972. The maximum payouts were provided to about 250 farmers, an amount that equaled about one fourth of household revenue. The future analysis will focus on how households smooth this shock and whether funds were used for later investments.

 

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