ETHIOPIAN DEVELOPMENT RESEARCH INSTITUTE

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Formal and Informal Insurance: Experimental Evidence from

EthiopiaGuush Berhane*, Stefan Dercon++, Ruth Vargas Hill+ and

Alemayehu Seyoum Taffesse*

* International Food Policy Research Institute++ University of Oxford and Department of International Development, UK

+ The World Bank

Workshop on “Innovations in Index Insurance to Promote

Agricultural and Livestock Development in Ethiopia”Capital Hotel, Addis Ababa

Dec 3, 2015,

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Background Weather risk remains a major challenge to farming

and farming communities in Ethiopia; Many large surveys in Ethiopia report a large

fraction of rural households – 50% (ERHS), 32% (AGP), 51% (this survey) - are affected by drought every year.

This is over and above the large slow onset drought (that now seems to occur every 10 years or so).

Evidence documenting drought had significant impacts on welfare; short- and long-term.

Suggestive evidence that some insurance against weather risk would have high demand.

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Background Information asymmetry problems and high

implementation costs limit viability of traditional insurance;

Informal insurance hampered by risk covariance Index-based weather insurance offers new

possibilities; However, demand remains invariably low with

basis-risk, trust & transaction cost being among some of its key challenges;

Little is known about how to mitigate basis risk & to what extent doing so would trigger demand in poor rural environments like in Ethiopia;

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index insurance becomes a complement to informal risk-sharing (iddirs, for example) in the presence of basis risk (Dercon et al, 2012); demand for index insurance can be higher among group

members that can share risk partly via reducing basis risk and improving trust.

enhancing the resilience and adaptation of traditional groups in the face of covariant shocks.

informal risk-sharing arrangements such as iddirs can serve as sustainable retail outlets for index insurance; reduce transaction costs, increase trust.

Premise

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Research questions Study objective: to assses the (welfare) impact of:

providing a well-priced, well-designed insurance product; supporting informal risks-sharing groups, and combine support to informal risk-sharing groups and

weather index insurance. Specific questions:

Can informal insurance groups be encouraged to mitigate basis risk - by increasing transfers in the event of individual-specific bad outcomes that may not be correlated with the index?

i. Does this encourage demand for insurance?ii. Does this impact other informal transfers?

What is the impact of formal and informal insurance on productive investments and welfare?

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Study approach:

randomized field experiment conducted from 2011-2013 with an index insurance product offered alongside activities to strengthen risk-sharing groups in the area: iddir.

110 villages selected around 3 weather stations in Oromia region – Shashemene, Dodota and Bako Tibe (all ERHS woredas);

Primary interest - target risk-sharing groups: iddirs. Network mapping exercise to ensure low probability of network overlap between “treatment” and “control” villages.

Weather index pilot in Ethiopia

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In-depth discussions to understand the context

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Villages within 15 km radius of weather stations

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110 villages

INSURANCE(60

villages)CONTROL

(50 villages)

RANDOMIZATION:Insurance

insurance contract: Designed on the basis of information collected by

the long ERHS panel survey – useful within limits; Price discounts offeredo 40-100% (free) in 2011o 10-60% in 2012o None in 2013

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110 villages

INSURANCE(60

villages)CONTROL

(50 villages)

INDIVIDUAL(25 villages)

GROUP(35

villages)

RANDOMIZATION:Group vs. Individual

• Group: encouraged to insure against basis risk: e.g. payment to member if ill-health prevented working on the field. 800 Birr offered to groups to start a fund for this (incentive)

• Individual: 16 individuals randomly selected to receive 50 Birr.

• Total flow of money into the village is the thus same

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110 villages

INSURANCE(60 villages)

CONTROL(50 villages)

INDIVIDUAL(25 villages)

GROUP(35 villages)

MANDATED(18 villages)

NON-MANDATED(17 villages)

RANDOMIZATION:Mandated v NOT

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Strengthening risk sharing rules: two approaches

1. Mandated rules The group establishes regular savings to a common pot; 10% of any insurance payout in this group goes to this

pot; This pool is disbursed to members that experience

idiosyncratic basis risk, as a zero-interest loan; Disbursement criteria is discussed and set by the group

at the beginning of the year; Members apply for the loan, group follows disbursement

rules!2. Non-mandated: iddir free to set rules ex-ante or ex-

post, idea suggested but no format prescribed.

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Marketing: village & iddir level meetings, trainings

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Marketing: … involved drought games

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• Initially sales were small• Product refined further –

consecutive dry spells introduced;

• Discounts offered for late season policies (September):

• Demand increased (now 13% of target clients);

• There was payout in the later season

• Next season sales went up to 1500 hhs … payouts help, suggesting TRUST is key!!!

• Basis risk still a problem – Gap insurance introduced in 2012

Insurance sales and product refinements

Three key product features

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1) Cumulative rainfall cut-offs

2) Consecutive dry days

3) Crop-cutting – gap insurance

• Overall more than 5,000 farmers bought insurance in 55 sites.

• We had wide variation in penetration rates from less than 1% to 45% in different places and at different times

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Survey and analysis

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Timeline: sales vs. survey

2011

Baseline Survey Feb-Mar, 2011

Group rules + Sales

 

Insurance  

1st follow-up Survey

Dec, 2011

2012

2nd follow-up Survey 

Feb-Mar, 2012

SalesInsurance  

3rd follow-up Survey

Dec 2012- Jan2013

2013

 

Sales  

Insurance Implemented by BG alone 

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Baseline characteristics High incidence of drought: 51% experienced drought

shock in the last three years; Formal insurance an almost unknown concept:

10% had heard about traditional indemnity (car, life or health) insurance;

No-one had heard of weather or crop insurance before; Also:

Only 21% have heard of what a millimeter is; Only 7% had a bank account;

Initial interest in index-type insurance: 87% were interested in a weather indexed insurance policy

described to them in the survey; Indications of huge basis risk:

only 32% thought rainfall measured at the nearest weather station could accurately measure rainfall on their plots;

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Informal insurance very prevalent: only 5% did not belong to an iddir; 92% belonged to 1-5 iddirs

010

2030

40P

erce

nt

0 2 4 6 8d1_how many iddir are you or members of your household a member of?

Baseline characteristics

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estimate the ANCOVA for outcome variables of interest with baseline data:

estimate a difference in outcome equation for outcome variables of interest without baseline data:

IV - insurance treatment and the discount value to instrument an individual’s decision to purchase insurance.

Stratification at location (weather station-level) so dummies are included for this in all regressions

Randomization at village level, so standard errors are clustered at the village level

Groups compared depend on the research question

Econometric analysis

Comparison groups

Impact of formal insurance

Impact of informal

Impact of mandating

Impact of formaland informal

Referencegroup

Referencegroup

Referencegroup

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Key results

1. Formal insurance encourages productive investments

Formal insurance increased risk-taking - adoption of modern inputs - use of chemical fertilizers (consistent with other studies).

Specifically, formal insurance increases: the number of plots on which fertilizer is applied, the proportion of households spending on fertilizer, the amount of fertilizer purchased and amount spent on

fertilizer purchase, the use of improved seeds (weakly) It also slightly increased maize yields but not other

crops (probably due to increased use of fertilizer on maize and/or through maize’s higher fertilizer-yield response

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Selling insurance through iddirs increases risk-sharing but only through mandating/strengthening (no difference observed between non-mandated and controls):

Mandating improves access to grants/loans from the iddirs to cover crop losses;

Mandating increases perceived ability to finance emergencies;

Also some evidence that mandating reduces individual bilateral transfers (evidence of crowding-out effect)

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2. Selling insurance through iddirs increases risk-sharing

Strengthening informal insurance (i.e., mandating iddirs):

increase formal insurance demand by 29%– risk-sharing can help reduce some (not all!) of basis risk and some trust problems.

leads to increases in some welfare outcomes – purchase of some consumer goods (cloths and mobile phones)

But does not cause formal insurance to have any additional effect on productive outcomes (other than through increasing demand for formal insurance)

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3. Strengthening risk-sharing through iddirs increases formal insurance demand and some welfare

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Back to the research questions - observations

1. Can informal insurance groups be encouraged to mitigate basis risk by increasing transfers in the event of individual-specific bad outcomes? i. Does this encourage demand for insurance? YES

ii. Does this impact other informal transfers? Some evidence of it.

2. impact of formal and informal insurance on productive investments and welfare? Yes, positive impacts on investments and some welfare indicators

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Thank You

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Key lessons learned

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• Basis risk was a major constraint to sales in the first year, even with a unique 10 year household panel data set to help design contracts (very rare)

• Introducing “gap insurance” seemed to have helped increase farmers trust and value of the product and sales increased substantially in the second year

• Gap insurance fills the gap between village level yield loss and the weather index:

Gap insuranceIf widespread yield losses are observed but the weather index does not suggest a payout, a petition of farmers can call for a crop cut. If the average yield is lower than a specified amount an insurance payout is made.

Lesson 1: a good product with minimal basis risk

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• Not everyone needs it—consistently low demand in our site with the least amount of rainfall risk.

• Not everyone can afford it but still a willingness to pay -something to be insured beyond the insurance provided by safety nets– We randomized price discounts and this was

an important factor in determining demand.

– Demand was very low when unsubsidized.

Lesson 2: farmers are willing to spend on insurance, but not much

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• Piloted selling through iddirs in all years

• Iddirs play two roles: – make marketing easier and cheaper– can help manage idiosyncratic basis risk

• Sales are consistently higher through groups than through individuals even with very intensive marketing effort to individuals.

• The role of the group in managing idiosyncratic basis risk increases demand by 29%

Lesson 3: selling through groups helps

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• Trust in the provider is important– The first year of sales in a place where there was no

prior experience of BG was much more difficult than in areas where they were well known

• Selling early—around Meher harvest—also seems to be important, both when the farmer has money and before uncertainty surrounding rains in the current season is resolved.

Lessons 4 and 5: trust and timing

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Thank You

Mandating increased number of groups that offered grants and loans for crop-loss

Grant or loan for crop

loss

Grant or loan for crop

loss

Loan for crop loss

Loan for crop loss

Iddir 0.051** 0.066*** (0.022) (0.022) Iddir (not mandated) 0.010 0.024 (0.027) (0.026)

Iddir (mandated) 0.087*** 0.102*** (0.029) (0.029)

Individual 0.024 0.024 0.042* 0.042* (0.023) (0.023) (0.022) (0.022)

Constant 0.199*** 0.199*** 0.177*** 0.177*** (0.017) (0.017) (0.017) (0.017)

R-squared 0.010 0.013 0.013 0.016 Source: Authors’ calculation based on survey data. Notes: 3,850 observations; Standard Errors in brackets; ***, **,* Significant at 1%, 5%, and 10% level, respectively.

Although no clear impact on group transfers actually made

Some evidence of crowding out

Can receive support for 1000 Birr

emergency

Have you received a

transfer from an individual

Have you received a

transfer from an individual in the same

iddir

Have you send a

transfer to an individual

Have you send a

transfer to an individual in the same

iddir         Mandated iddir village 0.048 0.064 -0.007 -0.021 -0.028**

(0.036) (0.052) (0.012) (0.020) (0.011)Constant 0.566*** 0.054 0.039*** 0.071** 0.032**

(0.052) (0.055) (0.015) (0.034) (0.013)

Observations 1,361 1,361 1,361 1,361 1,361R-squared 0.066 0.167 0.040 0.028 0.016

Increasing group transfers increased formal insurance demand

Demand for insurance

Mandated iddir rules 0.108**(0.053)

Individual 0.077*(0.039)

Non-mandated iddir rules 0.023(0.014)

Observations 387R-squared 0.019

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Formal insurance encourages productive investments

Did you use

fertilizer?

Amount of fertilizer used (kg,

ln)

Amount spent on fertilizer (Birr, ln)

Input expenditure (Birr, ln)

Crop revenue (Birr, In)

Insurance (instrumented) 0.308*** 2.703*** 2.111*** 0.314* 0.392***

(0.061) (0.815) (0.391) (0.161) (0.145)Savings -0.212* -1.849* -1.185* 0.139 -0.605*

(0.111) (0.961) (0.651) (0.179) (0.359)Constant 0.553*** 1.622*** 3.103*** 4.080*** 4.342***

(0.054) (0.292) (0.347) (0.589) (0.331)

Observations 739 736 722 694 706R-squared 0.160 0.216 0.243 0.203 0.319

No additional impact on productive investment from insurance

Did you use

fertilizer?

Amount of fertilizer used (kg,

ln)

Amount spent on fertilizer (Birr, ln)

Input expenditure (Birr, ln)

Crop revenue (Birr, In)

Insurance (instrumented) 0.241*** 2.060*** 1.752*** 0.324*** 0.189

(0.041) (0.718) (0.308) (0.161) (0.114)Insurance in iddir villages 0.290 2.973 2.595 1.950 -0.958

(0.628) (5.686) (4.190) (2.146) (0.985)Iddir village -0.029 -0.296 -0.201 -0.318 0.066

(0.061) (0.595) (0.398) (0.268) (0.125)Constant 0.588*** 1.762*** 3.663*** 3.616*** 4.127***

(0.040) (0.244) (0.273) (0.571) (0.292)

Observations 1856 1849 1818 1752 1781R-squared 0.079 0.136 0.150 0.181 0.262