Innovative Financial Services for the Poor:Managing Rainfall Risk

Report on a Field Project with SEWA

Shawn ColeHarvard Business School

Acknowledgements

• SEWA Leadership, cooperation, and guidance

• USAID/BASIS Funding

• IFMR/CMF Funding, Technical Assistance, Research Support

• Terrific implementation and implementation team Dozens of SEWA members; Aparna Krishnan, Monika Singh,

Nilesh Fernando of CMF

• HBS DFRD Financial support

Today’s Talk

• Weather Insurance Description• Project Overview• Why Randomized Trials?• Results• Looking towards the future

An Urgent Need

• Two-thirds of India’s population is rural• Hundreds of millions are very poor, with

very limited ability to come with monsoon risk

• NGO, Government help insufficient• Result: Stress, suffering, farmer

suicides, reduced educational investments, costly diversification, under-investment

Price and Output Risk are Aggregate Shocks

• Cannot turn to friends, family, neighbors• Asset prices (e.g., livestock) may be

depressed• Monsoon correlated with Indian

economic growth (e.g., ability to borrow)

Financial Innovation: Rainfall Insurance

• Financial derivative on local rainfall Costs Rs. 50-250, pays Rs. 500-2000

• First sold in India in 2003 (Andhra Pradesh)

• Pioneered in Gujarat by SEWA in 2005

• Indian monsoon risk uncorrelated with global financial markets: in principle, insurance rates should be very low

• Subsequently copied in dozens of countries

Product Description

• Coverage during Kharif (monsoon)• Payout designed to correlate to economic loss

from deficit / excess• Limitations on how complex product can be

Transparency Pricing

• ICICI, IFFCO, and AIC Policies Policy starts after 20-50 mm accumulated Three phases: sowing, flowering, and harvest Each phase pays out or not separately

The Promise

• Low-cost, scalable intervention• Implement in other developing countries, as well as at the developed world

• Absence of such products has puzzled academics for decades

Key Benefits

No adverse selection No moral hazard Easy to price Divisible: policies as cheap, but individuals

may purchase many Easy to purchase (private company and

government provide) Fast claim settlement

Research: The Challenge

• Selling a custom-designed financial derivative to individuals with primary education and no experience with formal financial contracts

• “If I purchase the insurance, and the rains are good, so the policy doesn’t pay out, do I get a refund of my premium?”

Key limitations

Basis Risk Water needs perhaps not linear Distance between plots and gauge No cover for pests, prices, etc

Complicated Potentially expensive Limited re-insurance market

Research Programme

• SEWA and CMF Researchers Identified 1,500 households in 100

villages From 2006-2009, offered weather

insurance in ca. 50 villages Periodic household surveys A host of ‘marketing’ experiments

Research Agenda

• Impact Evaluation: (How much) better off are agricultural

laborers and farmers who obtain weather insurance

• Developing Sustainable Product Most effective ways to sell Optimal design of product Pricing of products Willingness to pay

Study Context

• SEWA NGO in Gujarat SEWA members: very poor, limited education, limited

landholdings Ongoing project: 2006-2010

• BASIX AP MFI, pioneered weather insurance Groundnut farmers, landowners, high level of trust with

BASIX 2006, 2009

• Large-Scale Project Ca. 3,500 households visited, involving up to 50 staff

Randomized Evaluation

Methodology• Select sample population• Randomly assign ‘treatment’ and ‘control’ groups• Evaluate outcomes following intervention• Similar to drug trials• Very expensive and time-consuming

Key advantages• Randomly assign ‘treatment’ and ‘control’ groups• Avoid selection problem• Estimate ‘average’ effects on population• Produce extremeley credible results (cf, drug trials)

Initial Product Take-Up “Low”

• Approximately 5% of households in a village purchase insurance in Andhra Pradesh

• Purchasing households tend to purchase only one policy

• Makes it difficult to offer the product in a sustainable fashion: marketing cost spread over few purchasers

Research Questions: What are the important barriers to adoption?

• Price• Expected Return• Liquidity• Trust• Product Education / Financial Literacy

Research Methodology

• Understanding demand for product crucial to success

• Can’t simple ask people: what is your elasticity of demand?

• Experimental approach: offer each household a random discount, measure how purchase decision varies

• In cooperation with insurance providers• Similar to medical studies

• Logic: Expected returns an important determinant of demand, at least in theory; but households have limited ability to calculate expected return

• Method: Randomly assign discount coupons to different households to measure price elasticity of demand (cf. Capital One)

• Result: A 10% decrease in price increases product demand 6.5 percentage points

• Analysis: Even when product is positive NPV (183% gross return), only 47% purchase

Key Results: Price

Key Results: Product Awareness

• Logic: Most households unaware of rainfall insurance; indeed, most have never entered a formal financial contract

• Method: (Costly) door-to-door marketing visits• Result: Increases purchase of the product

substantially: 13%• Analysis: Not a cost-effective marketing tool (unless

respondent becomes a subscriber)

Key Results: Product Education

• Logic: Households unfamiliar with index insurance• Method: Additional education module as part of

household visit• Result: No increase in take-up• Analysis: Surprisingly, education not effective

Key Results: Trust

• Logic: Insurance is a promise of a future contingent payment; ICICI/Lombard relatively unknown

• Method: BASIX representative, known to household, accompanies insurance salesperson and endorses product

• Result: Increases product demand 6.5 percentage points

• Analysis: May help explain success of AIC product

Key Results: Liquidity

• Logic: Insurance purchase decision made during planting, competing with other inputs (fertilizer, seeds)

• Method: Randomly assign cash compensation for survey of Rs. 125 to households (price of policy Rs. 100-Rs. 150)

• Result: Larger cash compensation increases take-up by 35 percentage points

• Analysis: Dramatic effect: suggests timing of insurance sales important; loans for policies might be effective; possible priming effect

Key Results: Willingness to pay

• Sustainability of product depends on willingness to pay

• Difficult to elicit willingness to pay with hypothetical questions

• Innovative field experiment measuring willingness to pay:

Given scratch card with a price sought Asked to indicate willingness to pay Number written down Scratch off result: if reported number is above scratch card

price, then purchase is made; if number below price, no sale

Key Results: Willingness to pay for 1 policy

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0.1 0.2 0.3 0.4 0.5 0.6 0.7 0.8 0.9 1

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Percentage of Market Value

Key Result: Willingness to pay for 4 policies

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0.1 0.2 0.3 0.4 0.5 0.6 0.7 0.8 0.9 1

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Bid as percentage of market price

Conclusion and Discussion

• Product has tremendous theoretical merit and practical promise

• Attractive alternative to crop insurance• Substantial barriers to adoption

• Difficult to effectively educate consumers• Consumers have difficulties evaluating product• Liquidity constraints bind

• Technological improvements my substantially improve product

• Developing reinsurance market may improve pricing• Group negotiations for policies quite desirable

Aawar