Author: Surabhi Agarwal
“Do you want rice that is 40Rs/KL, 50Rs/KL, or 60Rs/KL?”
A relatively simple question that we, as consumers, face when
purchasing rice at a local store. But have we considered how the farmer
decides which variety of rice to grow in the season? How does the farmer
ensure that the investments he is making in the inputs will result in a
profitable output? Generally, insurance is a way to protect such
investments. Parchure (2002) estimates that in India about 90% of
variation in crop production is caused by changes in rainfall levels and
patterns. Through a randomized experiment, A Moshfiq Mobarak and Mark Rosenzweig’s research seeks to study the demand for, and effects of, offering formal index-based rainfall insurance.
The absence of adopting formal insurance among rural poor does not
mean the poor are uninsured. However, the informal risk-sharing schemes,
identified via the sub-caste networks, find that risk-sharing is
incomplete and leads exposed farmers to choose low risk and lower-yield
production methods. The study adopts an innovative approach by combining
natural variation in levels of access to informal insurance (due to
membership in sub-caste risk-sharing networks) with designed
(randomized) variation in price and the methods of marketing the
insurance product.
The study markets a simple yet innovative index-based rainfall
insurance product where the payment schemes are based on publicly
observable local rainfall index. This design mitigates moral hazard and
adverse selection problems and eliminates the need for in-field
assessments, issues faced by the current insurance products in the
market. However, the main disadvantage of index insurance is the
presence of basis risk, or the potential mismatch between index-based
pay outs and the actual losses incurred by the policy holder. This is
because the rainfall realized on the land may not perfectly correlate
with the rainfall index as measured by the weather station due to the
distance of the land from the station. In this study, the effect of
basis risk was tested by randomly placing weather stations either at the
village level or the block level and testing the take-up on insurance
with this variation.
Results
The study confirms that members of informally insured networks that
had protected community-level shocks were less likely to purchase the
index-based product, but this was not the case if the informal insured
protected against individual level shocks. It discovers that in the
absence of basis risk, farmers choose full-coverage, formal
index-insurance, independent of being informally insured against
individual losses. However, with the introduction of basis risk (in
areas where the distance was greater), communities that are better able
to insure against individual losses may have a greater demand for index
insurance (the two products become complements). In addition, this
research marketed the product to agricultural labourers, whose
livelihoods are weather-dependent. They demonstrated as strong a demand
for weather index insurance as cultivating landowners.
Policy Implications
These results provide some important policy implications.
First, by placing the weather stations closer to the village-level will
reduce basis risk and increase the demand for the insurance product,
regardless of the level of informal insurance the farmer may have.
Although there may be cost constraints in increasing the number of
weather stations, it is a more systematic method of evaluation than
in-field assessments which can also be costly and face the limitations
mentioned earlier. In addition, currently, agricultural insurance
products are only offered to farmers and not agricultural labourers.
However, as seen, there is a demand for the insurance product by
agricultural labourers who would also be insuring their livelihoods by
purchasing the product. There are also results concerning variations in
marketing techniques and pricing that are currently being analysed that
will provide further policy implications.
To read about these studies and for more information on index-based products, please see our weather insurance web portal.
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