Barriers to Household Risk Management: Evidence from India

1. Shawn Cole Xavier Gine Jeremy Tobacman (HBS) (World Bank) (Wharton) PetiaTopalova Robert Townsend James Vickery (IMF) (MIT) (NY Fed) Barriers to Household Risk Management: Evidence from India Presentation by Shahid Vaziralli, Center for Microfinance, IFMR January 12, 2011

2. Introduction • Theory suggests households should diversify idiosyncratic risk. • Yet, most individuals (and countries) hold idiosyncratic risk even when publicly observable / exogenous: • e.g. exposure to house price risk, local weather fluctuations, commodity prices, regional income growth etc. • Sometimes hedging markets have simply not developed, in other cases they exist but are not widely used. Shiller (1998): “It is odd that there appear to have been no practical proposals for establishing a set of markets to hedge the biggest risks to standards of living”

3. Introduction • Research Question: Why don’t more households participate in formal markets when available? • We study participation in a retail-level rainfall insurance product offered to rural Indian households. • Test theories of insurance demand using a randomized evaluation in Gujarat • Setting where diversification benefits appear particularly high: • Nearly 90% of households in our study area cite rainfall shocks as most important risk faced by the household.

4. Outline • Motivation • Product Description • Setting, Sample, and Research Design • Determinants of Adoption • Conclusion and Future Research

5. Motivation • Agriculture is the primary activity of 2/3 of India (and 40% of the world) • Rainfall is an important determinant of yield and revenue • Lasting, successful, unsubsidized crop insurance is practically non-existent • National Agricultural Insurance Scheme has been disappointing

6. Motivation (cont…) • Is it strange why enough people don’t buy it? • Households use a range of ex-ante and ex-post mechanisms to smooth consumption and labor • Saving, intra-household transfers, grow safer crops etc. • Some evidence that these are: • Insufficient, especially for poor households. • Costly, in the sense that they trade-off risk for lower return. • Poor hedges against shocks that are aggregate to all households in a village, such as a drought. • Demand for weather insurance if the product can be used to hedge risk more cost effectively.

7. Outline • Motivation • Product Description • Setting, Sample, and Research Design • Determinants of adoption • Conclusion and Future Research

8. Product Description • Index-based Insurance on rainfall • Payouts based on rain measured at local rainfall station, relative to different thresholds • Sold within 30km of station by partner NGO • Coverage period spans from June 1 to August 31 • Expected payouts range from 50% to 57% of premium • Catastrophe insurance • Policies underwritten by IFFCO-Tokio

9. Expected Payouts

10. Key Benefits of Product • Reduces transaction costs • Data collection is relatively cheap • Objectivity of index construction • Historical rainfall data can be used to set prices • Divisible (policies as cheap as Rs. 44) and easy to purchase • Fast settlement and payment

11. Key Limitations • Basis Risk (Rainfall imperfectly correlated with income and consumption) • Correlation between rainfall and crop yields • Correlation between rainfall at gauge and plot • Expensive, in part due to small scale. Payout 50-57% of unsubsidized premium • Complicated to understand and evaluate

12. Outline • Motivation • Product Description and Simple Calibration • Setting, Sample, and Summary Statistics • Determinants of adoption • Conclusion and Future Research

13. Gujarat Setting and Sample • 100 villages in three districts (Ahmedabad, Anand, Patan) • Part of a five-year impact evaluation study • Fifteen households interviewed in each village • SEWA (NGO) sells IFFCO policies

14. Education and Financial Literacy • Low level of financial literacy (as good as guessing) • Limited understanding of insurance product

15. Uptake and persistence • Significant correlates of insurance uptake • Wealth • Financial literacy and probability skills (measured through a series of questions in the survey) • Household has other types of insurance products • Surprisingly, aversion to risk does not increase uptake • Of the households who purchased the policy in 2006, 40% purchased the following year • Indicating that rainfall insurance has yet to receive widespread acceptance amongst farmers

16. Outline • Motivation • Product Description and Simple Calibration • Setting, Sample, and Summary Statistics • Determinants of Adoption • Conclusion and Future Research

17. Field experiments • Design of treatments guided by potential barriers to adoption: • Theoretical determinants of willingness to pay • Price (relative to actuarial value) • Aversion to risk • Not enough cash on hand • Perception of basis risk • Size of risk • Non-standard – financial literacy, trust in the provider, religious cues in marketing materials

18. Experiment: Price • Motivation: Financial services expensive to provide in poor areas • Insurance premium ranges from Rs. 44 - Rs. 86 (USD 1 – USD 2) • Sample: 1,415 households • Intervention: Randomly assign discounts to households • Offer discount of Rs. 5, 15, or 30 for first policy purchased • Expected payout ranges from 54%-181% • Price elasticity of demand on order of 0.8 (significant at 1%) • 53% of households decline policy with expected gross return of 181% return over four months

19. Experiment: Trust • Motivation • Households may be less inclined to purchase products from unfamiliar sources • Sample: 2,391 households • Interventions • 1: Including religious symbols and cues on flyers • 2: Emphasizing the SEWA brand through videos • Results • Intervention 1 • Muslim households are 33% less likely to purchase a policy when the flyer includes Hindu symbols (significant at 5% level) • Hindu households are 10% less likely to purchase a policy when flyer includes Muslim symbols (significant at 5% level) • Intervention 2 • Surprisingly, SEWA Brand emphasis has main effect of zero despite evidence from other studies that branding is significant

20. Conclusions Adoption of innovative products may be slow Overall uptake was 26% among households receiving a video or flyer Insurance demand is sensitive to price Non-standard factors such as trust are important. First experimental evidence for role of trust in financial market participation

21. Policy Recommendations • Increase density of rainfall gauges • Foster competition in the market • Combine rainfall and crop-yield insurance • Combine product with a loan • Group policies

22. FIN