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Underwriting Area-based Yield Insurance to Crowd-in Credit Supply and Demand Michael R. Carter

Underwriting Area-based Yield Insurance to Crowd-in Credit Supply and Demand Michael R. Carter University of Wisconsin. The Problem. Risk rationing & restricted demand (and its costs) Restricted Credit supply (& its costs)

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Underwriting Area-based Yield Insurance to Crowd-in Credit Supply and Demand Michael R. Carter

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  1. Underwriting Area-based Yield Insurance to Crowd-in Credit Supply and Demand Michael R. Carter University of Wisconsin

  2. The Problem • Risk rationing & restricted demand (and its costs) • Restricted Credit supply (& its costs) • Insurance as solution, but moral hazard & adverse selection can make standard insurance (based on individual outcomes) infeasible • Can limited area-based yield insurance against correlated risk solve credit market problems? • Should resolve credit supply problem (economic & political-economic) • But will it help producers?

  3. Outline of Remainder of Talk • Illustrate Two Types of Moral Hazard-Proof Area-based Yield Insurance: • Based on Measured Average Yields • Based on Estimated Average Yields (weather index) • Estimate Benefits to Farmers/borrowers (using data on rice in Peru’s Lambeyeque Valley) • Estimate benefits to lenders • Argue that must move results into policy & practice by superseding past public good failures

  4. Output Risk

  5. Insurance Contracts

  6. Insurance Contracts

  7. Simulating the Value of Actual & Estimated ARBY Insurance

  8. Simulating the Value of Actual & Estimated ARBY Insurance

  9. Simulating the Value of Actual & Estimated ARBY Insurance

  10. So in Theory, Crowd-in Credit Supply & Demand • Analysis above indicates that: • Substantial reduction in default risk for lenders • When default remains, should be largely idiosyncratic • Should crowd-in credit supply • Analysis also indicates that: • $100 ($200) typical smallholder willingness to pay for estimated (measured) ARBY insurance above & beyond the actuarially fair premium • Together with reduction in default risk, should reduce risk rationing & crowd-in entrepreneurial risk taking and demand for credit • Together imply large social & private returns

  11. Market Failures Follow Public Good Failures • So why is market not providing? • Costs of innovation • Scarcity of reliable data for probability estimates and measurement of payoff condition • Costs of marketing product to smallholders • Note that all of these have a public good element

  12. From Theory to Policy & Practice Time to stop wringing hands about past public good failures and: • Follow example of micro-health insurance and bundle product with MFI loans • Create a policy trajectory which • Initially underwrites risk (& parameter uncertainty) • Creates institutions to collect better information and mover from less to more valuable forms of ARBY • Paper illustrates risk exposure related to public underwriting of initial risk

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