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Time vs. state in insurance: experimental evidence from contract farming in Kenya
Abstract
The gains from insurance arise from the transfer of income across states. Yet, by requiring that the premium be paid upfront, standard insurance products also transfer income across time. We show that this intertemporal transfer can help explain low insurance demand, especially among the poor, and in a randomized control trial in Kenya we test a crop insurance product which removes it. The product is interlinked with a contract farming scheme: as with other inputs, the buyer of the crop offers the insurance and deducts the premium from farmer revenues at harvest time. The take-up rate is 72%, compared to 5% for the standard upfront contract, and take-up is highest among poorer farmers. Additional experiments and outcomes indicate that liquidity constraints, present bias, and counterparty risk are all important constraints on the demand for standard insurance. Finally, evidence from a natural experiment in the United States, exploiting a change in the timing of the premium payment for Federal Crop Insurance, sho s that the transfer across time also affects insurance adoption in developed countries.
... Second, we contribute to the literature on liquidity and credit constraints of smallholders (e.g. Casaburi and Willis 2018;Burke, Bergquist, and Miguel 2019). Our finding on the positive effect of credit intervention is consistent with those of Burke, Bergquist, and Miguel (2019) and Casaburi and Willis (2018), which indicate that smallholders are creditconstrained. ...
... Casaburi and Willis 2018;Burke, Bergquist, and Miguel 2019). Our finding on the positive effect of credit intervention is consistent with those of Burke, Bergquist, and Miguel (2019) and Casaburi and Willis (2018), which indicate that smallholders are creditconstrained. Casaburi and Willis (2018) finds that the demand for insurance is higher at harvest compared to the earlier time of the crop season, which indicates that relaxing the credit constraint increases the demand for agricultural inputs. ...
... Our finding on the positive effect of credit intervention is consistent with those of Burke, Bergquist, and Miguel (2019) and Casaburi and Willis (2018), which indicate that smallholders are creditconstrained. Casaburi and Willis (2018) finds that the demand for insurance is higher at harvest compared to the earlier time of the crop season, which indicates that relaxing the credit constraint increases the demand for agricultural inputs. In the context of the hermetic storage technology, Aker, Dillon, and Welch (2023) indicate that traders see liquidity as a barrier to the adoption. ...
Uninsured risk is often cited to explain the lagging adoption of new agricultural technologies in low-income regions. However, insurance interventions suffer from poor take-up. We test whether bundling a new product–hermetic storage bags–with a warranty can serve as a viable alternative. We compare the warranty to a credit intervention and a control using an incentivized auction in rural Bangladesh. We find the warranty had no impact on demand. Providing the bags on credit significantly increased willingness-to-pay, and machine learning estimates indicate credit may have raised the demand for the most marginal farmers. Warranties failed to stimulate demand along any dimension.
... Premiums are typically paid up-front, while claims payments are made throughout the coverage period. Therefore, time preferences also matter for how insurance is evaluated by consumers (Dionne and Eeckhoudt, 1984;Baicker et al., 2015;Casaburi and Willis, 2018). An important dimension of time preferences is the preference for the timing of uncertainty resolution; this preference has received attention in decision theory and features prominently in asset pricing and macroeconomics (Tallarini Jr, 2000;Nielsen, 2020;Schlag et al., 2021). ...
... Our paper contributes to the recent debate on the role of time preferences in insurance demand. Casaburi and Willis (2018) find that the timing of the premium payment in an insurance contract greatly affects insurance demand for small-holder farmers. Others allude to the role of certain time preferences, such as present bias, in the demand for health insurance (Baicker et al., 2015). ...
... Consumer behavior is not always well-represented by traditional models of insurance demand, and insurers may adjust contract design accordingly (Sydnor, 2010;Knoller et al., 2016;Gottlieb and Smetters, 2021). Tailoring insurance contracts to consumers' preferences and individual circumstances can make them more appealing and stimulate demand in the market, thus increasing insurance take-up (Casaburi and Willis, 2018). Our results suggest that consumers who exhibit PERU may appreciate insurance contracts with a longer time horizon also because these consumers dislike a late resolution of uncertainty. ...
... Premiums are typically paid up-front, while claims payments are made throughout the coverage period. Therefore, time preferences also matter for how insurance is evaluated by consumers (Dionne and Eeckhoudt, 1984;Baicker et al., 2015;Casaburi and Willis, 2018). An important dimension of time preferences is the preference for the timing of uncertainty resolution; this preference has received attention in decision theory and features prominently in asset pricing and macroeconomics (Tallarini Jr, 2000;Nielsen, 2020;Schlag et al., 2021). ...
... Our paper contributes to the recent debate on the role of time preferences in insurance demand. Casaburi and Willis (2018) find that the timing of the premium payment in an insurance contract greatly affects insurance demand for small-holder farmers. Others allude to the role of certain time preferences, such as present bias, in the demand for health insurance (Baicker et al., 2015). ...
... Consumer behavior is not always well-represented by traditional models of insurance demand, and insurers may adjust contract design accordingly (Sydnor, 2010;Knoller et al., 2016;Gottlieb and Smetters, 2021). Tailoring insurance contracts to consumers' preferences and individual circumstances can make them more appealing and stimulate demand in the market, thus increasing insurance take-up (Casaburi and Willis, 2018). Our results suggest that consumers who exhibit PERU may appreciate insurance contracts with a longer time horizon also because these consumers dislike a late resolution of uncertainty. ...
In this paper, we study the role of preferences over the timing of uncertainty resolution for insurance demand, both theoretically and in an incentivized laboratory experiment. We use Kreps-Porteus-Selden preferences and risk-sensitive preferences to disentangle risk and time. When people prefer to resolve uncertainty early, having to wait for the resolution of the loss raises their willingness to pay for insurance. Our experimental results are directionally consistent with the theoretical prediction but not statistically significant. We also calibrate preference parameters in the two models based on the subjects' choices in the experiment. Consistent with our results about willingness to pay, the parameters are directionally consistent with a preference for early resolution of uncertainty. Our results have implications for insurance contract design, particularly in the realm of long-term contracting.
... Given the limited assets of many informal workers, liquidity constraints might pose a more significant problem in the informal sector than in insurance markets with higher access to credit. Recent evidence suggests that the timing of premium payments can enhance demand by relaxing liquidity constraints (Casaburi and Willis (2018) refer to pay-at-harvest insurance, and Bauchet and Morduch (2019) consider weekly instead of lump sum payments). ...
This chapter provides an overview of microinsurance and reviews existing supply, demand, and impact research. Despite half of the world’s population lacking traditional insurance solutions, offering low-cost, low-coverage insurance products has not been effective. Our review shows that supply-side and demand-side limitations explain why take-up has been much lower than expected, and encouraging take-up is difficult. We review the processes, give an overview of the challenges, and provide impulses for further research and product development. The “contributive & collaborative” (C&C) microinsurance model offers a customer-centric and demand-driven alternative to empower individuals and communities.
... As an essential tool to hedge income and consumption risk, many governments exercise great efforts to develop and market private insurance products. However, the diffusion of insurance services is still slow, and the global insurance density was only $818 in 1 Although existing research has analyzed factors influencing insurance take-up such as liquidity constraints, lack of financial literacy, present bias, lack of trust, and economic policy uncertainty in the insurance provider (Banerjee et al. 2019;Cai et al. 2015;Casaburi and Willis 2018;Cole et al. 2013;Gaurav et al. 2011;Giné et al. 2008;Gupta et al. 2019;Pradhan et al. 2017), the insurance take-up rate is still low when removing these barriers in experimental settings (Bridle et al. 2020). Investigating the potential factors affecting private insurance enrollment is pivotal for the insurance market. ...
This paper utilizes data from the China Family Panel Studies (CFPS) to explore the influence of clan culture on the demand for households’ private insurance. The findings reveal that clan culture enhances the likelihood of enrolling in private insurance and increases premium expenditures. Additionally, our research examines how clan culture impacts household private insurance demand and identifies that the solid social interaction among clansmen primarily drives the positive effect of clan culture on private insurance uptake. Furthermore, the positive relationship between clan culture and private insurance uptake is particularly pronounced among rural households, low-income families, and households without internet access and high cognitive abilities.
... In both cases, given frequent repayment rates, they would only be willing to do so if either the new investment financed by the microloan generated an immediate return, or they were willing to run down their stock of savings or reduce consumption in the transition before the returns to investment began to be realized. This is less likely to be the case for labour activities based on agriculture, where earning streams are often bunched at certain times of the year, and are volatile at those times of year, creating demand for short-run liquidity for consumption smoothing (Casaburi and Willis 2018;Casaburi and Macchiavello 2019). ...
The bulk of the world's extreme poor work in subsistence agriculture. Diversification out of this activity is often seen as the sine qua non of economic development. We evaluate whether the roll-out of a mainstay development intervention-microfinance-into poor, agricultural and largely unbanked populations in rural Uganda helps borrowers to diversify into non-agricultural labour activities. The new microfinance product is targeted to women, and differs from existing sources of formal and informal credit in that it allows them to borrow larger amounts but has inflexible repayment dates and the use of funds is monitored. We find that the arrival of microfinance enables women to diversify out of agriculture and into service-based activities such as small-scale trading. This low-level structural change, however, is not transformative in that it does not lead-at least after two years-to significant uplifts in earnings, consumption, savings, investment and overall wealth.
... By transferring the climate risks facing borrowers and lenders to the insurance markets, it is also expected that both demand-and supply-side credit rationing can be reduced thereby increasing the elasticity of credit demand and supply (Shee et al., 2019). Second, unlike the conventional, stand-alone agricultural insurance products that require upfront premium payment, premiums in insurance-linked credit are paid at the end of the cropping cycle, which can help in overcoming liquidity constraints that plague the agricultural insurance markets (Casaburi & Willis, 2018;Kramer et al., 2022;Liu, Chen, & Hill, 2020). ...
... Giné et al. (2008) argued that farmers equally evaluate the decision between insurance or the purchase of new technology because of their perception of the distribution of insurance benefits. Casaburi and Willis (2018) reached an interesting finding that the determinant that affects the decision to buy insurance from farmers is the time and method of payment of the insurance premium. According to this study, if insurance companies would offer the sale of products during the harvest period or the possibility of payment in installments, more would be bought by farmers due to the high liquidity in that period. ...
This study aims to explore the development of agriculture insurance from farmers’ perspective in a developing country such as Albania and to identify the reasons why farmers choose to be insured or not. Moreover, the paper aims to evaluate the willingness of farmers to choose agricultural insurance as the best method to reduce agricultural risks based on the offer of the insurance market in the agricultural sector. For this purpose, the study employs primary data gathered from 452 questionnaires distributed in four regions with the highest agriculture contribution and the highest number of farmers in Albania (Tirana, Dibër, Korçë and Fier). The results indicate that Albanian farmers, despite being aware of the various risks involved in agricultural production, opt not to purchase insurance policies and instead choose to self-insure. Analysis shows that this choice is influenced by factors such as lack of information, price, and trust in insurance providers. Moreover, the study points out that farmers are willing to pay a low premium that does not match the price set by insurance companies for this service.
... De plus, les auteurs ont constaté que la prime d'assurance a un effet négatif sur la propension à souscrire une assurance. Casaburi et Willis (2018) dans une étude expérimentale de l'assurance avec paiement à la récolte auprès de petits producteurs contractuels de canne à sucre au Kenya, ils ont constaté que les agriculteurs demandaient moins d'assurance au début de la saison, non pas en raison de problèmes de liquidité, mais parce que le paiement à l'avance n'était pas marginalement approprié pour leur rendement attendu. ...
L'agriculture est un enjeu économique et de sécurité alimentaire pour la plupart des pays en
développement. Cependant, si le secteur est exposé à de nombreux aléas, notamment ceux liés aux
facteurs climatiques, l'assurance agricole s'est imposée comme une option de filet de sécurité afin de
protéger le bien-être des agriculteurs. Cependant, par rapport aux autres continents comme Europe,
Amérique latine et Asie, le taux d'adoption de l'assurance agricole par les agriculteurs et les éleveurs
en Afrique est faible. La synthèse bibliographique a été à partir de 85 publications scientifiques récentes
inventoriées dans les moteurs de recherche (scopus, google scholar et Web of science) sur l’assurance
indicielle afin de ressortir la perception, les facteurs d’adoption et son impact pour sa mise à l’échelle,
ainsi que les facteurs d’ordre sociodémographiques (l’âge, le sexe, le niveau d’éducation et la religion),
économique (le revenu de l’agriculteur) et techniques (la connaissance de l’objet de l’assurance, les
modes de sensibilisation, la participation des producteurs et surtout des agriculteurs à l’évaluation, etc.)
qui déterminent l’adoption de l’assurance indicielle. La synthèse bibliographique attire l’attention sur le
fait d’impliquer la gent féminine qui est laissée pour compte, de développer les programmes
d’alphabétisation et de rendre palpable la participation des gouvernements locaux et des agriculteurs
en les plaçant au coeur du processus d’adoption. Il sera nécessaire de subventionner tout en proposant
des services d'assurance adaptés et collaboratifs, en tenant compte des profils des agriculteurs et de
leur environnement.
Mots clés : Perception de l’assurance, Assurance de l’agriculture indicielle, Adoption de l’assurance,
Impact de l’assurance, revue systématique
... However, it can leave higher-risk individuals without affordable insurance options, most notably those who have become high-risk after many years of having been insured when they were considered low-risk. constraints [67,68]. Studies have highlighted the impacts of compound risk aversion and ambiguity aversion on insurance uptake [69,70]. ...
This chapter offers a detailed analysis of microinsurance (nowadays often called “inclusive insurance”), an innovative hybrid model combining grassroots initiatives with top-down approaches to reach populations not covered by government-operated social protection systems. With half of the global population, primarily in low and middle-income countries, lacking social protection, the chapter focuses on the potential of microinsurance to address this pressing issue. The commercial microinsurance attempts, often labeled as “insurance for the poor,” have been largely insufficient. An alternative lies in the “Collaborative and Contributive” (C&C) model of microinsurance,
which harnesses social forces, typically more compelling than market forces in informal settings, to stimulate demand. The chapter evaluates microinsurance’s social and economic impacts, drawing insights from 25 years of progress. It underscores
the need for policymakers, international development bankers, and the reinsurance industry to recognize the potential of the C and C model in providing comprehensive insurance to marginalized populations.
... 23 At the time of the study, Inclusive Guarantee was known as PlaNet Guarantee. purchase the insurance (Casaburi and Willis 2018). Farmer groups had to collectively decide whether or not to purchase the insurance. ...
... Empirical evidence reveals that lowering the prices of microinsurance increases demand, but overall uptake is minimal [63][64][65]. Households with higher liquidity and easier access to credit are more likely to buy insurance, i.e., slightly less price sensitive [63,66], and adjusted premium payment structures can ease liquidity constraints [67,68]. Studies have highlighted the impacts of compound risk aversion and ambiguity aversion on insurance uptake [69,70]. ...
This chapter offers a detailed analysis of microinsurance (nowadays often called “inclusive insurance”), an innovative hybrid model combining grassroots initiatives with top-down approaches to reach populations not covered by government-operated social protection systems. With half of the global population, primarily in low and middle-income countries, lacking social protection, the chapter focuses on the potential of microinsurance to address this pressing issue. The commercial microinsurance attempts, often labeled as “insurance for the poor,” have been largely insufficient. An alternative lies in the “Collaborative and Contributive” (C&C) model of microinsurance, which harnesses social forces, typically more compelling than market forces in informal settings, to stimulate demand. The chapter evaluates microinsurance’s social and economic impacts, drawing insights from 25 years of progress. It underscores the need for policymakers, international development bankers, and the reinsurance industry to recognize the potential of the C and C model in providing comprehensive insurance to marginalized populations.
... This paper also contributes to the index insurance literature. Several field studies investigate the demand and efficiency of index insurance (Cole et al. 2013(Cole et al. , 2014Casaburi and Willis 2018). Clarke (2016) and Jensen et al. (2016) show that basis risk causes the low demand of index insurance. ...
Weather risk affects the economy, agricultural production in particular. Index insurance is a promising tool to hedge against weather risk, but current piecewise-linear index insurance contracts face large basis risk and low demand. We propose embedding a neural network-based optimization scheme into an expected utility maximization problem to design the index insurance contract. Neural networks capture a highly nonlinear relationship between the high-dimensional weather variables and production losses. We endogenously solve for the optimal insurance premium and demand. This approach reduces basis risk, lowers insurance premiums, and improves farmers’ utility.
This paper was accepted by Agostino Capponi, finance.
Funding: This work was supported by the Research Grants Council, University Grants Committee [Grants GRF 16502020, GRF 16504522, and T31-603/21-N], Singapore Ministry of Education Academic Research Fund Tier 1 [Grants RG143/19 and RG55/20], the Natural Sciences and Engineering Research Council of Canada [Grants RGPIN-2021-04144 and DGECR-2021-00330], the Research Database Matching Fund, and the School of Business and Management, Hong Kong University of Science and Technology.
Supplemental Material: The data files and online appendices are available at https://doi.org/10.1287/mnsc.2023.4902 .
... While the Fragility Index measures pressures and shocks, the Resilience Index measures the capacities a country has in dealing with a crisis. 70 Even if the country is very resilient, a crisis will occur at some point, but its intensity will be muted and its effects contained. Measuring a country's resilience allows preventive efforts to be undertaken and resources to be allocated in preparation for the next crisis. ...
We test whether payments for ecosystem services (PES) can curb the highly polluting practice of crop residue burning in India. Standard PES contracts pay participants after verification that they met a proenvironment condition (clearing fields without burning). We randomize paying a portion of the money up front and unconditionally to address liquidity constraints and farmer distrust, which may undermine the standard contract’s effectiveness. Incorporating partial up-front payment into the contract increases compliance by 10 percentage points, which is corroborated by satellite-based burning measurements. The cost per life saved is 3,600–5,400. The standard PES contract has no effect on burning. (JEL D86, O13, Q12, Q15, Q18, Q53, Q58)
Using administrative data for 63,000 individuals across 2,500,000 person‐month observations, we find that wealthier individuals have better life insurance coverage, controlling for the value of the asset insured, namely, the consumption needs of dependents. This positive wealth‐insurance correlation, which is surprising given the prevailing view that wealth substitutes for insurance, persists after allowing for wealth‐related differences in risk or bequest preferences, pricing, background risk, education, employment, or liquidity constraints. Our findings call for further investigation of this wealth‐coverage correlation but support theories emphasizing the consumption‐smoothing role of insurance across not only states of the world, but also time.
Severe climate events pose an increasing threat to households’ financial well-being. Households affected by these events can face a significant financing challenge as disaster expenses and damages may exceed tens or even hundreds of thousands of dollars. We review the literature to describe how households fund recovery, with a focus on the role of insurance. While insurance is a key financial tool for managing such large losses, many households are uninsured and rely on a patchwork of savings, credit, federal assistance programs, and help from family and friends. Low-income households and racial or ethnic minority households have more limited access to recovery funding. Households who are unable to fund repairs appear at greater risk of financial distress in the years after the disaster. Our findings highlight the importance of disaster insurance and motivate a comprehensive view of financial recovery where income and race play critical roles.
Social protection programs have become increasingly widespread in low- and middle-income countries, with their own distinct characteristics to match the environments in which they are operating. This paper reviews the growing literature on the design and impact of these programs. We review how to identify potential beneficiaries given the large informal sector, the design and implementation of redistribution and income support programs, and the challenges and potential of social insurance. We use our frameworks as a guide for consolidating and organizing the existing literature and also to highlight areas and questions for future research. (JEL E26, H23, I13, I32, I38, O12, O16)
This chapter explores how the deployment of financial digitalization can foster agriculture and inclusive development. It provides critical insights into recent developments in digital finance, how digital finance can drive agriculture and inclusive development, and the challenges associated with financial digitalization. The chapter recommends options for harnessing financial digitalization to foster agriculture and inclusive development.
Rainfall index insurance can enable farm households to manage production risk, but demand in developing countries remains low at market prices, in part because the insurance trigger may not correlate well with individual farm losses. Area‐yield crop insurance, which links payouts to average yield in a geographic zone, attempts to increase demand by more accurately targeting insurance payouts to production shortfalls. However, shifting from an exogenous weather‐based to an endogenous yield‐based index introduces concerns of asymmetric information, which can lead to market failures that constrain supply from providers. These features are inversely related: larger insurance zones inhibit index manipulation, but average yield is less informative about any individual plot. We quantify this tradeoff for maize in Ghana using a spatial yield model calibrated to match observed production. Insurers must demarcate zones of no more than 5000 farmers for area‐yield insurance to outperform weather insurance. The framework presented in this paper allows assessment of the relationship between index performance and asymmetric information in new crop insurance products.
We use a cash transfer to relax households’ borrowing constraints, then elicit their willingness to pay for a remedial education programme offering tutoring and life skills training. Lottery losers were willing to pay 3,300 Tanzanian Shillings for the programme, which is 7% of per capita monthly expenditures. For those identified at baseline as able to borrow, willingness to pay increases by 3% upon winning a lottery prize of 3,200 Tanzanian Shillings. For those unable to borrow, willingness to pay increases by 27% upon winning the lottery. We conclude that borrowing constraints limit access to educational programmes, and may increase inequality of educational attainment.
Health insurance plans increasingly pay for expenses only beyond a large annual deductible. This paper explores the implications of deductibles that reset over shorter timespans. We develop a model of insurance demand between two actuarially equivalent deductible policies in which one deductible is larger and resets annually and the other deductible is smaller and resets biannually. Our model incorporates borrowing constraints, moral hazard, midyear contract switching, and delayable care. Calibrations using claims data show that the liquidity benefits of resetting deductibles can generate welfare gains of 3–10 percent of premium costs, particularly for individuals with borrowing constraints. (JEL D15, D82, G22, G51, G52, I13)
Using a multi-year, spatially diversified randomised controlled trial spanning two African countries, this paper explores whether a complementary bundle of genetic and financial technologies can boost the resilience and productivity of small-scale farmers. The analysis shows that both moderate droughts and more severe yield losses undermine the resilience of control-group households, and that these shocks have long-lasting effects as farmers invest and produce less following shocks. Severe yield shocks also increase hunger and food insecurity. The genetic technology—drought-tolerant seeds—provides economically significant protection against mid-season drought and mitigates the long-term drop in farm productivity seen in the control group. The financial technology—satellite-based index insurance—offsets the long-term consequences of severe yield losses that are not mitigated by the drought-tolerant seeds. Finally, the analysis shows that treatment-group farmers who experienced shocks and saw the technologies in action subsequently increased their agricultural investment beyond pre-shock levels, an effect we call the resilience dividend. Unfortunately, this apparent experiential learning cuts both ways. Farmers who did not experience the efficacy of the risk management technologies backed away from using them. Our findings thus showcase how genetic and financial risk-mitigating technologies can offer farmers more complete protection, as well as the challenge of inducing sustained uptake of technologies that are midway between experience and credence goods and only infrequently reveal their benefits.
We study the provision of financial services to small firms, consumers, and workers in developing countries as part of value chain relationships: value chain microfinance (VCMF). We first explore how VCMF can both overcome barriers to financial access—including asymmetric information, enforcement, and behavioural biases—and strengthen value chains, but also how it can introduce new challenges. We then review a recent empirical literature at the intersection of value chains and microfinance, studying the demand for and effects of VCMF in credit, insurance, and savings markets. We conclude by highlighting promising directions for future work.
Climate change is increasing the frequency of extreme weather events, with low‐income countries being disproportionately impacted. However, these countries often face market frictions that hinder their ability to adopt effective adaptation strategies. In this paper, I explore the role of credit market failures in limiting adaptation. To achieve this, I collaborate with a large microfinance institution and offer a randomly selected group of farmers access to guaranteed credit through an “Emergency Loan” following a negative climate shock. I document three key results. First, farmers who have access to the emergency loan make less costly adaptation choices and are less severely affected when a flood occurs. Second, I find no evidence of adverse spillover effects on households that did not receive the Emergency Loan. Finally, I demonstrate that providing the Emergency Loan is profitable for the microfinance institution, making it a viable tool for the private sector to employ in similar circumstances.
Pay-as-you-go contracts reduce minimum purchase requirements, which may increase market participation. This paper randomizes the introduction and price(s) of a novel pay-as-you-go contract to the California auto insurance market, where 17% of drivers are uninsured. The pay-as-you-go contract increases take-up by 10.8 p.p. (89%) and days with coverage by 4.6 days over the 3-month experiment (27%). Demand is relatively inelastic, and pay-as-you-go increases insurance coverage in part by relaxing liquidity requirements: most drivers’ purchasing behavior is consistent with a cost of credit in excess of payday lending rates, and 19% of drivers have a purchase rejected for insufficient funds.
Authors have furnished an Internet Appendix, which is available on the Oxford University Press Web site next to the link to the final published paper online
The diffusion of credit cards may have relaxed households' liquidity constraints, thereby stimulating the diffusion of commercial insurance. By investigating Chinese urban households who had no commercial insurance in 2013, we find that their initial access to credit cards significantly increased the likelihood of their holding commercial insurance in 2015. Our instrumental variable (IV) estimations confirm the causality. This positive effect is more pronounced among more liquidity‐constrained households and among households with more financial knowledge. Last, the initial access to credit cards also significantly enhanced commercial insurance renewal in 2015 among those households who had commercial insurance in 2013.
In this chapter, we introduce the role of government and how it impacts the policymaking process. Mainly, the duties of government focus on correcting externalities and reducing social inequalities. To achieve these goals, governments use policy tools to try to change behaviors of citizens and organizations. They do so, however, often with the ideal citizen in mind – that who is only motivated by the economic costs and benefits of their actions and who is perfectly attentive to them, immune to internal conflicts between reason and affect and to social pressure, and with perfect ability to follow through on past plans. For good or bad, real citizens are not like that. Through concrete examples, we motivate the use of insights from the behavioral sciences for diagnosing the key drivers of public problems, to better inform the design of effective public policies and social programs.KeywordsGovernmentPublic problemsReal citizenBehavioral insightsMSI matrixPRIx matrix
This chapter presents a novel methodology for diagnosing policy-relevant behavioral mechanisms: the MSI framework, whereby the acronym stands for motivation, self-control, and inattention problems. This framework is motivated by the fact that, while individuals respond to financial incentives, they also respond to a broad range of behavioral mechanisms. As such, public policies designed for the “ideal citizen” usually face important limitations. This chapter introduces the MSI framework, explaining each behavioral mechanism and providing examples of how they manifest in widespread social problems across a range of applications.KeywordsMSI frameworkBehavioral mechanismsMotivationSelf-controlInattention
This chapter covers a novel methodology for augmenting policy tools with behavioral insights: the PRIx framework, whereby the acronym stands for pricing, regulatory, and information policies, and the x indicates its use combined with the mechanisms of the MSI framework. This framework aims at repurposing policy instruments already widely used in the public sector to address the behavioral mechanisms that affect the “real citizen.” The chapter introduces the PRIx framework, explaining how each policy tool can be modified to leverage each behavioral mechanism, and providing examples of how such adaptations (some more than others) could help address widespread social problems across a range of applications.KeywordsPricingRegulationInformationPRIx framework
We conduct a randomized controlled trial to examine the impacts of delayed premium payment on insurance uptake and the subsequent investment decisions among smallholder farmers in rural China. Our results show uptake among those with the delayed payment option is 10% higher than and three times as high as among those without the option. We also find a positive impact of delayed premium payment and insurance adoption on household investment in production, especially higher risk activities.
Using data from a randomized experiment in rural China, we study the influence of social networks on weather insurance adoption and the mechanisms through which they operate. To quantify network effects, the experiment provides intensive information sessions about the product to a random subset of farmers. For untreated farmers, the effect of having an additional treated friend on take-up is equivalent to granting a 13 percent reduction in the insurance premium. By varying the information available about peers’ decisions and randomizing default options, we show that the network effect is driven by the diffusion of insurance knowledge rather than purchase decisions.
Risk and time are intertwined. The present is known while the future is inherently risky. This is problematic when studying time preferences since uncontrolled risk can generate apparently present-biased behavior. We systematically manipulate risk in an intertemporal choice experiment. Discounted expected utility performs well with risk, but when certainty is added common ratio predictions fail sharply. The data cannot be explained by prospect theory, hyperbolic discounting, or preferences for resolution of uncertainty, but seem consistent with a direct preference for certainty. The data suggest strongly a difference between risk and time preferences.
There is a vigorous debate on liberalization of the heavily regulated agricultural markets in India. A crucial institutional characteristic is the role of state-regulated brokers in wholesale markets. Relying on data from a unique survey in Uttarakhand, a state in North India, we find that regulations on margins are ineffective, since most brokers charge rates that significantly exceed the regulated ones. We also find that a majority of farmers self-select into long-term relationships with brokers. These relationships allow some of the farmers to interlink credit and insurance markets to the agricultural output market. This interlinkage does not, however, appear to be an instrument for farmer exploitation (since it does not lead to worse inputs, higher interest rates, or lower implicit output prices) but is seemingly an extra service provided by brokers to establish farmer loyalty and thereby ensure future supplies.
Risk and time are intertwined. The present is known while the future is inherently risky. Discounted expected utility provides a simple, coherent struc-ture for analyzing decisions in intertemporal, uncertain environments. Critical to such analysis is the notion that certain and uncertain utility are functionally interchangeable. We document an important and robust violation of discounted expected utility, which is essentially a violation of this interchangeability. In pa-rameter estimations, certain utility is found to be almost linear while uncertain utility is found to be substantially more concave. These results have implications for discounted expected utility theory and decision theory in general. Applica-tions are made to dynamic inconsistency, the uncertainty effect, the estimation of risk preferences, and probability weighting.
Many severe health risks in developing countries could be substantially reduced with access to appropriate preventive measures. However, the associated costs are often high enough to restrict access among poor households, and free provision through public health campaigns is often not financially feasible. We describe findings from the first large-scale cluster randomized controlled trial in a developing country context that evaluates the uptake of a health-protecting technology, insecticide-treated bednets (ITNs), through micro-consumer loans, as compared to free distribution and control conditions. Numerous studies have shown that widespread, regular use of ITNs is one the most effective preventive measures against malaria. However, ownership rates remain very low in most malarious areas, including our study areas in rural Orissa (India). Despite the un-subsidized price, 52 percent of sample households purchased at least one ITN, leading to 16 percent of individuals using a treated net the previous night, relative to only 2 percent in control areas where nets were not offered for sale. However, the increase fell significantly short of the 47 percent previous-night usage rate achieved with free distribution. Most strikingly, we find that neither micro-loans nor free distribution led to improvements in malaria and anemia prevalence, measured using blood tests. We examine and rule out several plausible explanations for this latter finding. We conjecture that insufficient ITN coverage is the most likely explanation, and discuss implications for public health policy.
This article studies strategic default on forward sale contracts in the international coffee market. To test for strategic default, we construct contract-specific measures of unanticipated changes in market conditions by comparing spot prices at maturity with the relevant futures prices at the contracting date. Unanticipated rises in market prices increase defaults on fixed-price contracts but not on price-indexed ones. We isolate strategic default by focusing on unanticipated rises at the time of delivery after production decisions are sunk and suppliers have been paid. Estimates suggest that roughly half of the observed defaults are strategic. We model how strategic default introduces a trade-off between insurance and counterparty risk: relative to indexed contracts, fixed-price contracts insure against price swings but create incentives to default when market conditions change. A model calibration suggests that the possibility of strategic default causes 15.8% average losses in output, significant dispersion in the marginal product of capital, and sizable negative externalities on supplying farmers.
We present the results of an experiment introducing commercial rainfall index insurance into drought‐prone farming cooperatives in Amhara Region, Ethiopia. We provided a market‐priced rainfall deficit insurance product through producer cooperatives and tested a number of potential ways to kick start private demand. Take up of the insurance at market prices is very low, between 0.5% and 3% across seasons. When we use a randomized experiment to distribute small free insurance contracts to farmers, 39% of subsidized individuals enroll but this fails to stimulate input use, yields, or income, nor does it enhance demand in subsequent seasons. A training and promotion on the product improves uptake and willingness to pay but also does not improve farming outcomes. We conclude with a case study of our efforts to interlink index insurance with credit for agricultural inputs.
This paper studies alcohol consumption among low-income workers in India. In a 3-week field experiment, the majority of 229 cycle-rickshaw drivers were willing to forgo substantial monetary payments in order to set incentives for themselves to remain sober, thus exhibiting demand for commitment to sobriety. Randomly receiving sobriety incentives significantly reduced daytime drinking while leaving overall drinking unchanged. I find no evidence of higher daytime sobriety significantly changing labor supply, productivity, or earnings. In contrast, increasing sobriety raised savings by 50 percent, an effect that does not appear to be solely explained by changes in income net of alcohol expenditures.
Despite extensive evidence that preferences are often time-inconsistent, there is only scarce evidence of willingness to pay for commitment. Infrequent payments for frequently provided goods and services are a common feature of many markets and they may naturally provide commitment to save for lumpy expenses. Multiple experiments in the Kenyan dairy sector show that: (i) farmers are willing to incur sizable costs to receive infrequent payments as a commitment device, (ii) poor contract enforcement, however, limits competition among buyers in the supply of infrequent payments. We then present a model of demand and supply of infrequent payments and test its additional predictions.
This paper develops an experimental approach to measure competition among intermediaries in agricultural markets, based on the random allocation of subsidies to traders. We show that, in individual-level randomizations with competitive spillovers, treatment-control differences in prices can inform an intuitive test of the degree of differentiation among firms. In the context of the Sierra Leone cocoa industry, traders compete by providing farmers credit, as well as through prices. Even when accounting for both the price and the credit margin, differentiation among traders is low. By combining the experimental results with quasi-experimental estimates of the pass-through rate, we then estimate market size the effective number of traders competing for farmers' supply and we find it to be substantially larger than the village. These results are consistent with a view of competitive agricultural markets.
Weather is a key source of income risk, especially in emerging market economies. This paper uses a randomized controlled trial involving Indian farmers to study how an innovative rainfall insurance product affects production decisions. We find that insurance provision induces farmers to invest more in higher-return but rainfall-sensitive cash crops, particularly among educated farmers. This shift in behavior occurs ex ante, when realized monsoon rainfall is still uncertain. Our results suggest that financial innovation can mitigate the real effects of uninsured production risk.
Received December 26, 2014; editorial decision June 14, 2016 by Editor Philip Strahan.
This article provides a review of recent research on agricultural insurance (AI) in developing countries. Agricultural producers face a variety of significant risks; historically, only government-subsidized products have achieved widespread adoption. A recent contractual innovation, which links insurance payouts to realized weather rather than farmer indemnity, has spurred substantial research in the past decade. This review begins by describing the experience in developed economies and then turns to developing countries, covering the following topics: farmers’ adoption of AI, how AI affects their decision to invest in risky assets, and the extent to which AI helps farmers smooth income and consumption. We conclude with suggestions for future research and practice related to AI in developing countries. Expected final online publication date for the Annual Review of Economics Volume 9 is August 2, 2017. Please see http://www.annualreviews.org/page/journal/pubdates for revised estimates.
Many consumers do not adopt products with health and wellbeing benefits apparently far greater than their costs. A sales offer combining a free trial, time payments, and the option of returning the product can overcome barriers such as liquidity constraints and poor information about benefits and usability. We tested this sales offer (and alternatives) in an experiment with a fuel-efficient charcoal stove in urban Uganda and a fuel-efficient wood stove in rural Uganda. Consistent with the importance of these barriers, this offer dramatically increased uptake—in urban Kampala, from 4% to 46%, and in rural Mbarara, from 5% to 57%. (JEL: I12, O12, O33, Q56)
Self-control problems change the logic of agency theory by partly aligning the interests of the firm and worker: both now value contracts that elicit future effort. Findings from a year-long field experiment with full-time data entry workers support this idea. First, workers increase output by voluntarily choosing dominated contracts (which penalize low output but give no additional rewards for high output). Second, effort increases closer to (randomly assigned) paydays. Third, the contract and payday effects are strongly correlated within workers, and this correlation grows with experience. We suggest that workplace features such as high-powered incentives or effort monitoring may provide self-control benefits.
This paper provides evidence on the importance of reputation in the context of the Kenyan rose export sector. A model of reputation and relational contracting is developed and tested. A seller's reputation is defined by buyer's beliefs about seller's reliability. We show that (i) due to lack of enforcement, the volume of trade is constrained by the value of the relationship; (ii) the value of the relationship increases with the age of the relationship; and (iii) during an exogenous negative supply shock deliveries are an inverted-U shaped function of relationship's age. Models exclusively focusing on enforcement or insurance considerations cannot account for the evidence.
Traditional models of insurance choice are predicated on fully informed and rational consumers protecting themselves from exposure to financial risk. In practice, choosing an insurance plan is a complicated decision often made without full information. In this paper we combine new administrative data on health plan choices and claims with unique survey data on consumer information to identify risk preferences, information frictions, and hassle costs. Our additional friction measures are important predictors of choices and meaningfully impact risk preference estimates. We study the implications of counterfactual insurance allocations to illustrate the importance of distinguishing between these micro-foundations for welfare analysis.
This paper studies regulated health insurance markets known as exchanges, motivated by the increasingly important role they play in both public and private insurance provision. We develop a framework that combines data on health outcomes and insurance plan choices for a population of insured individuals with a model of a competitive insurance exchange to predict outcomes under different exchange designs. We apply this framework to examine the effects of regulations that govern insurers' ability to use health status information in pricing. We investigate the welfare implications of these regulations with an emphasis on two potential sources of inefficiency: (i) adverse selection and (ii) premium reclassification risk. We find substantial adverse selection leading to full unraveling of our simulated exchange, even when age can be priced. While the welfare cost of adverse selection is substantial when health status cannot be priced, that of reclassification risk is five times larger when insurers can price based on some health status information. We investigate several extensions including (i) contract design regulation, (ii) self-insurance through saving and borrowing, and (iii) insurer risk adjustment transfers.
In this paper we draw on recent progress in the theory of (1) property rights, (2) agency, and (3) finance to develop a theory of ownership structure for the firm.1 In addition to tying together elements of the theory of each of these three areas, our analysis casts new light on and has implications for a variety of issues in the professional and popular literature, such as the definition of the firm, the “separation of ownership and control,” the “social responsibility” of business, the definition of a “corporate objective function,” the determination of an optimal capital structure, the specification of the content of credit agreements, the theory of organizations, and the supply side of the completeness-of-markets problem.
Incentivized experiments are commonly used to estimate marginal rates of intertemporal substitution (MRS) in the lab and in the field in order to make inferences about individual time preferences. This paper considers an integrated model of behavior in which individuals are subject to financial shocks and credit constraints, and take those into account when making experimental choices. The model shows that measured MRS depends on the individual’s effective interest rate which is equal to the relative marginal utility of current and future consumption. Experimental responses should therefore be correlated with other variables that describe the subject’s financial situation, like savings and shocks to income and consumption. We test the model using a new a panel data set from Mali and find evidence for such effects. Our results imply that the relationship between experimentally elicited MRS and time preferences is not straightforward. However, measured MRS can be useful in determining the importance of different types of financial shocks to the household.
Rational demand for index insurance products is shown to be fundamentally different to that for indemnity insurance products due to the presence of basis risk. In particular, optimal demand is zero for infinitely risk-averse individuals, and is nonmonotonic in risk aversion, wealth, and price. For a given belief, upper bounds are derived for the optimal demand from risk-averse and decreasing absolute risk-averse decision makers. A simple ratio for monitoring basis risk is presented and applied to explain the low level of demand for consumer hedging instruments as a rational response to deadweight costs and basis risk.
The investment decisions of small-scale farmers in developing countries are conditioned by their financial environment. Binding
credit market constraints and incomplete insurance can limit investment in activities with high expected profits. We conducted
several experiments in northern Ghana in which farmers were randomly assigned to receive cash grants, grants of or opportunities
to purchase rainfall index insurance, or a combination of the two. Demand for index insurance is strong, and insurance leads
to significantly larger agricultural investment and riskier production choices in agriculture. The binding constraint to farmer
investment is uninsured risk: when provided with insurance against the primary catastrophic risk they face, farmers are able
to find resources to increase expenditure on their farms. Demand for insurance in subsequent years is strongly increasing
with the farmer’s own receipt of insurance payouts, with the receipt of payouts by others in the farmer’s social network and
with recent poor rain in the village. Both investment patterns and the demand for index insurance are consistent with the
presence of important basis risk associated with the index insurance, imperfect trust that promised payouts will be delivered
and overweighting recent events.
Agricultural index insurance indemnifies a farmer against losses based on an index that is correlated with, but not identical to, her or his individual outcomes. In practice, the level of correlation may be modest, exposing insured farmers to residual, basis risk. In this article, we study the impact of basis risk on the demand for index insurance under risk and compound risk aversion. We simulate the impact of basis risk on the demand for index insurance by Malian cotton farmers using data from field experiments that reveal the distributions of risk and compound risk aversion. The analysis shows that compound risk aversion depresses demand for a conventional index insurance contract some 13 percentage points below what would be predicted based on risk aversion alone. We then analyze an innovative multiscale index insurance contract that reduces basis risk relative to conventional, single‐scale index insurance contract. Simulations indicate that demand for this multiscale contract would be some 40% higher than the demand for an equivalently priced conventional contract in the population of Malian cotton farmers. Finally, we report and discuss the actual uptake of a multiscale contract introduced in Mali.
Microfinance institutions have started to bundle their basic loans with other financial services, such as health insurance. Using a randomized control trial in Karnataka, India, we evaluate the impact on loan renewal from mandating the purchase of actuarially-fair health insurance covering hospitalization and maternity expenses. Bundling loans with insurance led to a 16 percentage points (23 percent) increase in drop-out from microfinance, as many clients preferred to give up microfinance than pay higher interest rates and receive insurance. In a Pyrrhic victory, the total absence of demand for health insurance led to there being no adverse selection in insurance enrollment.
We study the dynamics of microinsurance demand by risk-averse agents who can borrow and lend subject to a liquidity constraint, and also perceive a risk of insurer default. Liquidity constraints and perceived insurer default both reduce the demand for insurance, possibly leading to nonparticipation. We also evaluate an alternative insurance design that allows agents to delay premium payment until the end of the insured period when income is realized and indemnities are paid. We show this alternative design increases insurance take-up by relaxing the liquidity constraint and ameliorating concerns about insurer default. We also investigate the value of delayed premium payment, and the importance of the associated problem of reneging if the insured event does not occur, under a range of conditions.
Why do many households remain exposed to large exogenous sources of non-systematic
income risk? We use a series of randomized field experiments in rural India to test the
importance of price and non-price factors in the adoption of an innovative rainfall
insurance product. We find demand is significantly price-elastic, but that even if
insurance were offered with payout ratios similar to US, widespread coverage would not
be achieved. We then identify key non-price frictions that limit demand: liquidity
constraints, particularly among poor households, lack of trust, and limited salience. We
suggest potential improvements in contract design to mitigate these frictions.
The poor often behave in less capable ways, which can further perpetuate poverty. We hypothesize that poverty directly impedes
cognitive function and present two studies that test this hypothesis. First, we experimentally induced thoughts about finances
and found that this reduces cognitive performance among poor but not in well-off participants. Second, we examined the cognitive
function of farmers over the planting cycle. We found that the same farmer shows diminished cognitive performance before harvest,
when poor, as compared with after harvest, when rich. This cannot be explained by differences in time available, nutrition,
or work effort. Nor can it be explained with stress: Although farmers do show more stress before harvest, that does not account
for diminished cognitive performance. Instead, it appears that poverty itself reduces cognitive capacity. We suggest that
this is because poverty-related concerns consume mental resources, leaving less for other tasks. These data provide a previously
unexamined perspective and help explain a spectrum of behaviors among the poor. We discuss some implications for poverty policy.
Using data from a randomized experiment in rural China, this paper studies the influence of social networks on the decision to adopt a new weather insurance product and the mechanisms through which social networks operate. We provided financial education to a random subset of farmers and found a large social network effect on take-up: for untreated farmers, having an additional friend receiving financial education raised take-up by almost half as much as obtaining financial education directly, a spillover effect equivalent to offering a 15% reduction in the average insurance premium. By varying the information available to individuals about their peers’ take-up decisions and using randomized default options, we show that the positive social network effect is not driven by the diffusion of information on purchase decisions, but instead by the diffusion of knowledge about insurance. We also find that social network effects are larger in villages where households are more strongly connected, and when people who are the first to receive financial education are more central in the social network.
Reaching-for-yield - investors’ propensity to buy riskier assets in order to achieve higher yields - is believed to be an important factor contributing to the credit cycle. This paper presents a detailed study of this phenomenon in the corporate bond market. We show that insurance companies, the largest institutional holders of corporate bonds, reach for yield in choosing their investments. Consistent with lower rated bonds bearing higher capital requirement, insurance firms’ prefer to hold higher rated bonds. However, conditional on credit ratings, insurance portfolios are systematically biased toward higher yield, higher CDS bonds. Reaching-for-yield exists both in the primary and the secondary market, and is robust to a series of bond and issuer controls, including bond liquidity and duration, and issuer fixed effects. This behavior is related to the business cycle, being most pronounced during economic expansions. It is also more pronounced for firms with poor corporate governance and for which regulatory capital requirement is more binding. A comparison of the ex-post performance of bonds acquired by insurance companies shows no outperformance, but higher systematic risk and volatility.
Experimental tests of dynamically inconsistent time preferences have largely relied on choices over time-dated monetary rewards.
Several recent studies have failed to find the standard patterns of present bias. However, such monetary studies contain often-discussed
confounds. In this paper, we sidestep these confounds and investigate choices over consumption (real effort) in a longitudinal
experiment. We pair this effort study with a companion monetary discounting study. We confirm very limited time inconsistency
in monetary choices. However, subjects show considerably more present bias in effort. Furthermore, present bias in the allocation
of work has predictive power for demand of a meaningfully binding commitment device. Therefore our findings validate a key
implication of models of dynamic inconsistency, with corresponding policy implications.
To investigate the effectiveness of scaling-up existing bednet distribution campaigns, a randomised controlled trial with
516 farming households in Katete District, a rural area with highly endemic malaria in Zambia's Eastern Province, was evaluated.
In the trial, selected farmers were assigned to bednet programmes that allowed them to obtain additional bednets for free
or at subsidised prices through agricultural loan programmes. On average, 2.4 nets were distributed in the free distribution
group and 0.9 in the net loan group. The marginal health impact of additional nets appears large, reducing the odds of self-reported
all-cause morbidity by 40–42% and the odds of self-reported confirmed malaria by 53–60%.
This paper explores the relationship between capital and index insurance market development using a theoretical model in which small farm households have the option to either (i) adopt a capital-intensive technology that is risky but high yielding, or (ii) to self-insure by adotping a traditional low input technology. We show that neither market is likely to develop in isolation from the other, and that uptake of improved technology will be low absent efforts to link capital and insurance. The failure of index insurance markets to independently develop is not per se due to the existence of basis risk or to its expense as self-insurance strategies are similarly characterized by basis risk and are costly to the household as they are reduce mean incomes. However, we show that the interlinkage of credit and index insurance contracts can allow both markets to develop because the interlinked contract can stochastically dominate self-insurance. The analysis also shows that the way interlinkage will work depends fundamentally on the nature of the agricultural credit market and the degree to which lenders are able to demand and seize collateral in the event of loan default. This interplay between collateral and the nature of credit-insurance interlinkage has direct and important implications for the design of programs to simultanteously boost small farm productivity and deepen rural financial markets.
Households risk management, that is, households' insurance against adverse shocks to income, assets, and financing needs, is limited and often completely ab-sent, in particular for poor households. We explain the limited extent and absence of risk management in an intertemporal model in which households have access to complete markets subject to collateral constraints and in which the financing needs for consumption and durable goods purchases override the risk management concerns. The absence of many markets for claims which allow household risk man-agement is consistent with our model and should not be considered a puzzle. Risk management of the price risk of durable goods moreover depends on the sign of the hedging demand and on whether the household owns or rents the durable goods.
Unpredictable rainfall is an important risk for agricultural activity, and farmers in developing countries often receive incomplete insurance from informal risk-sharing networks. We study the demand for, and effects of, offering formal index-based rainfall insurance through a randomized experiment in an environment where the informal risk sharing network can be readily identified and richly characterized: sub-castes in rural India. A model allowing for both idiosyncratic and aggregate risk shows that informal networks lower the demand for formal insurance only if the network indemnifies against aggregate risk, but not if its primary role is to insure against farmer-specific losses. When formal insurance carries basis risk (mismatches between payouts and actual losses due to the remote location of the rainfall gauge), informal risk sharing that covers idiosyncratic losses enhance the benefits of index insurance. Formal index insurance enables households to take more risk even in the presence of informal insurance. We find substantial empirical support of these nuanced predictions of the model by conducting the experiment (randomizing both index insurance offers, and the locations of rainfall gauges) on castes for whom we have a rich history of group responsiveness to household and aggregate rainfall shocks.
We study the demand for household water connections in urban Morocco, and the effect of such connections on household welfare. In the northern city of Tangiers, among homeowners without a private connection to the city's water grid, a random subset was offered a simplified procedure to purchase a household connection on credit (at a zero percent interest rate). Take-up was high, at 69%. Because all households in our sample had access to the water grid through free public taps (often located fairly close to their homes), household connections did not lead to any improvement in the quality of the water households consumed; and despite significant increase in the quantity of water consumed, we find no change in the incidence of waterborne illnesses. Nevertheless, we find that households are willing to pay a substantial amount of money to have a private tap at home. Being connected generates important time gains, which are used for leisure and social activities, rather than productive activities. Because water is often a source of tension between households, household connections improve social integration and reduce conflict. Overall, within 6 months, self-reported well-being improved substantially among households in the treatment group, despite the financial cost of the connection. Our results suggest that facilitating access to credit for households to finance lump sum quality-of-life investments can significantly increase welfare, even if those investments do not result in income or health gains.
Both financing and risk management involve promises to pay which need to be collateralized resulting in a financing vs. risk management trade-off. We study this trade-off in a dynamic model of commodity price risk management and show that risk management is limited and that more financially constrained firms hedge less or not at all. We document that these predictions are consistent with the evidence using panel data for fuel price risk management by airlines. More constrained airlines hedge less both in the cross section and within airlines over time. Risk management drops substantially as airlines approach distress and recovers only slowly after airlines enter distress.
Collateral constraints imply that financing and risk management are fundamentally linked. The opportunity cost of engaging in risk management and conserving debt capacity to hedge future financing needs is forgone current investment, and is higher for more productive and less well-capitalized firms. More constrained firms engage in less risk management and may exhaust their debt capacity and abstain from risk management, consistent with empirical evidence and in contrast to received theory. When cash flows are low, such firms may be unable to seize investment opportunities and be forced to downsize. Consequently, capital may be less productively deployed in downturns.
Farmers face a particular set of risks that complicate the decision to borrow. We use a randomized experiment to investigate (1) the role of crop-price risk in reducing demand for credit among farmers and (2) how risk mitigation changes farmers’ investment decisions. In Ghana, we offer farmers loans with an indemnity component that forgives 50 percent of the loan if crop prices drop below a threshold price. A control group is offered a standard loan product at the same interest rate. Loan uptake is high among all farmers and the indemnity component has little impact on uptake or other outcomes of interest.
Randomized controlled trials are increasingly used to evaluate policies. How can we make these experiments as useful as possible for policy purposes? We argue greater use should be made of experiments that identify the behavioral mechanisms that are central to clearly specified policy questions, what we call "mechanism experiments." These types of experiments can be of great policy value even if the intervention that is tested (or its setting) does not correspond exactly to any realistic policy option.
This paper integrates elements from the theory of agency, the theory of property rights and the theory of finance to develop a theory of the ownership structure of the firm. We define the concept of agency costs, show its relationship to the ‘separation and control’ issue, investigate the nature of the agency costs generated by the existence of debt and outside equity, demonstrate who bears these costs and why, and investigate the Pareto optimality of their existence. We also provide a new definition of the firm, and show how our analysis of the factors influencing the creation and issuance of debt and equity claims is a special case of the supply side of the completeness of markets problem.The directors of such [joint-stock] companies, however, being the managers rather of other people's money than of their own, it cannot well be expected, that they should watch over it with the same anxious vigilance with which the partners in a private copartnery frequently watch over their own. Like the stewards of a rich man, they are apt to consider attention to small matters as not for their master's honour, and very easily give themselves a dispensation from having it. Negligence and profusion, therefore, must always prevail, more or less, in the management of the affairs of such a company.Adam Smith, The Wealth of Nations, 1776, Cannan Edition(Modern Library, New York, 1937) p. 700.
Government intervention in insurance markets is ubiquitous and the theoretical basis for such intervention, based on classic work from the 1970s, has been the problem of adverse selection. Over the last decade, empirical work on selection in insurance markets has gained considerable momentum. This research finds that adverse selection exists in some insurance markets but not in others. And it has uncovered examples of markets that exhibit "advantageous selection"—a phenomenon not considered by the original theory, and one that has different consequences for equilibrium insurance allocation and optimal public policy than the classical case of adverse selection. Advantageous selection arises when the individuals who are willing to pay the most for insurance are those who are the most risk averse (and so have the lowest expected cost). Indeed, it is natural to think that in many instances individuals who value insurance more may also take action to lower their expected costs: drive more carefully, invest in preventive health care, and so on. Researchers have taken steps toward estimating the welfare consequences of detected selection and of potential public policy interventions. In this essay, we present a graphical framework for analyzing both theoretical and empirical work on selection in insurance markets. This graphical approach provides both a useful and intuitive depiction of the basic theory of selection and its implications for welfare and public policy, as well as a lens through which one can understand the ideas and limitations of existing empirical work on this topic.
It is often argued that cost-sharing-charging a subsidized, positive price-for a health product is necessary to avoid wasting resources on those who will not use or do not need the product. We explore this argument through a field experiment in Kenya, in which we randomized the price at which prenatal clinics could sell long-lasting antimalarial insecticide-treated bed nets (ITNs) to pregnant women. We find no evidence that cost-sharing reduces wastage on those who will not use the product: women who received free ITNs are not less likely to use them than those who paid subsidized positive prices. We also find no evidence that cost-sharing induces selection of women who need the net more: those who pay higher prices appear no sicker than the average prenatal client in the area in terms of measured anemia (an important indicator of malaria). Cost-sharing does, however, considerably dampen demand. We find that uptake drops by sixty percentage points when the price of ITNs increases from zero to 0.15 below the price at which ITNs are currently sold to pregnant women in Kenya. We combine our estimates in a cost-effectiveness analysis of the impact of ITN prices on child mortality that incorporates both private and social returns to ITN usage. Overall, our results suggest that free distribution of ITNs could save many more lives than cost-sharing programs have achieved so far, and, given the large positive externality associated with widespread usage of ITNs, would likely do so at a lesser cost per life saved. (c) 2010 by the President and Fellows of Harvard College and the Massachusetts Institute of Technology..
Take-up of an innovative rainfall insurance policy offered to smallholder farmers in rural India decreases with basis risk
between insurance payouts and income fluctuations, increases with household wealth, and decreases with binding credit constraints.
These results are consistent with the predictions of a simple neoclassical model with borrowing constraints. Other patterns
are less consistent with the benchmark model. For example, participation in village networks and measures of familiarity with
the insurance vendor are strongly correlated with insurance take-up decisions, and risk-averse households are less, not more,
likely to purchase insurance. These results may reflect household uncertainty about the product, given their limited experience
with it.
Does production risk suppress the demand for credit? We implemented a randomized field experiment to ask whether provision of insurance against a major source of production risk induces farmers to take out loans to adopt a new crop technology. The study sample was composed of roughly 800 maize and groundnut farmers in Malawi, where by far the dominant source of production risk is the level of rainfall. We randomly selected half of the farmers to be offered credit to purchase high-yielding hybrid maize and groundnut seeds for planting in the November 2006 crop season. The other half of farmers were offered a similar credit package, but were also required to purchase (at actuarially fair rates) a weather insurance policy that partially or fully forgave the loan in the event of poor rainfall. Surprisingly, take-up was lower by 13 percentage points among farmers offered insurance with the loan. Take-up was 33.0% for farmers who were offered the uninsured loan. There is suggestive evidence that reduced take-up of the insured loan was due to farmers already having implicit insurance from the limited liability clause in the loan contract: insured loan take-up was positively correlated with farmer education, income, and wealth, which may proxy for the individual's default costs. By contrast, take-up of the uninsured loan was uncorrelated with these farmer characteristics.
There is an emerging consensus among macro-economists that differences in technology across countries account for the major differences in per-capita GDP and the wages of workers with similar skills across countries. Accounting for differences in technology levels across countries thus can go a long way towards understanding global inequality. One mechanism by which poorer countries can catch up with richer countries is through technological diffusion, the adoption by low-income countries of the advanced technologies produced in high-income countries. In this survey, we examine recent micro studies that focus on understanding the adoption process. If technological diffusion is a major channel by which poor countries can develop, it must be the case that technology adoption is incomplete or the inputs associated with the technologies are under-utilized in poor, or slow-growing economies. Thus, obtaining a better understanding of the constraints on adoption is useful in understanding a major component of growth.
We propose a guaranteed renewability (GR) insurance in which a sequence of premiums would enable insurers to break even and would be chosen by both low- and high-risk buyers, whether or not they had suffered a loss. The premium schedule would continually decline over time, as the insurer collects more information to determine who the low-risk buyers are. The highest premiums are charged initially to protect the insurer if low-risk individuals leave for the spot market. The concluding portion of the article discusses the limitations of a GR policy in the health and environmental liability area, the most serious being instability in estimates of underlying loss trends. Peer Reviewed http://deepblue.lib.umich.edu/bitstream/2027.42/47916/1/11166_2005_Article_BF01083557.pdf
Several recent studies have suggested that empirical rejections of the permanent income/life cycle model may be due to the existence of liquidity constraints. This paper tests the permanent income hypothesis against the alternative hypothesis that consumers optimize subject to a well-specified sequence of borrowing constraints. Implications for consumption in the presence of borrowing constraints are derived and then tested using time-series/cross-section data on families from the Panel Study of Income Dynamics. The results generally support the hypothesis that an inability to borrow against future labor income affects the consumption of a significant portion of the population. Copyright 1989 by University of Chicago Press.