The effects of formal insurance on informal risk management: evidence from Ethiopia

Authors: TOTH, RUSSELL - University Of Sydney; BARRETT, CHRISTOPHER - Cornell University; BERNSTEIN, RICHARD - Cornell University; Clark, Pat; GOMES, CARLA - Cornell University; MOHAMED, SHIBIA - International Livestock Research Institute (ILRI) - Kenya; MUDE, ANDREW - International Livestock Research Institute Ethiopia; TADESSE, BIRHANU - International Livestock Research Institute (ILRI) - Kenya

Submitted to: American Agricultural Economics Association Meeting
Publication Type: Proceedings
Publication Acceptance Date: 1/5/2020
Publication Date: N/A
Citation: N/A

Interpretive Summary: Formal insurance may induce reduced ex ante informal risk management – (i) self-insurance, to reduce the magnitude of a potential loss, and/or (ii) self-protection, to reduce the probability of loss. Empirical testing of these predictions has proven difficult due to the asymmetric information problems inherent to conventional indemnity insurance and to challenges in measuring self-protection effort. We overcame those obstacles using a unique experimental design and an index-based livestock insurance (IBLI) product among Ethiopian herders whose self-protection efforts we directly measured at high spatio-temporal resolution. We found that market insurance indeed substitutes for both self-insurance and self-protection. These findings will impact pastoralists, insurance purveyors, and other international development stakeholders throughout East Africa and other regions of the world where IBLI programs are being implemented.

Technical Abstract: We study the impacts of formal insurance on informal risk management behaviors. In theory, formal insurance may induce reduced ex ante informal risk management – (i) self-insurance, to reduce the magnitude of a potential loss, and/or (ii) self-protection, to reduce the probability of loss. But empirical tests of those predictions have proved difficult due to the asymmetric information problems inherent to conventional indemnity insurance and to challenges in measuring self-protection effort. We obviate those obstacles using a unique experimental design and an index-based livestock insurance product among Ethiopian herders whose self-protection efforts we directly measure at high spatio-temporal resolution. We find that market insurance indeed substitutes for both self-insurance and self-protection. The effect varies with ex ante wealth and understanding of the insurance product.