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Is the demand of the index-based livestock insurance and informal insurance network substitute or complement?

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Presented by Kazushi Takahashi at the IBLI academic workshop, Nairobi, 10to11 June 2015

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Is the demand of the index-based livestock insurance and informal insurance network substitute or complement?

  1. 1. Is the demand of the index-based livestock insurance and informal insurance network substitute or complement? Kazushi Takahashi (with Chris Barrett and Munenobu Ikegami)
  2. 2. Motivation  Index insurance attracts attention as the next financial revolution.  Several studies discuss that formal insurance may crowd out informal insurance networks (de Janvry et al. 2013 ; Boucher and Delpierre, 2014;)  Free-riding: well-connected individuals can free-ride on their group-members' insurance payout, resulting in a socially suboptimal level of coverage  Moral hazard: a greater degree of formal insurance allows for excessive risk-taking, which informal networks should absorb, imposing a negative externality on network members- crowding-out of informal risk-sharing
  3. 3. Motivation  Counterargument is also provided to explain that the demand of the index insurance can be complementary to informal insurance networks (Berhane, et al., 2014: Chemin, 2014; Dercon et al., 2014; Mobarak and Rosenzweig, 2013;) .  Basis risk and crowed-in: the difference between the losses actually incurred and the losses insured= idiosyncratic risk of incomplete compensation  pooled and managed within an informal risk-sharing group  Increased trust: social learning in groups from early adopters who have tested the system before, and thus alleviate fears of non-reimbursement
  4. 4. Motivation  Empirical evidence on whether the index insurance crowed-in or crowed-out informal risk-sharing networks when sold to individuals is scarce, and it is theoretically ambiguous.  Our paper aims to provide empirical evidence to this issue, by using the data collected in Borena, Ethiopia.
  5. 5. Data  17 Study sites in Borena-Southern Ethiopia (near to Kenya Boundary)  514 households from Round 3
  6. 6. Design of IBLI  IBLI insures against area average herd loss predicted based on the index fitted to past livestock mortality data.  Index: Normalized Differenced Vegetation Index (NDVI) – a numerical indicator of the degree of greenness recorded by satellite  Payout rule: if the index falls below the 15th percentile of historical distribution since 1981. ZNDVI: Deviation of NDVI from long-term averageNDVI (Feb 2009, Dekad 3)
  7. 7. Design of IBLI  Insurance contract Timing of Purchase: before rainy seasons (two times in a year) Coverage: 1 year Timing of Payout: after dry seasons (two times in a year)
  8. 8. Design of IBLI  Premium payment: 𝑊𝑜𝑟𝑒𝑑𝑎 𝑠𝑝𝑒𝑐𝑖𝑓𝑖𝑐 𝑖𝑛𝑠𝑢𝑟𝑎𝑛𝑐𝑒 𝑝𝑟𝑒𝑚𝑖𝑢𝑚 𝑟𝑎𝑡𝑒𝑠 ∗ 𝑇𝐼𝐻𝑉. (9.75% for Dilo, 8.71% for Teltele, 7.54% for Yabello, 9.49% for Dire, 8.58% for Arero, 9.36% for Dhas, and 11.05% for Miyo and Moyale, depending on differences in expected mortality risk)  Total insured herd value (TIHV): # 𝑜𝑓 𝑐𝑎𝑚𝑒𝑙 𝑖𝑛𝑠𝑢𝑟𝑒𝑑 ∗ 15,000 + (# 𝑜𝑓 𝑐𝑜𝑤𝑠 𝑖𝑛𝑠𝑢𝑟𝑒𝑑) ∗ 5,000 + (# 𝑜𝑓 𝑔𝑜𝑎𝑡𝑠 𝑎𝑛𝑑 𝑠ℎ𝑒𝑒𝑝 𝑖𝑛𝑠𝑢𝑟𝑒𝑑) ∗ 700  Indemnity Payout: Max: 0.5*TIHV Min: Premium payment (depending on the severity of the drought)
  9. 9. Empirical strategy  We want to explore the impact of informal insurance on the uptake of IBLI or vice versa.  Potential problems  Formation of informal networks/uptake of IBLI is clearly endogenous  Measuring informal network is often problematic (Santos and Barrett, 2011; Maertens and Barrett, 2013)  Census is costly, and infeasible  Network within sampling method (either list up certain number or not) artificially truncates the network, and resultant network data are non- representative  Open question tends to elicit only strong network link  Remedy  Apply “random matching within a sample” method
  10. 10. Empirical strategy  A household is randomly matched with 5 near neighbors and 3 non-near neighbors within a sample  Two questions: (1) Do you know (the match)? (2) If yes, are you willing to transfer cattle as a loan if the match asked for it.  A dummy, representing a link, equal to 1 if the answer to (2) is yes  This is a hypothetical question, but hopefully, this may not be a problem as informal asset transfers among Boran pastoralists are generally small. Also, there is evidence that the inferred determinants of insurance networks derived from this approach closely match those obtained from analysis of real insurance relations among the same population (Santos and Barrett, 2011).
  11. 11. Empirical strategy  Basic model (via ivprobit) LINK 𝑖𝑗 = 𝜔 + 𝑎𝑥𝑗 + 𝑏𝑥𝑖 + 𝛽 𝐼𝐵𝐿𝐼𝑖 + 𝜏𝑖𝑗 + 𝜓𝑖𝑗  LINK: 1 if there is the possibility of transferring cattle as a loan if the match asked for it between a household i and j,  Xi: characteristics of household i,  Xj: characteristics of matched household j,  Τ: characteristics to replect relationships between i and j  𝐼𝐵𝐿𝐼𝑖: the predicted IBLI uptake of previous one year (instrumented with some exogenous variables, such as the discount coupon recipient (assigned randomly: RCT) dummy) 𝛽>0 is complementary; 𝛽<0 is supplement
  12. 12. Empirical strategy  Some extension  Assuming that individual knows others’ purchase decision.  Individuals strategically decide whether to purchase IBLI given others’ decisions .  Set of recursive equations via multivariate probit: 𝐼𝐵𝐿𝑖𝑗= 𝜔1 + 𝑎1 𝑥𝑗 + 𝑐1 𝑧𝑗 + 𝜓𝑗 𝐼𝐵𝐿𝑖𝑖= 𝛽1 𝐼𝐵𝐿𝐼𝑗 + 𝜔2 + 𝑎2 𝑥𝑖 + 𝑐2 𝑧𝑖 + 𝜓𝑖 𝐿𝑖𝑛𝑘𝑖𝑗 = 𝛽1 𝐼𝐵𝐿𝐼𝑗 + 𝛽2 𝐼𝐵𝐿𝐼𝑖 + 𝜔 + 𝑎𝑥𝑗𝑡 + 𝑏𝑥𝑖𝑡 + 𝜏𝑖𝑗 + 𝜓𝑖𝑗
  13. 13. Descriptive statistics Knowing and lending Lend Know No Yes Total No 1,153 474 1,627 70.87% 29.13% 100% Yes 633 1,844 2,477 25.56% 74.44% 100% Have heard name, but never met No 450 1,484 1,934 23.27% 76.73 100% Yes 183 360 543 33.7% 66.3% 100% Relative No 599 1,365 1,964 30.5% 69.5% 100% Yes 34 479 513 6.63% 93.37% 100%
  14. 14. Preliminary results  Basic model (IVprobit) IBLI: =1 if purchase IBLI at either 3 or 4 sales period Control: HHsize, Head male (=1), Head age and its squared, Head’s completed years of education, risk preference dummies, same clan (=1), study site fixed effect for both own and mathed IV: dummy to receive discount coupons at either 3 or 4 sales period (1) (2) VARIABLES Link Link far -0.968*** (0.045) 𝐼𝐵𝐿𝐼𝑖 -0.057 -0.022 (0.233) (0.243)
  15. 15. Preliminary results  Extension (IV+multivariate probit) (1) (2) (3) (4) Link 𝐼𝐵𝐿𝐼𝑖 Link 𝐼𝐵𝐿𝐼𝑖 far -0.971*** (0.081) 𝐼𝐵𝐿𝐼𝑖 0.136 0.139 (0.284) (0.311) 𝐼𝐵𝐿𝐼𝑗 0.248* -0.229*** 0.163 -0.240*** (0.138) (0.068) (0.143) (0.068) *** p<0.01, ** p<0.05, * p<0.1
  16. 16. Preliminary results  Robustness check  Not simultaneous decision. Given others’ previous purchase decision. (1) (2) (3) (4) Link 𝐼𝐵𝐿𝐼𝑖 Link 𝐼𝐵𝐿𝐼𝑖 far -0.973*** (0.080) 𝐼𝐵𝐿𝐼𝑖 0.141 0.134 (0.288) (0.319) 𝐼𝐵𝐿𝐼𝑗𝑅3 0.108 -0.301** 0.065 -0.312** (0.150) (0.152) (0.165) (0.152) *** p<0.01, ** p<0.05, * p<0.1
  17. 17. Preliminary findings  Some indication of free-riding:  negative coefficient of others’ IBLI purchase on own purchase  positive coefficient of others’ IBLI purchase on link formation (lend cow)  no robust results on whether the own purchase of IBLI crowed-out informal risk sharing network (insignificant coefficient of own IBLI purchase on link formation, though sign is positive)  Some other findings:  If the match is in the same clan, prob (link) is positive and significant  Others’ wealth measured in TLU does not affect own purchase decision  More risk averse households tend to buy IBLI  Discount coupons positively affect the uptake of IBLI
  18. 18. Future work  It seems important to investigate whether the free-riding is driven by the fact that the subject knows very well about the economic conditions of the matches.  Cai et al. (2015) show positive network effects are driven by the diffusion of insurance knowledge rather than purchase decision.  Vasilaky et al. (2014) show groups in which individuals knew of one another's assets were less likely to purchase their insurance within a group (in line with Boucher and Delpierre, 2014)  We will add two questions in R4: (1) do you think the match bought IBLI six month ago? (2) how many cows do you think the match herds?

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