Risk, Informal Institutions, and Index Insurance
18 Pages Posted: 7 Dec 2017 Last revised: 24 Jun 2021
Date Written: April 15, 2019
The question of how informal institutions interact with formal markets is a central economic question, particularly in developing countries. We analyze this issue for the demand of an innovative weather insurance product. Specifically, when does informal risk-sharing act as barrier or support to the take-up of index-based insurance? The presence of an individual in a risk-sharing arrangement reduces her risk aversion, termed “Effective Risk Aversion”— a sufficient statistic for index decision making. Our analysis establishes that such reduction in risk aversion can lead to either reduced or increased take up of index insurance. These results provide alternative explanations for two empirical puzzles: unexpectedly low take- up for index insurance and demand being particularly low for the most risk averse. From a policy perspective, our results highlight how the combination of premium subsidies and informal networks might promote take-up and how this might eventually facilitate better protection against weather risks.
Keywords: Basis risk, climate insurance, risk aversion, informal institutions
Suggested Citation: Suggested Citation