Behavioural Substitution of Formal Risk Mitigation: Index Insurance in East Africa Presenter: Russell Toth Co-authors: Chris Barrett, Richard Bernstein, Patrick Clark, Carla Gomes, Shibia Mohamed, Andrew Mude, Birhanu Taddesse Abstract
Risk-mitigating instruments such as insurance have the potential to improve welfare by enhancing wealth and consumption smoothing through reducing the impact of negative shocks. At the same time, the presence of insurance changes the distribution of payoffs over future states, which may induce behavioural responses distinct from the classical moral hazard channel, through an expected wealth e˙ect. The welfare impact of these behavioural responses is ambiguous in general. We present novel evidence on the expected wealth effect in the context of index-based livestock insurance (IBLI) in East Africa, where microinsurance has the potential to enhance the welfare of poor livestock herders by providing protection against droughts. Conditioning the payout of such insurance on a regional weather index reduces the cost of insurance provision, and in principle eliminates the classical moral hazard channel that plagues indemnity-based insurance. However the presence of index insurance still changes the distribution of expected wealth over future states, which might lead livestock herders to substitute away from prior self-insurance behaviours. Hence our setting allows us to focus on the expected wealth effect, while eliminating the classical moral hazard channel, which we focus on in two dimensions. First, if precautionary savings motives for holding livestock assets dominate, then we would expect to see households that receive IBLI to reduce herd sizes. However if risk-adjusted investment motives dominate, then we would expect households to build larger herds. Second, the presence of insurance might induce livestock herders to reduce their efforts to protect their herds from loss, even if they are fully rational and cannot inuence insurance payouts with their actions. To test between these theoretical possibilities, we implement two complementary randomized control trials in southern Ethiopia, paired with novel, high frequency data collection that provides unique insight on livestock herder effort. The results suggest that in the presence of IBLI herders tend to increase herd sizes, particularly as they gain greater knowledge of, and experience with, IBLI. Furthermore, they also appear to put in less herding effort. This suggests a potential unintended spillover of insurance in this setting: herds grazing more intensively on smaller pasture areas, which has the potential to intensify degradation of environmental public goods. The results have implications for the ecological impacts of scaling up index insurance programs, and for microinsurance design. More broadly, these results allow us to identify unintended behavioural consequences of insurance even in the absence of classical moral hazard incentives.