The Subjective Well-being Effects of Imperfect Insurance that Doesn’t Pay out

1. The Subjective Well-being Effects of Imperfect Insurance that Doesn’t Pay out KibromHirfrfot Christopher Barrett Erin Lentz Birhanu Taddesse Cornell University July 28, 2014

2. Does index insurance lead to welfare gains? Most people are risk averse (Rosenzweig & Binswanger, 1993) In theory, actuarially fair insurance improves welfare regardless of payout. Insurance usually not actuarially fair – loading. But, there is still demand – offers peace of mind. Assessing welfare gains in expected benefit terms is misleading. There is little evidence that insurance generates welfare gains. Low uptake of index insurance suggest no welfare gains from insurance (Gine et al. 2008; Cole et al. 2013; Binswanger-Mkhize, 2012) However, Jensen et al. (2014) find index insurance produces net utility benefit in Kenya. Yet if one believes in DARA, the poor stand to gain the most from insurance. We explore whether an imperfect insurance improves subjective well-being (SWB) for a poor, rural population. Novel approach: we exploit panel nature of data and no indemnity payout to test buyers’ remorse.

3. Study setting and index insurance • Cyclical movement in search of forage and water is common. • Indigenous insurance institutions have declined due to recurrent drought. We use data from eight woredas in the Borana zone of southern Ethiopia. Mobile pastoralism is main means of sustenance.

4. Study setting and index insurance (cont’d) Index based livestock insurance (IBLI) was introduced in August 2012. Uses NDVI to identify premiums and makes indemnity payout based on observable, exogenous index of rangeland conditions for each woreda. Payout is made when vegetation falls below a contractually stipulated threshold. There are four season in Borana: long rainy, long dry, short rainy, short dry. IBLI contracts are sold in two sales periods before the rainy seasons. l

5. Data Three rounds of data have been collected A random sub-sample of respondents received discount coupons. Others received information extension. Some received both. Information extension: Poem tape and Comic books To date, there have been no indemnity payouts. Households who bought IBLI are materially worse off, but could be better off in broader well-being terms. Are they?

6. Estimation strategy IBLI purchase (“opt-in”) decisions are likely to be endogenous. Opt-in decision is likely to depend on subjective assessment of risk. We use IBLI’s randomized design features to deal with endogeneity. Two-step estimation strategy: First we estimate an uptake (selection) equation as All treatments are randomly assigned - can only be correlated with SWB through IBLI uptake. We control for a series of covariates that may affect IBLI uptake – herd size and income, gender, age and educational attainment of household head, food aid receipt, household composition, reera fixed effects.

7. Estimation strategy (cont’d) In stage two we estimate the SWB equation as There are at least two ways IBLI can influence SWB Non-monetary (psychological) benefits or costs Insurance may reduce stress about adverse outcomes (give peace of mind): ( Insurance could increase stress if basis risk is high, and it’s like lottery: ( Buyer’s remorse: Monetary benefits or costs – effect on net income/wealth Since premium payment reduces net income/wealth, indemnity payment increases it, net indemnity payments will influence SWB. This effect is captured by .

8. Estimation strategy (cont’d) We therefore estimate the aggregate effect of IBLI on SWB as: Where is the TLU equivalent of wealth gained or lost due to IBLI purchase: Since there wasn’t any payout to date, our estimates are lower bound of the effects of IBLI on SWB. In SWB terms the actuarially fair premium is given as:

9. Controls : Household head gender, age, age squared, schooling, and household size. Results (cont’d) • In all 3 models, IBLI has a positive and significant effect on SWB. • Our result is robust to inclusion of income, wealth, and var. controls. • We find significant buyer’s remorse effect. • The positive piece of mind effect is significantly greater than the negative buyer’s remorse. Ordered logit regression estimates Standard errors clustered at the reera level in parentheses *** p<0.01, ** p<0.05, * p<0.1

10. Results(cont’d) Aggregate effect of IBLI on SWB and actuarially fair premium rates Standard errors clustered at the reera level in parentheses *** p<0.01, ** p<0.05, * p<0.1 IBLI has a positive and significant aggregate effect on SWB. The point estimate suggests insuring a TLU increases SWB by 0.205. Insuring 5 TLU moves one from “very bad” to “bad” or “good” to “very good” on the SWB ladder. Average TLU owned≈20. Our result suggests full coverage would lift one from lowest to highest SWB category.

11. Conclusions: Insurance, even when it does not pay out, leads to welfare gains While we find statistically significant evidence of buyer’s remorse, its magnitude is considerably smaller than the positive effect of having insurance coverage. Even an imperfect insurance product that does not pay out can leave a poor rural population better off. Given IBLI is yet to payout in Borana, the actuarially fair premium for the sample period was roughly 51 Birr, significantly less than the average premium per TLU ( Birr 698 in R2 and Birr 575 in R3) IBLI was welfare enhancing even at a premium rate that was (temporarily and ex post only) an order of magnitude higher than the actuarially fair rate

12. Thank You

13. Treatments Prior to the August-September 2013 and January-February 2014 sales periods only discount coupons were distributed to 408 hh each.

14. Controls : Annual income, TLU owned, expected TLU loss, value of non-livestock assets, household demographic variables, household composition, group membership, and religion dummies LPM results • Randomized instruments have significant effect on IBLI uptake. • Receiving discount coupon and amount of discount have strong effect. • Income has negative effect on IBLI uptake. Self insurance? • Sargan & Basmannoveridentification tests confirm instruments are valid. • Wald test rejects null of joint insignificance of instruments. LPM estimates of IBLI uptake Standard errors clustered at the panel round and reera level in parentheses *** p<0.01, ** p<0.05, * p<0.1

15. Estimation results of IBLI uptake Randomized instruments of discount coupons and information extension (comic books and poet tapes) have significant effect on IBLI uptake. Receiving discount coupon and amount of discount have strong effect. Income has negative effect on IBLI uptake. Self insurance? Sargan & Basmannoveridentification tests confirm instruments are valid. Wald test rejects null of joint insignificance of instruments. Controls : Annual income, TLU owned, expected TLU loss, value of non-livestock assets, household demographic variables, household composition, group membership, and religion dummies