Selling formal insurance to the informally insured

Agricultural activity is inherently risky, and smoothing consumption across years or seasons is a significant challenge for agrarian households in developing countries. Farmers and entrepreneurs in rural agrarian economies thus have high demand for credit and insurance services, but often access to such services is limited. Institutional innovations that lower the cost of loans have led to thriving microcredit enterprises in certain areas. But farmers still largely resort to informal alternatives, insuring each other through gifts and loans, forward selling labour to landowners at high implicit interest rates, to cope with risks associated with pest or drought-induced harvest failure, or price volatility in commodities markets.

Surprisingly, rainfall insurance markets do not function well even in areas where farmers face large weather risks. Recent studies show that take-up rates are extremely low even when actuarially fair rainfall insurance contracts are offered. This research project seeks to understand why Indian farmers exposed to rainfall risk are reluctant to purchase formal insurance products that mitigate those risks.

There are several possible explanations for the observed low demand for formal insurance products: liquidity constrained households cannot afford premiums, insurance products are too complex for uneducated farmers, farmers do not trust the insurance seller to make the promised payouts, or farmers are already implicitly insured through their informal networks or through limited liability credit contracts, which in turn limits their demand for a formal insurance product.

This research will generate evidence by making use of a unique design that combines natural variation in how well (informally) insured Indian farmers already are (that stems from their membership-by-birth to their sub-caste-based risk-sharing network) with designed (randomised) variation in the trustworthiness of the insurance seller and the price of the contract offered. The randomised design component of the project will help identify the effects of liquidity constraints or lack of trust in the seller on low take-up rates. On the other hand, marketing to farmers from different sub-castes or jatis, who are differentially indemnified through their informal risk-sharing networks, will help identify whether farmers are reluctant to purchase formal insurance contracts simply because they are already informally insured. Jati-based networks in India, which have been in existence for centuries, have been very active in smoothing members’ consumption through a system of gift exchanges and in-group loans. Moreover, there is a great deal of variation in how insured the farmers are across different sub-caste groupings, based on the wealth, diversification, and occupational characteristics of the specific jati that the farmer belongs to. The researchers have already collected data to create such measures for different jatis.

The study will examine whether informally insured jati members have more price-sensitive demand for formal insurance products. Given the cultural salience of jati identity in rural India – an institution sustained over many generations through strict restrictions against inter-marriage – it will be also possible to examine the importance of mistrust as a serious impediment to insurance market development by simply varying the sub-caste identity of the insurance salespeople.