What Is Rainfall Index Insurance Worth? A Comparison of Valuation Techniques

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Shawn Cole; Daniel Stein; Jeremy Tobacman

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Research Report


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Abstract: Rainfall index insurance is a theoretically attractive nancial product that has achieved only limited adoption. This paper seeks to understand the structure of demand for rainfall index insurance in India. We develop two approaches to estimating households’ valuation of rainfall insurance and evaluate them against an experiment in which xed prices are randomly assigned. The rst approach uses a simple structural model of index insurance demand that includes basis risk{the possibility that policy-holders may su er a negative shock yet receive little or no payout. We use survey data from members of an insurance pilot in Gujarat, India to t the model and estimate the willingness to pay (WTP) for rainfall insurance coverage. Relative to the choices we observe at randomly assigned xed prices, the structural model signi cantly overestimates demand. Our second approach uses a Becker-Degroot-Marschak (BDM) methodology to empirically elicit WTP from potential insurance customers at the time of marketing. We nd that BDM does a better job of predicting xed price purchasing behavior, but the distribution of stated willingness to pay has large mass points at focal points. Finally, we directly compare the two approaches and nd the theoretical model has weak predictive power for WTP as elicited by BDM. We explore which household characteristics are correlated with WTP and determine that recent experiences with rainfall and insurance are important factors not captured in our static model, suggesting that learning dynamics may be a promising direction for future analyses

Additional Bibliographic Information

Cole, Shawn, Daniel Stein and Jeremy Tobacman. "What Is Rainfall Index Insurance Worth? A Comparison of Valuation Techniques." Working paper 2011

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