Basis Risk, Uptake And Impacts Of Index Based Livestock Insurance In Northern Kenya

Abstract

Index insurance is a promising tool for fighting poverty where households face climactic uncertainty and incomplete financial markets. Although index insurance products avoid many of the costs that prohibit supply of conventional loss-indemnifying insurance for small holders in developing countries, index products expose insured households to basis risk because they can only insure covariate losses and indices are inevitably imperfect. Until now, no empirical study has examined the magnitude of basis risk in the context of the developing world. Nor have direct estimates of basis risk been included in demand analyses. Furthermore, the impacts of index based insurance on household welfare have been unknown. This dissertation looks closely at basis risk, demand, and impacts of index insurance. The Index Based Livestock Insurance (IBLI) product, available to pastoralists in northern Kenya since 2010, provides an ideal setting for such an analysis. The IBLI index was constructed using methods explicitly designed to minimize basis risk and implementation included an in-depth longitudinal household survey. The first paper finds that basis risk is substantial due to the high degree of variability between households and inaccuracies in the index. Although the existence of design risk is expected, the great deal of idiosyncratic risk is surprising in a region where large covariate droughts are known to be the major cause of livestock mortality. The second paper finds that product-related factors are at least as important as demographic and financial related characteristics in determining demand for IBLI. Both idiosyncratic risk and households' observed design risk play a large role in determining demand. In addition, a simplified premium schedule generated significant spatiotemporal adverse selection. The third paper finds that IBLI coverage reduces precautionary savings held in livestock and increases investments in productivity through mobility and livestock veterinary services. These adjustments to production strategies are associated with increases in income from milk and income per adult equivalent. When compared to the costs and impacts of the Hunger Safety Net Program, an ongoing cash transfer program in the same region, IBLI performs quite well and may become even more cost effective as the initial costs are spread across more clients.