Demand for insurance products indexed to weather among coffee farmers increasingly exposed to the risks from climate change are much lower than would be expected. Even in the most straightforward case of partial insurance, a commercial product may not be viable.
This is the main conclusion of research by Craig McIntosh, Felix Povel and Elisabeth Sadoulet published in the August 2019 issue of The Economic Journal, which uses a set of laboratory games played with farmers from coffee cooperatives in Guatemala to measure the demand for insurance.
They also find that while group insurance might seem to be an attractive way of dealing with these risks, the willingness to pay is lower and farmers are not optimistic that groups will be successful in pooling the risk to any substantial degree.
Over the course of a day of incentivised games, the researchers presented farmers with a variety of different scenarios featuring different types of weather risk and insurance contracts. They also introduced the possibility that the cooperatives themselves could serve as brokers for group insurance. The researchers then rank these alternatives according to the utility of each of the farmers and then use this to predict what demand ‘should’ have been in a variety of difference scenarios.
The study finds that farmers respond in a very dramatic way to even a very small possibility of weather shocks not covered by the insurance. This is consistent with previous research and underlines how multi-peril risk environments make the construction of effective weather indexes a challenge.
According to the research, individuals recognise and are willing to pay for group insurance to pool risk. However, they only expect the group to carry out about a quarter of the degree of risk sharing possible. There is also dislike of the group mechanism that provides compensation in terms of willingness to pay for the degree of pooling they expect to occur.
The researchers conclude that, seen in a positive light, the large behavioural response to small uncovered risks implies that apparently minor improvements in the ability of insurance indexes to capture loss events could lead to large improvements in demand.
Utility, Risk and Demand for Incomplete Insurance: Lab Experiments with Guatemalan Co-Operatives by Craig McIntosh, Felix Povel and Elizabeth Sadoulet is published in the August 2019 issue of The Economic Journal.
Professor of Economics at School of Global Policy & Strategy
Professor of Agricultural and Resource Economics at UC Berkeley