Addressing Climate Change Through Risk Mitigation: Welfare Implications of Index Insurance in Northeastern Tanzania
While index insurance offers a compelling solution to the problem of covariant risk among smallholder farmers in developing countries, most rainfall-based contracts suffer from poor quality due to a low correlation between the index and farmer losses. Mor
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Addressing Climate Change Through Risk Mitigation: Welfare Implications of Index Insurance in Northeastern Tanzania Jon Einar Flatnes and Michael R. Carter
Abstract While index insurance offers a compelling solution to the problem of covariant risk among smallholder farmers in developing countries, most rainfall-based contracts suffer from poor quality due to a low correlation between the index and farmer losses. Moreover, a lack of historical household-level yield data has made it difficult to quantify the level of basis risk and the impact on farmer welfare. This paper utilizes a unique dataset of plot-level historical rice yields in Northeastern Tanzania to estimate the level of basis risk and the welfare implications of two hypothetical index insurance contracts. One is a standard area-yield contract, while the other uses an index based on publicly available high-resolution satellite data that are mapped to actual yields to minimize basis risk. Our results suggest that the satellite index explains approximately 55 % of the variation in zone-level yields across years. Moreover, despite the presence of large basis risk under both contracts, they are each found to improve the welfare of the average farmer in the sample. Finally, we show that the demand for satellite contracts may be as high as 30 % under reasonable assumptions about loading costs and risk preferences. Keywords Agriculture sensing Tanzania
Basis risk Index insurance Microinsurance Remote
JEL Classification O10
O13 O16 Q14
J.E. Flatnes (&) Department of Agricultural, Environmental, and Development Economics, The Ohio State University, Columbus, OH 43210, USA e-mail: [email protected] M.R. Carter Department of Agricultural and Resource Economics, University of California, Davis, One Shields Avenue, Davis, CA 95616, USA © Springer International Publishing AG 2016 R. Lal et al. (eds.), Climate Change and Multi-Dimensional Sustainability in African Agriculture, DOI 10.1007/978-3-319-41238-2_30
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Introduction
An overwhelming body of literature has left no doubt that risk poses one of the greatest threats to development in low-income economies. Particularly small-scale farmers are plagued by risk, as weather variation is the largest source of risk in agriculture (Cole et al. 2013; Giné and Yang 2009) and because such risk is spatially correlated, making local risk sharing mechanisms ineffective and affecting everyone in the community. While index insurance offers a compelling solution to the problem of covariant risk, these products have generally suffered from low demand. For example, Cole et al. (2013) find that the adoption rate for a rainfall based index insurance product offered to smallholder farmers in two regions in India is close to zero. This somewhat disconcerting observation has prompted several empirical and experimental studies attempting to isolate the determinants of the demand for index insurance. While this evidence suggests that price, liquidity, interlinkage with credit,
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