Risk, informal institutions, and index insurance

The question of how informal institutions interact with formal markets is a central economic question, particularly in developing countries. We analyze this issue for the demand of an innovative weather insurance product. Specifically, when does informal risk-sharing act as barrier or support to the take-up of index-based insurance? The presence of an individual in a risk-sharing arrangement reduces her risk aversion, termed Effective Risk Aversion- a sufficient statistic for index decision making. Our analysis establishes that such reduction in risk aversion can lead to either reduced or increased take up of index insurance. These results provide alternative explanations for two empirical puzzles: unexpectedly low takeup for index insurance and demand being particularly low for the most risk averse. From a policy perspective, our results highlight how the combination of premium subsidies and informal networks might promote take-up and how this might eventually facilitate better protection against weather risks.

Automated summary

The interaction between informal institutions and formal markets is a key economic question, especially in developing countries. This study examines the demand for an innovative weather insurance product and investigates how informal risk-sharing can act as a barrier or support to the uptake of index-based insurance. The findings provide alternative explanations for empirical puzzles and highlight the potential of combining premium subsidies and informal networks to promote better weather risk protection.