Only the Rich Need Apply? A Dynamic Model of Index-Based Insurance Choice

I present a dynamic expected utility model to explain farmers’ borrowing decisions and observed low demand for index-based agricultural insurance. Results indicate that, in the absence of insurance, only low- and medium-wealth households access credit for farming and consumption. Once insurance contracts become available, however, cases exist in which borrowing initially declines with wealth until a critical wealth level is reached, after which wealthier households take out loans in order to purchase insurance. Implications of simulations suggest that index-based products may not be tailored for the ultra-poor, who must borrow the maximum amount simply to meet consumption needs. As such, researchers piloting index-based insurance programs must seriously consider the effects of liquidity constraints on contract uptake