Index insurance could mitigate the impacts of weather shocks, especially for the poor.
•
We implement a lab experiment in Cambodia.
•
Investment decisions change under risk or ambiguity, for different levels of initial wealth, under contract nonperformance and in presence of a subsidy.
•
While the presence of a market for insurance increases investment, this effect is heterogeneous according to wealth and uncertainty status.
Abstract
The livelihoods of poor people in developing countries are increasingly dependent on weather shocks whose effects are exacerbated by the lack of access to adequate insurance markets allowing risk hedging. Index-based insurance underwrites a weather risk as a proxy for economic loss: when the index falls below a certain level, farmers automatically get a payment. The aim of this paper is to study the impact of an Index-based insurance on investment decisions in profitable but risky inputs in presence of weather shocks by means of an incentivized lab-in-the-field experiment conducted in Cambodia. The protocol is designed so as to study the extent to which investment decisions change under risk or ambiguity, for different levels of initial wealth, under contract nonperformance (i.e., when claims are not repaid by the insurer) and when the insurance is fully subsidized. The findings indicate that, while the mere presence of a market for insurance increases investment, the strength of the effect crucially depends upon the level of initial wealth and upon the subjects' ability to correctly assess the probability of a shock.
