RISK PREFERENCES AND DEMAND FOR INSURANCE UNDER PRICE UNCERTAINTY: AN EXPERIMENTAL APPROACH FOR COCOA FARMERS IN CÔTE D’IVOIRE Euphrasie B.H. KOUAME Aka Narcisse KOMENAN University of Cocody, Cote d Ivoire 2012 Research Conference on Microinsurance

Agricultural risks and risk aversion Risk is a central issue that affects many different aspects of people’s livelihoods in the developing world. In rural Africa, risk is present in all management decisions of agricultural systems, as a result of price, yield and resource uncertainty. The existence of risks could alter farmers’ behaviour in different ways, based on their level of risk aversion. In the empirical literature, many researchers have found that risks cause risk averse farmers to be less willing to undertake activities and investments that have higher expected outcomes, but carry with them risks of failure (Adebusuyi, 2004).

Risk responses by farmers In Côte d’Ivoire, rural households producing cocoa are exposed to a variety of income uncertainties affecting their daily life. Response: farmers rely on several kinds of informal arrangements and institutions (crop diversification, precautionary saving, sharing risk within social network). These traditional strategies only mitigate a small part of overall risk, especially when those swings are systemic shocks to the whole sector, like instable commodity price. Need to make modern risk management instruments like insurance available to farmers:  Knowledge of farmers’ risk preferences  knowledge of their interest in and WTP for insurance

Research questions What are cocoa farmers’ risk preferences schemes in Côte d’Ivoire? What determine farmers’ attitude toward risks? What are farmers’ perceptions about existing agricultural risks? What is the potential willingness of producers to pay, namely their underlying demand for hypothetical insurance against cocoa price risks? Does risk aversion matters in farmers’ decision to purchase price insurance?

Objective of the paper: Analyze cocoa farmers’ demand for hypothetical price insurance, with a particular focus on the role of risk aversion in insurance decision.

1) Eliciting farmers’ risk aversion behaviour: the experiment Binswanger (1981) with real payments: data from 364 farmers A series of “schedules of alternatives” (called games) is presented to each subject (farmer) Each subject is asked to select one of six alternatives: O, A, B, C, D, or E Once they have chosen, a coin is tossed and they receive the left-hand amount (bad outcome) if the coin shows heads and the right hand amount (good outcome) if the coin shows tails. ChoiceBad Outcome “Heads” Good Outcome “Tails” Expected Gain Standard Deviation Risk* classification O100 0Extreme A Severe B Intermediate C Moderate D Slight to Neutral E Neutral to Preferring

2) Determinants of risk aversion: the ranked responses from the game were used in an Ordered Logit model. 3) Perception of risks within farmers: 5-point Likert scale from 1 (no impact) to 5 (high impact). 4)Interest in and WTP survey design: Contingent Valuation  Detail description of how a minimum price insurance contract works was presented to farmers  Farmers were asked on whether such a contract would interest them  WTP questions were administered only to those respondents who declared that they were interested in price insurance.

 Three hypothetical contracts were designed (in line with farmers’ price experience over the past five years)  For each contract three different bid values (namely prices to pay) were selected  Each farmer was randomly assigned to answer whether he/she would be willing to pay one of these bid values for each contract 5) Modelling WTP for insurance: Heckman 2-stage procedure to take into account the sample selection bias Cocoa Price Insurance Contracts (all amount in FCFA) Minimum Price 400 FCFA Minimum Price 600 FCFA Minimum Price 800 FCFA Village group Group Group Group

Experimental Result: Farmers’ attitude towards risk Distribution of farmers’ choices in risk game by pay-off level (% of farmers)* Games Extreme (%) Severe (%) Intermediate (%) Moderate (%) Slight to Neutral (%) Neutral to Preferring (%) 100 FCFA. (game 1, real) FCFA. (game 2, real) FCFA. (game 3, hyp.) Note: * Percentage shares are calculated for each game level, where 100 FCFA is the lowest and 5000 FCFA is the highest game level. A total of 362 households participated in all the games. Increasing partial risk aversion High level of risk aversion

Econometric results on determinants of risk aversion Wealth (-): decreasing absolute risk aversion Age (+) Education (-) Gender, male (-) Dependence on cocoa revenue (-) Previous luck (-)

Perceptions of risk sources Mean scores and rank of sources of risks (n=362) Risk SourcesImportance Score( Mean) Rank by Mean Score Technical Drought Pest/disease Floods Market Input access Output price Social Ill-health/death Unavailability of Labour Land(unsecured tenure) 1.067

Interest in minimum price insurance Zone Interest in Minimum Price Insurance (%) YESNOTotal Zone Zone Zone Total Probit selection results:  Risk aversion (-): high RA is negatively correlated with price insurance take up decision. Lack of confidence in the insurance policy, limited trust in the credibility of the insurer.  Existing risk management strategy, social network (+) Interest in minimum price insurance among cocoa producing households (n=362)

WTP for minimum price insurance Zone 400 FCFA600 FCFA800 FCFA WTP (Mean) WTP (Share of 400FCFA min. price) WTP (Mean) WTP (Share of 600FCFA min. price) WTP (Mean) WTP (Share of 800FCFA min. price) Zone % % % Zone % % % Zone % % % Total % % % Mean WTP for each minimum cocoa price insurance contract (n=239) These WTP results are relatively low compared to others studies like the one by Sarris et al. (2006) for the case of Tanzania, where farmers were willing to pay between 13 and 30% of the option valu e.

Summary of the findings Contribution to the ongoing debate on agricultural risk management in developing countries  Relatively high level of risk aversion among Ivorian cocoa farmers with IPRA and DARA;  Younger, educated and male farmers exhibit lower levels of risk aversion;  Cocoa price risk has been ranked as the most important source of risks faced by farmers;  Considerable interest in minimum price insurance (66%);  High risk aversion has been found to inhibit the demand for price insurance;  Farmers’ individual WTP for minimum price insurance are relatively low.

Policy implications  Whether in technology development or for policy formulation, the risk aversion of farmers must be taken into account;  Address the individual barriers and design problems that have been identified as disincentives to farmer participation in insurance program. More importantly, farmers should be convinced of the reliability and the credibility of the insurance provider;  A major focus should be on community education, in order to reduce farmers’ risk aversion and equip them with the skills to understand the role of agricultural insurance as a key tool to deal with risks;  Farmers’ organizations should be strengthened to better serve farmers in providing information on modern risk management instruments.

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