Underwriting Area-based Yield Insurance to Crowd-in Credit Supply and Demand Michael R. Carter University of Wisconsin

The Problem Risk rationing & restricted demand (and its costs) Restricted Credit supply (& its costs) Insurance as solution, but moral hazard & adverse selection can make standard insurance (based on individual outcomes) infeasible Can limited area-based yield insurance against correlated risk solve credit market problems? –Should resolve credit supply problem (economic & political-economic) –But will it help producers?

Outline of Remainder of Talk 1.Illustrate Two Types of Moral Hazard-Proof Area-based Yield Insurance: –Based on Measured Average Yields –Based on Estimated Average Yields (weather index) 2.Estimate Benefits to Farmers/borrowers (using data on rice in Peru’s Lambeyeque Valley) 3.Estimate benefits to lenders 4.Argue that must move results into policy & practice by superseding past public good failures

Output Risk

Insurance Contracts

Simulating the Value of Actual & Estimated ARBY Insurance

So in Theory, Crowd-in Credit Supply & Demand 1.Analysis above indicates that: Substantial reduction in default risk for lenders When default remains, should be largely idiosyncratic Should crowd-in credit supply 2.Analysis also indicates that: $100 ($200) typical smallholder willingness to pay for estimated (measured) ARBY insurance above & beyond the actuarially fair premium Together with reduction in default risk, should reduce risk rationing & crowd-in entrepreneurial risk taking and demand for credit 3.Together imply large social & private returns

Market Failures Follow Public Good Failures 1.So why is market not providing? Costs of innovation Scarcity of reliable data for probability estimates and measurement of payoff condition Costs of marketing product to smallholders 2.Note that all of these have a public good element

From Theory to Policy & Practice Time to stop wringing hands about past public good failures and: 1.Follow example of micro-health insurance and bundle product with MFI loans 2.Create a policy trajectory which Initially underwrites risk (& parameter uncertainty) Creates institutions to collect better information and mover from less to more valuable forms of ARBY 3.Paper illustrates risk exposure related to public underwriting of initial risk