Dynamic Effects of Index Based Livestock Insurance on Household Intertemporal Behavior and Welfare Munenobu Ikegami, Christopher B. Barrett, and Sommarat Chantarat International Livestock Research Institute (ILRI), Cornell University, and The Australian National University (ANU) At “Mobile Pastoralism, Index Insurance, Computational Sustainability and Policy Innovations for the Arid and Semi-arid Lands of East Africa”, ILRI, on June 10, 2015

0. Outline 1.Introduction –Literature –Central Question 2.Methodology 3.Model a. Autarky b. under IBLI 4.Results a. Key Findings & policy implication based on model prediction b. Compare model prediction with data Next step

1. Introduction Index-based insurance –Reduce vulnerability of agricultural households –Increase their resilience and welfare The focus of previous/ealry studies –Reduce Income fluctuation = direct effects The focus of this study –Further positive effects: Reduce precautionary saving Encourage investment in productive asset How large are the indirect effects?

1. Introduction Previous studies on further positive effects –Ex-ante evaluation Crop and technology adoption: De Nicola (2014) Demand and impact of IBLI under poverty trap: –Chantarat, Mude, Barrett, Turvey (2014) –Janzen, Carter, Ikegami (2015) Environmental feedback: Muller, Quaas, Frank, Baumgartner (2011) –Reduced form ex-post evaluation of IBLI: Carter and Janzen (2014) Chebelyon, Lyons (2015) Jensen, Barrett, Mude (2015) Toth et al. (2014) This paper –focus on joint decisions on investment and insurance purchase –Structural ex-post evaluation –Omit environmental feedback and poverty trap

1. Introduction Does Index Based Livestock Insurance (IBLI) induce pastoralists to increase their herd size? –Livestock as productive asset => increase their herd –Livestock as precautionary saving => decrease their herd –Does IBLI induce (further) over grazing and environmental degradation? How much of their herd and under what conditions do pastoralists insure? –Is the current design of the insurance contract OK? How much would IBLI reduce pastoralists’ vulnerability and improve welfare in the long run? –How large are “the further” effects?

2. Methodology Model –household decisions on livestock investment and insurance purchase –Stochastic structure of livestock accumulation Data –IBLI Marsabit Household Survey from (Round 1-5) –Vegetation condition: Normalized Differenced Vegetation Index (NDVI) from 2001 to 2013 (MODIS NDVI)

2. Methodology Fit the model to data –1 st Step: Estimate milk production and stochastic structure of livestock accumulation –2 nd Step: Compute optimal decisions on livestock investment and insurance purchase Counter-factual / ex ante policy simulation Compare data with model prediction (ex post impact evaluation)

3.a. Model: Autarky (without IBLI)

3.b. Model: under IBLI:  Temporal coverage of current IBLI (1 year with 2 seasons) IBLI Contract Feature: Temporal Structure

3.b. Model: under/with IBLI

4. Results a. Key Finding & Policy Implication based on model prediction b. Compare model prediction with data

Key Findings & Policy Implications Does IBLI induce pastoralists to increase their herd size? –Livestock as productive asset => increase their herd –Livestock as precautionary saving => decrease their herd –Does IBLI induce (further) over grazing and environmental degradation?

Net Livestock Investment in Upper Marsabit

Initial asset and last asset under autarky and IBLI by initial asset level and non-livestock income in Upper Marsabit

Key Findings & Policy Implications Does IBLI induce pastoralists to increase their herd size? –Livestock as productive asset => increase their herd –Livestock as precautionary saving => decrease their herd –Does IBLI induce (further) over grazing and environmental degradation? –=> Pastoralists would invest less in livestock in bad seasons (in order to buy IBLI) –=> but insurance/safety net effects let pastoralists accumulate more livestock –=> reduced risk exposure but might bring environmental delegation and decreased productivity

IBLI purchase and non-livestock income

Key Findings & Policy Implications How much would IBLI reduce pastoralists’ vulnerability and welfare in the long run? –IBLI is more beneficial for vulnerable households with less non-livestock income as an alternative insurance mechanism

Key Findings & Policy Implications How much of their herd and under what conditions do pastoralists insure? –households may insure herd sizes larger than they own as insurance against covariate income shocks more broadly –households may divest livestock in order to buy insurance

IBLI purchase and forage condition

Results: IBLI purchase and forage condition

Key Findings & Policy Implications How much of their herd and under what conditions do pastoralists insure? –households seek to buy more insurance when current vegetation conditions are bad and they expect poor range conditions – and thus a higher livestock mortality rate – in the following season –Is the current design of the insurance contract OK? Do not adjust pricing as baseline range conditions change do not use an index that is conditional on range conditions as of the contract sales date –=> Intertemporal opportunistic behavior problem –=> negative for insurance company

4. Results b. Compare model prediction with data

model predicts too large TLU insured in bad seasons

model predicts too large offtake in bad season under IBLI

model predicts too large offtake even under autarky

Next step Model predicts large offtake and large TLU insured in bad seasons but data do not show such intertemporal opportunistic behaviour with such magnitudes Model predicts too large offtake even under autarky in good seasons under IBLI For too large offtake, we relax assumption of constant TLU value over time For too large TLU insured, we introduce learning of indemnity payout function (maybe in a separate following paper)

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