Underwriting Area-based Yield Insurance to Crowd-in Credit Supply and Demand
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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)

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

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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

  • Illustrate Two Types of Moral Hazard-Proof Area-based Yield Insurance:

    • Based on Measured Average Yields

    • Based on Estimated Average Yields (weather index)

  • Estimate Benefits to Farmers/borrowers (using data on rice in Peru’s Lambeyeque Valley)

  • Estimate benefits to lenders

  • Argue that must move results into policy & practice by superseding past public good failures


Output Risk


Insurance Contracts


Insurance Contracts


Simulating the Value of Actual & Estimated ARBY Insurance


Simulating the Value of Actual & Estimated ARBY Insurance


Simulating the Value of Actual & Estimated ARBY Insurance


So in Theory, Crowd-in Credit Supply & Demand

  • Analysis above indicates that:

    • Substantial reduction in default risk for lenders

    • When default remains, should be largely idiosyncratic

    • Should crowd-in credit supply

  • 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

  • Together imply large social & private returns


Market Failures Follow Public Good Failures

  • 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

  • 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:

  • Follow example of micro-health insurance and bundle product with MFI loans

  • 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

  • Paper illustrates risk exposure related to public underwriting of initial risk


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