Identifying Information Asymmetries in Insurance: Experimental Evidence on Crop Insurance from the Philippines

Why have insurance markets for many important risks failed to develop? Economic theory suggests this is most likely due to asymmetric information problems, but their presence is hard to identify empirically. In this paper I provide empirical estimates of information asymmetries in the insurance for crops, a market that has failed to develop for the most important types of natural hazards to crops. The evidence is based on a randomized field experiment among rice farmers in the Philippines that also includes an incentivized choice experiment and is combined with administrative data and detailed survey data. The design provides several unique tests of contract theory. I find strong evidence for both adverse selection and moral hazard, and provide estimates of magnitudes. Most of the worlds’ poor live in rural areas and depend to a large degree on agriculture for their livelihood. This dependence on agricultural production leaves rural households exposed to enormous risks from floods or droughts, hurricanes, pests or crop diseases. This risk depresses investment and access to credit, inhibits the development of markets and has serious direct welfare consequences. Yet, despite the importance of this risk, formal insurance markets to manage this risk have failed to develop1. Previous research has identified adverse selection, moral hazard and spatial co-variability of risk as the most likely causes of the failure of crop insurance markets. But empirical evidence for these information asymmetries is scarce since they are hard to identify using observational data. The paper makes contributions in two main areas: I) As a contribution towards understanding the failure of crop insurance markets, this paper examines in detail information asymmetries that may be 1The main exceptions to the lack of insurance markets is the development of markets for insurance that is relatively free from the problems of adverse selection and moral hazard, such as the recent development of index insurance markets (which are more akin to hedging instruments than insurance) and specialized markets such as hail insurance in Australia and Europe. Farmers in many countries, such as the US and the Philippines, also have access to government subsidized insurance but these are very expensive to governments and reportedly mired in problems with adverse selection and moral hazard.