Asset Insurance Markets and Chronic Poverty

This paper uses numerical dynamic stochastic programming methods to show that an insurance market can reduce the long-term extent and depth of poverty in a stylized, risk-prone rural region. This impact operates through both an ex post vulnerability reduction effect and an ex ante investment incentive effect. The result is not only lower poverty, but also substantial savings in public cash transfer expenditures that would be needed to close the poverty gap of all indigent households. Despite these results, the potential impacts of the insurance market are blunted, because initially vulnerable households do not (immediately) purchase insurance at market prices. These same households do, however, exhibit highly elastic demand for insurance. As a result, insurance subsidies further enhance the extent of poverty reduction that can be achieved with unsubsidized insurance. While targeted subsidies add to the cost of a traditional contingent cash transfer program in the short term, they actually provide significant cost savings over time compared to a conventional social protection scheme that operates in the absence of an asset insurance market. (JEL: D91, G22, H24, O16). ∗Sarah Janzen is Assistant Professor, Department of Agricultural Economics and Economics, Montana State University. Michael Carter is Professor, Department of Agricultural and Resource Economics at the University of California, Davis. Munenobu Ikegami is an economist at the International Livestock Research Institute in Nairobi, Kenya. We thank the BASIS Assets and Market Access Innovation Lab through the United States Agency for International Development (USAID) grant number EDH-A-00-06-0003-00 and UKaid (Department for International Development) for financial support. We also thank seminar participants at the 2012 NEUDC Conference, the 2012 AAEA Annual Meeting, the Pacific Development Conference 2012, the 7th International Microinsurance Conference and the I4 Technical Meeting 2011 for helpful comments. All errors are our own. The Impact of Asset Insurance Markets on Chronic Poverty In developing countries, governments increasingly address the indigence associated with chronic poverty using cash transfer programs. While there is evidence that such programs may diminish poverty inter-generationally through the human capital development of children (see reviews by Rawlings and Rubio, 2005, Baird et al., 2013 and Fiszbein et al., 2009), there is much less evidence that cash transfers offer a pathway out of poverty in the medium term. Indeed, the eligibility requirements of these programs may, if anything, discourage efforts by beneficiaries to build assets and boost income. In addition, as an ex post palliative for those who have already fallen into indigence, cash transfer programs do not address the underlying dynamics that generate indigence in the first place. As noted by Barrientos, Hulme, and Moore (2006), to be effective, social protection must address poverty dynamics and the factors that make and keep people poor. In this paper, we explore whether and how asset insurance markets might alter the forces that both drive and sustain chronic poverty. Our work is motivated by the risk-prone pastoral regions of the horn of Africa, yet it speaks in principal to the many rural areas of the developing world where risk looms large. We utilize dynamic stochastic programming methods to decompose two mechanisms through which a competitive asset insurance market might alter long-term poverty dynamics: first, by breaking the descent into chronic poverty of vulnerable households (the vulnerability reduction effect) and, second, by incentivizing poor households to prudentially take on additional investment and craft a pathway from poverty (the investment incentive effect). The magnitude of either effect will depend on the initial asset distribution of the population. In a stylized economy that begins with a uniform asset distribution, the existence of an asset insurance market cuts the long-term poverty headcount Gertler, Martinez, and Rubio-Codina (2012) provide an exception, showing that beneficiaries of the Opportunidades program in Mexico invested some of their cash transfers in productive assets, leading to sustained increases in consumption through investment, even after transitioning out the program. Pastoralist households living in the arid and semi arid regions of northern Kenya are highly vulnerable to drought risk. In 2009, a targeted unconditional cash transfer program was introduced by the government to improve the capacity of targeted households to meet immediate, essential needs, and to make productive investments. At the same time, an index-based livestock insurance program was also developed to help pastoralist households protect against livestock losses caused by drought (McPeak, Little, and Doss, 2012; Hurrell and Sabates-Wheeler, 2013; Chantarat et al., 2007, 2012; Mude et al., 2009). Krishna (2006), for example, documents the role of weather shocks in driving long-term descents into poverty in Andhra Pradesh, while Centre (2008) has a more general discussion of climatic and other shocks as drivers of chronic poverty at a global scale.