Investigating the Impact of Climate Change on Index Insurance Demand

July 31, 2017

Climate Change has the potential to increase the likelihood of droughts and other systemic shocks faced by smallholder farmers in the developing world. Index insurance has been proposed as part of the solution to this increased risk, but little research has examined whether index insurance programs themselves are vulnerable to changes in risk associated with climate change. Using a framed field experiment in the Dodoma Region of Tanzania, we find that it take many rounds of data for farmers to update their willingness to pay for insurance in response to a change in the drought probability in the absence of ex ante information about the timing and magnitude of the change. We show by estimating actuarially fair premiums that the sustainability of index insurance programs could be imperiled due to lower uptake rates. Finally, we show that portions of our sample exhibit ambiguity aversion, recency bias, and incomplete learning, and that these behavioral factors play important roles in determining smallholder farmers’ responses.