Protecting land and livelihood under climate risks: What hinders crop insurance adoption?

Abstract

Small-scale agriculturists in developing countries face continuous weather-related risks, which are exacerbated by the growing issues of climate change (See Shah et al., 2018 for Pakistan; Zakaria et al. (2020) for Sub Sahara Africa). Despite efforts to introduce formal crop insurance at a subsidized rate by many governments, including in India, insurance penetration rates remain low in less developed countries (LDCs). One reason for this is continued reliance on informal credit as a risk-coping mechanism in poorer regions in times of agricultural distress. This prompts the question as to why farmers rely on these methods when apparently less expensive formal crop insurance is available. To answer, we investigate the link between the conditionalities of informal credit and the decision to adopt crop insurance together with other factors such as farmers’ socioeconomic class, education, and attitude to risk. Thereby, we derive policy implications for enhancing insurance penetration among poor farmers. A theoretical model is first constructed to provide a motivation for the empirical relation examined. An analysis of the decision to adopt crop insurance and the extent of insurance coverage availed is undertaken using a two-part fractional logistic regression with crop insurance data from India (provided by the National Sample Survey Office). The results demonstrate that informal interest rates are significantly and positively correlated with the probability of taking up crop insurance, and disparities between economic and social classes in the adoption of crop insurance exist. Although the ills of usurious informal interest rates are often highlighted (Bhaduri, 1997), this indirect positive effect on crop insurance penetration has not been established heretofore. The exercise also looks at the possibility of loss expected by a farmer and their insurance adoption behaviour by relating it to Prospect Theory (Kanheman, Tversky, 1979).