Utility, Risk, and Demand for Incomplete Insurance: Lab Experiments with Guatemalan Cooperatives

Workshop on Disaster Risk Financing and Insurance (DRFI)

Researchers play a series of incentivized laboratory games with risk-exposed cooperativebased coffee farmers in Guatemala to understand the demand for index-based rainfall insurance. We show that insurance can meet with strong demand in environments where severe risk makes insurance partial (payouts are smaller than losses), but demand is adversely effected by more complex risk structures in which payouts are probabilistic (it is possible that a shock occurs with no payout). We use numerical techniques to estimate a flexible utility function for each player and consequently can put exact dollar values on the magnitude of the behavioral response triggered by probabilistic insurance. Exploiting the group structure of the cooperative, we investigate the possibility of using group loss adjustment to smooth idiosyncratic risk. Our results suggest that consumers value probabilistic insurance using a prospect-style utility function that is concave both in probabilities and in income, and that group insurance mechanisms are unlikely to solve the issues of low demand that have bedeviled index insurance markets.