The role of microcredit and microinsurance in coping with

natural hazard risks

Sonia Akter1 and Naureen Fatema2

1
Corresponding author: Crawford School of Economics and Government, The Australian
National University, Canberra, ACT 2601, Australia, E-mail: sonia.akter@anu.edu.au,
Tel: +61 2 6125 1221, Fax: +61 2 6125 8448
2
Department of Economics, McGill University, Canada.

1
 ABSTRACT

The study investigates the role of post disaster credit market access in determining micro-crop-
insurance demand in the rural floodplains of Bangladesh. In a double bounded contingent
valuation study, over 500 flood stricken farmers were asked for their preferences to pay premium
to protect themselves against crop damage risks. Our results show a negative relationship
between farmers access to post disaster microcredit and their willingness to pay premium for a
crop insurance contract. This finding was consistent across institutional characteristics of the
rural credit market. This result has a number of policy implications. The most important of all is
that the recent and growing trend of offering compulsory bundled insurance scheme is likely to
curb the demand for microfinance products that are linked with weather related income
generation activities in developing countries.

Key Words: Flood, crop insurance, microcredit, Asia, Bangladesh

2
Acknowledgements

The work presented in this paper is part of the Poverty Reduction and Environmental
Management (PREM) program in Bangladesh funded by the Dutch Ministry of Foreign Affairs.
We gratefully acknowledge the cooperation of the following organizations at various stages of
this research: Bangladesh Water Development Board (BWDB), Climate Change Cell (CCC) at
Department of Environment (DOE), Flood Forecasting and Warning Center in Bangladesh
(FFWC), Water Resource Planning Organization (WARPO) and Geographic Information System
(GIS) cell in Local Government Engineering Department. We, furthermore, thank Professors
Robert D. Cairns, Sonia Laszlo and Roy Brouwer for their valuable inputs.

3
 1. INTRODUCTION

Microcredit and microinsurance are often referred to as important and effective ex post natural

hazard risk coping mechanisms (Brouwer et al., 2007, Khandker, 2007, Botzen and van den

Bergh, 2008; Brouwer and Akter, 2010). Accordingly, natural hazard risk insurance programmes

have been introduced alongside the existing microcredit programs in many developing countries

in order to help the poor cope with increased climatic disaster risks (Mechler et al., 2006; Akter

et al., 2009). In majority of the instances, such insurance products are offered by microfinance

institutions that traditionally and predominantly focus on the provision of microcredit

(ProVention/IIASA, 2006). In some cases, providers offer microinsurance products bundled with

microcredit loans. Such schemes require the uptake of insurance as a condition for extending

loans or savings arrangements to the microfinance clients. For example, a variant of index-based

insurance was implemented in Malawi that offers microlending together with mandatory crop

insurance contract (ProVention/IIASA, 2006).

Bundled insurance schemes have three key supply side advantages. First, the system enables the

insurer to diversify risks by adding other risks to the portfolio that are uncorrelated across clients.

Second, adverse selection is reduced if clients are obliged to purchase the insurance, including

those facing low risk of natural hazard. Third, if the insurance is offered jointly with other

products, transaction costs are lower than if they were sold separately. Despite these advantages

from the providers viewpoint, there is a real risk that bundled insurance may affect the take-up

rate of weather insurances by reducing its popularity among insurance clients. Although both

microcredit and microinsurance helps risk coping and microcredit is often referred to as implicit

insurance against natural hazards (Brouwer et al., 2007), there are important differences in the

4
way these instruments function. Microcredit provides households access to financial resources

after natural hazard strikes and thus helps cope with natural disaster induced losses or damage

incurred to any asset owned by the household. A microinsurance scheme, on the other hand,

requires payment on a regular basis before the hazardous event takes place. It generally covers

damage or losses incurred to the product(s) against which the insurance was purchased, for

example crop, livestock or house property. Finally, the amount of compensation offered by an

insurance contract is often uncertain as it is subject to post disaster damage assessment by the

insurance provider.

Given the differences in the way microcredit and microinsurance operates, the nature of their

interactions in the natural hazard risk coping domain is not clearly understood. A case study by

Gine et al. (2008) examined the relationship between farmers access to pre disaster credit

facility and demand for rainfall-index insurance in a drought prone region in India. They found

that credit constrained farmers were less likely to purchase rainfall-index insurance implying that

pre disaster microcredit and microinsurance are complimentary goods. Such relationship is

substantiated on the basis of the so-called affordability argument, i.e. access to pre disaster

microcredit increases insurance affordability by enhancing household income or by relaxing

liquidity constraints.

While the complementary nature of pre disaster microcredit and weather related microinsurance

is being increasingly taken into accounts now-a-days to package microfinance products in

developing countries by offering bundled insurance schemes, the substitutability between them

as disaster risk coping instruments are being vastly ignored. According to microeconomic theory,

5
post disaster microcredit and microinsurance are expected to be substitute goods given that they

independently serve as natural disaster loss mitigation instruments. This implies that access to

post disaster credit facility and insurance demand are expected to be negatively related. It is

reasonable to presume that household decisions to purchase an insurance contract ex ante will, to

some extent, be influenced by the availability and access to microcredit ex post. If the direction

and magnitude of this influence are not clearly understood and not accounted for in the design of

microfinance products, it is likely that these newly innovated bundled microfinance products will

fail to accomplish their goals of eradicating poverty by reducing weather induced vulnerability in

developing countries.

Against this background, we carried out an in-depth empirical examination to shed further light

on this issue. More specifically, the main objective of this study is to understand the nexus

between ex post credit and microinsurance in the natural hazard risk management domain. To the

best of our knowledge, no empirical study has addressed this issue before. Building upon the

growing empirical evidence regarding natural hazard insurance demand, we conducted a double

bounded (DB) contingent valuation (CV) study where flood stricken farmers in the rural

floodplains of Bangladesh were asked for their preferences to pay premium to protect themselves

against crop damage risks due to natural hazards. A hypothetical insurance market was

constructed because a real crop insurance market currently does not exist in Bangladesh. We

estimated a series of econometric models and tested the relationship between farmers access to

post disaster microcredit and their willingness to pay (WTP) premium for the hypothetical crop

insurance contract. The institutional characteristics of the rural credit market were taken into

account by controlling for farmers access to formal and informal credit institutions. We

6
observed a statistically significant negative relationship between access to microcredit and crop

insurance demand. More specifically, respondents WTP for flood-crop-insurance was found to

be curbed by their access to both formal and informal credit institutions and their degree of

access to the credit sources. This finding conforms to the proposition of conventional

microeconomic theory which suggests post disaster microcredit and microinsurance, to some

extent, substitute each other.

The rest of the paper is organized as follows: the next section provides a description of the case

study and survey design. We then describe the development of our empirical model. Then the

paper gives the statistical analysis results, and offers a conclusion and policy recommendation.

2. STUDY SITE AND SURVEY DESCRIPTION

Bangladesh is primarily an agrarian economy, with close to 65 percent of the total workforce

being involved in agriculture, either directly or as day labourers, and generating about 22 percent

of the countrys GDP (BBS, 2005). The high sensitivity of agriculture to weather shocks

combined with the geophysical characteristics of the country (riverine delta and low land

elevation) make the countrys agricultural sector vulnerable to flooding. Typical instruments to

cope with flood risks at the individual farm level include product diversification, cultivation of

local, deep-water and shorter maturity period crop varieties, changing the cropping cycle or

skipping a cycle altogether, future markets and vertical integration. At the national level, flood

risk management has traditionally focused on infrastructural measures such as building

embankments, and ex post flood relief measures, such as distribution of free seed, fertilizer and

increased access to post-flood credit facilities.

7
Following the overwhelming success of microcredit in Bangladesh, there is a growing optimism

in microinsurance solutions to protect rural farm households from income shocks resulting from

weather related events. The National Adaptation Program of Action (NAPA), prepared by the

Ministry of Environment and Forests (2005), suggests exploring options of a flood insurance

market as an important climate change risk adaptation strategy. Following the NAPA

recommendation, a commercial feasibility study of microinsuarnce was undertaken in 2006 (see

Akter et al. 2009; Akter et al., forthcoming). The study involved a large-scale stated preference

survey in the riverine floodplains of Bangladesh. The stated preference techniques estimate

monetary values of non-market environmental goods and services by analyzing individuals

stated behavior in hypothetical settings. The CV method and choice experiment belong to the

stated preference class of non-market valuation techniques. These methods employ public

surveys to ask the affected (or relevant) group of population about their WTP by constructing a

hypothetical market or referendum.

The questionnaire used for the survey gathered information on three broad categories: a) socio-

demographic profile such as age, occupation, education, family size, sources of income, assets,

etc; b) flood damage information such as the type and extent of damage, duration of floods,

inundation level, level of preparedness, type of ex ante and/or ex post disaster loss mitigation

measures adopted, access to formal and informal credit institutions and c) the valuation section

where the households were asked about their WTP for different hypothetical insurance schemes

such as crop, house property, health and unemployment insurance. 566 respondents expressed

preferences solely for a crop insurance scheme. The current study used these 566 observations.

8
The survey used a DB DC elicitation method where respondents were asked two WTP questions:

do you accept a start bid and do you accept a follow up bid. In recent years, the DB DC method

has gained popularity over the single bounded approach based on the finding that this method

generates more efficient estimates than those based on a single bounded CV (Hanemann et al.,

1991; Cameron and Quiggin, 1994; Alberini, 1995). After respondents were explained the

proposed insurance scheme, they were asked for a weekly premium ranging between BDT 5

(USD 0.07) and BDT 50 (USD 0.71). These weekly premiums were chosen from a previous CV

survey (see Brouwer et al. 2009). A total of six different start bids were used. For each of the six

starting bids, a high bid level and a low bid level were pre-assigned, e.g. for a start bid of 30, if

respondents rejected this bid, they were asked if 20 was acceptable and if they accepted the start

bid of 30, they were asked if 40 was acceptable. The bid levels were assigned randomly across

respondents to avoid starting point bias.

Four un-embanked riverine districts located near the two major rivers (Meghna and Jamuna)

were selected on the basis of damage intensity levels monitored during the 2004 flood. One

district located inside the Ganges-Kobadak project (one of the oldest and biggest Flood Control

and Irrigation Projects in the country) and one coastal district (surrounded by the Bay of Bengal

and lower Meghna) were selected. An embanked area was included as one of the study sites

because of the high failure rate of flood protection embankments in Bangladesh. Although flood

protection embankments help reduce the frequency and intensity of riverine flooding, they have

historically contributed to water logging inside the embanked area due to poor design,

construction, and maintenance standards (Rashid and Mallik, 1993; Hossain and Sakai, 2008;

Nahar et al., 2010). The geographical locations of the study areas are presented in Figure 1. The

9
selection of households in each of the villages followed a random sampling approach where

every fifth household located along the village roads was interviewed. Only the heads of

households were interviewed in this survey.

INSERT FIGURE 1 HERE

3. SAMPLE CHARACTERISTICS, MAGNITUDE OF THE NATURAL

HAZARD DAMAGE AND CREDIT MARKET ACCESS

Table 1 compares the demographic and socio-economic characteristics of the 566 farmers

included in the sample with the national population statistics. All household heads interviewed in

the survey were men. The average age of the respondents was 46 years, ranging between 30 and

75 years. About half (45%) of the respondents included in the survey was unable to read and

write. Just about a quarter (24%) finished primary school and only 13 percent finished high

school. Each household consisted, on average, of six family members. Agricultural farming was

the primary occupation of about three quarters (74%) of the sampled households. Approximately

18 percent of the sample population was involved in agricultural farming as a secondary source

of livelihood. Almost all sampled farmers (97%) owned the farmland where they cultivate their

crops. The average size of the farm land was one hectare. Average yearly crop income accounted

for 70 percent of yearly household income.

INSERT TABLE 1 HERE

Average annual household income (related to the past 12 months) was about US$1750, while

half of the sample population earned US$1176 per year. Dividing the median yearly income by

the average household size and 12 months, average per capita income equaled US$16 per month,

10
which is slightly higher than the national average rural per capita income (US$14) (BBS, 2005).

Average household crop damage costs due to natural hazards were US$509 per household per

flood event. Trimming off five percent high and low values, the average household crop damage

cost equals to US$397 which is equivalent to about three to six percent of average yearly

household income (based on the assumption that a natural hazard takes place once in every five

to 10 years).

Average crop damage cost inside the embanked area was significantly higher than the damage

cost in the unprotected riverine area (Kruskal Wallis 2 = 24; p<0.001). Although this finding

appears to be counterfactual, it is consistent with existing empirical evidence which shows that

farmers within an embanked area are more vulnerable to crop damage than those outside the

embankment (Rashid and Mallik, 1993). This is because farmers inside the embanked area

follow different cropping patterns and use larger proportion of farmland for crop growing

including low-lying lands. Therefore, a poorly functioning protection causes a larger amount of

damage compared to the farmlands in the unprotected area. However, the frequency of natural

hazard inside and outside the embankment was found to be significantly different. Households

living within an embanked area experienced relatively lower frequency of water logging (once

every six years) than those living outside or without the embankment (once every five years).

When respondents were asked how they coped with losses induced by the flood event of 2004,

over 80 percent of them said that they used their savings and 70 percent stated that they

borrowed money from the rural credit market. Significant heterogeneity was observed across

respondents in terms of the nature (formal and informal) and degree of accessibility (number of

11
credit sources) to the ex-post disaster credit facilities. About 44 percent of the sampled farm

households did not access to any form of post disaster credit sources while the rest accessed to at

least one source with a maximum of three. About a quarter (26%) of those who borrowed money

to cope with flood damage accessed to the formal credit market (bank or microcredit institutions)

and 87 percent accessed to informal credit sources (e.g., relatives, friends, or village leader).

On average, relatively wealthier households who owned larger farmland and earned higher

yearly average agricultural income relied entirely on savings to cope with the losses (land size:

Mann-Whitney Z=-6, p<0.001; agricultural income: Mann-Whitney Z=-8, p<0.001). Size of

farmland and agricultural income were found to be inversely related to the degree of credit

market access (land size: Chi square=72, p<0.001; agricultural income: Chi square=69,

p<0.001). In other words, farmers who owned smaller farmland and earned relatively low

agricultural income, on average and other things remaining the same, were found to have sought

loans from multiple sources. Finally, on average, relatively low income farmers with smaller

number of livelihood sources borrowed money from formal credit institutions more than medium

or high income farmers and farmers with larger number of livelihood sources (agricultural

income: Mann-Whitney Z=-4, p<0.001; number of income sources: Mann-Whitney Z=-2,

p<0.001).

4. DEVELOPMENT OF AN EMPIRICAL MODEL

According to standard microeconomic theory individual with an initial wealth of W0 who suffers

from damage D with risk exposure level , chooses to buy a coverage of amount C paying

premium of amount P=pC. Assuming that the individual household has a von Neumann-

12
Morgenstern utility function U(W)1, insurance will be purchased if and only if households

expected utility from risk transfer exceeds expected utility from an uninsured state, that is:

U (W 0 pC D + C ) + (1 )U (W 0 pC ) > U (W 0 D ) + (1 )U (W 0 )

Therefore, households decision of purchasing insurance is expected to be influenced by the level

of risk exposure ( ), level of wealth (W0), expected amount of damage and rate of premium (p).

Household wealth, in part, reflects households ability to pay premium and damage refers to the

consequence of a hazardous incident. The higher the wealth and damage, other things remaining

the same, the more should be the farmers WTP for crop insurance.

The demand for crop insurance is expected to be positively related to the level of environmental

risk ( ), i.e. the higher the exposure level to environmental risk, higher the likelihood of

purchasing crop insurance. Exposure to environmental risk can be divided into two components,

namely, exogenous and endogenous risks (Shogren and Crocker, 1991; Smith, 1992). Exogenous

risk refers to the aspect of environmental risk on which households have no control. The

exposure to exogenous risk can be measured by either subjective or objective probability of

natural hazards (e.g. flood return period). Subjective probability of flood return period is

reflected by households perceptions of flood occurrence in future while objective probability of

flooding can be measured through the frequency of flooding in the past.

Endogenous risk refers to the aspect of environmental risk that, to some extent, can be mitigated

through protective actions. The social vulnerability literature refers to the distance people live

from the source of hazard as an indicator of endogenous risk exposure level (e.g. the closer to the

1
U(W) is continuous and twice differentiable; that is, marginal utility U(W)>0 and U(W)<0.

13
river, the higher the probability of getting affected by flooding) (Brouwer et al., 2009).

Geographical location is considered an endogenous factor because farmers have the choice to

reduce the risk exposure level by moving further away from the river (Brouwer et al., 2010).

Flood protection embankment can also be viewed as another indicator of endogenous risk

exposure level. An embankment supposedly protects the embanked area from flooding. Hence,

theoretically, households without a flood protection embankment are more exposed to the risk of

flooding than the households living within an embankment.

According to microeconomic theory, demand of a commodity is determined by the availability of

its substitute and complement products. The demand for crop insurance, an ex post hazard

coping strategy, is expected to depend upon the availability of alternative ex ante and ex post

hazard risk coping instruments. Diversification of income sources is a well documented ex ante

risk transfer strategy in rural areas (e.g. Rosenzweig and Stark, 1989; Brouwer et al. 2007).

Brouwer et al. (2007) showed that households with higher number of non-nature dependent

income sources were better able to cope with flood damage. Therefore, it can be expected that

farmers with larger number of non-nature dependent income sources would be less likely to

purchase crop insurance.

Access to post disaster credit facility, ex post disaster relief2 and savings are common ex post

hazard coping strategies in developing economies. The relationship between ex post hazard relief

and hazard insurance is fairly straightforward and well documented in the natural hazard

literature, i.e. the provision of ex post disaster relief reduces incentives to buy private insurance

2
Ex-post hazard relief refers to distribution of food, drinking water, clothing and medical assistance by government
and non-government organizations during and after the natural hazard.

14
contracts against natural disasters (Kunreuther, 2006; Raschky, 2007). Savings and insurance

demand are expected to be positively related simply because households with savings are less

cash constrained and hence are able to pay insurance premium. The relationship between access

to ex post credit facilities and hazard insurance has not been investigated before. On one hand,

access to post disaster credit facilities is considered an ex post disaster coping mechanism and an

implicit insurance scheme (Brouwer et al., 2007). Hence, the relationship between post disaster

credit and flood-crop-insurance is expected to be negative implying that the existence of one

reduces the desirability for the other. On the other hand, there is widespread evidence that

suggests microcredit in general enhances households income generation activities (Khadaker et

al., 1998; Khadaker, 2005) and thus increases their affordability to purchase insurance. This

implies that access to credit facilities may in general induce the demand for microinsurance.

The statistical model through which we aim to test the hypotheses takes the following form:

(1)

WTPi (Crop Insurance) = 0 + 1 Wealth i + 2 Crop Damagei + 3 Flood Frequencyi + 4 River Distance
+ 5 Embankment + 6 Relief i + 7 Credit i + 8 Income Sources i + 9 Demographic Characteristics i + e i

The summary statistics of the explanatory variables used in the statistical model are presented in

Table 2.

INSERT TABLE 2 HERE

5. EMPIRICAL RESULTS

5.1. WTP for Crop Insurance

Table 3 summarizes farmers responses to the DB WTP questions. For each respondent, let Bid0

denote the start bid, Bidl denote the follow-up lower bid (in the case where they rejected the start

bid) and Bid2 denote the follow-up higher bid (in the case where they accepted the start bid),

15
where Bidl < Bid0 < Bid2 for each individual. The interval for the WTP for each respondent was

generated as shown in Table 3 WTPL and WTPH denote the lower and upper bounds of the WTP

respectively and WTP* is the latent WTP.

INSERT TABLE 3 HERE

Over half of the sampled farmers (59%) said Yes to both bid levels while about a quarter (24%)

of the farmers rejected the first bid but accepted the lower bid level. Eight percent of the sample

farmers said No to both bid level and the rest accepted the first bid but rejected the higher bid.

The referendum CV program (GAUSS) written by Cooper (1999) was used to estimate mean

WTP for crop insurance and its 95 percent confidence interval. The mean WTP for crop

insurance was estimated at BDT 42 (US$0.6) per household per week. This amounts to

approximately 15 percent of the average weekly income of the sample farm households. Krinsky

and Robb confidence interval of the mean WTP value was generated by applying Monte Carlo

simulation technique as adapted by Park et al (1991). The 95 percent confidence interval of mean

WTP for crop insurance is BDT 40- BDT 44.

5.2. Determinants of WTP

Next we estimated a series of regression models to identify the determinants of farmers WTP

for crop insurance. The interval (or grouped data) regression approach, similar to an ordered

probit model, was applied to analyze the data. The interval regression approach is applicable

when the dependent variable is limited to a certain number of categories, but the ranges of the

16
underlying variable to which each category refers to are known (Wooldridge, 2007).

Theoretically, an interval regression approach is more efficient than an ordered probit approach

to model this later type of variable since the estimation procedure utilizes information provided

by the thresholds values to produce an estimate of the standard deviation rather than requiring

that this be normalized to one (Horowitz, 1994). Note that an alternate estimation could be to use

the Ordinary Least Squares (OLS) regression with the average of the lower and upper bounds of

the WTP as the dependent variable. However, this analysis would neither reflect the uncertainty

concerning the nature of the exact values within each interval, nor would it deal adequately with

the left- and right-censoring issues in the tails.

Table 4 presents the results from five different model specifications. The models differed

because four different independent variables to control for credit market characteristics were

used3. All of the estimated models turned out to be significant at the one percent level as

measured through the likelihood ratio test, which implies that the estimated parameters in each

model were significantly different from zero (i.e. the model with a constant term only).

INSERT TABLE 4 HERE

In all regression models presented in Table 4, wealth and crop damage are statistically significant

determinants of WTP at the five and 10 percent level respectively. Note that the results shown

report the marginal effects of the explanatory variables on the dependent variable evaluated the

means of the independent variables. Therefore, the estimated coefficient for wealth varying

between 0.05 and 0.06 in Models 1 and 5 can be interpreted as: an yearly increase in an

3
Due to high positive correlation among the variables constructed to control for credit market characteristics, it was
not possible to use them simultaneously in one model.

17
individuals wealth in thousand BDT leads to an average increase in the WTP for crop insurance

by BDT 0.05 to BDT 0.06 per week from its mean value of BDT 42 per week, holding all other

explanatory variables constant at their mean values. Likewise, the estimated coefficient of (ln of)

crop damage varies from 1.2 to 1.5 in Models 1 and 5 implying that a one percent increase in

crop damage per hazardous incident leads to an average increase in the WTP for crop insurance

by BDT 1.2 to BDT 1.5 per week.

Flood frequency, measured through households perceptions of the frequency of flooding in

future, an indicator of exogenous risk exposure level, as expected, has significant negative

impact on the WTP for crop insurance4 in Models 1 and 5. This implies that the higher the

number of years it took for a natural disaster to recur, other things remaining the same, the lower

the WTP for crop insurance. If flood was expected to recur an additional year later, the mean

WTP fell by BDT 1.32 per week. The mean coefficient of River Distance, an indicator of

endogenous risk exposure level, is negative and statistically significant at less than 10 and five

percent levels in all estimated regression models presented in Table 4. This suggests that the

further away the household lived from the main river, other things remaining the same, the lower

the WTP for crop insurance. More specifically, for an increment of one kilometer distance to the

household from the main river, mean WTP for crop insurance decreased by BDT 0.54 to BDT

0.60 per week.

The mean value of the coefficient of embankment, another indicator of exogenous risk exposure

level, is positive and statistically significant at less than one percent level in Models 1 to 5. The

4
Note that the objective probability of flooding, measured through the frequency of flooding in the past, were used
as an alternative indicator of exogenous risk exposure level. No statistically significant influence of this variable was
determined on farmers WTP for crop insurance.

18
magnitude of the coefficient varied between 9 to 10 implying that respondents, who lived inside

a protected area, on average and other things remaining the same, were willing to pay additional

BDT 9 to BDT 10 per week to purchase crop insurance. This finding is consistent with the higher

crop damage costs reported by the farmers located within the flood protection embankment.

Of particular interest to this study is the relationship between access to post disaster credit

facility and crop insurance demand. The influence of access to credit on farmers WTP for crop

insurance was tested by controlling for the institutional characteristics of the rural credit market

and the degree of accessibility to the credit sources. In Model 1, the mean coefficients of Credit,

reflecting farmers access to formal or informal or both sources of credit to mitigate flood

damage costs incurred during the 2004 flood year, was negative and statistically significant at

less than one percent level. This implies that, on average and other things remaining the same,

farmers who accessed post disaster microcredit (either only formal, only informal or both formal

and informal) were willing to pay BDT 6 to BDT 8 less to purchase crop insurance than farmers

who did not access post flood credit facilities.

In Model 2, the variable Formal Credit refers to farmers access to formal credit institutions only.

The mean coefficient of the variable is negative and statistically significant at less than ten

percent level. Likewise, the variable Informal Credit, reflecting farmers access to the informal

sources of microcredit, in Model 3 is negative and statistically significant at less than ten percent

level. These results imply that the institutional characteristics of the rural credit market do not

play any role in determining the relationship between post disaster credit and farmers WTP for

flood-crop-insurance. Finally, the variable Credit Sources in Model 4 measures the number of

19
credit sources farmers accessed during the 2004 flood event. The mean coefficient of the variable

is negative and statistically significant at the one percent level implying that the higher the

number of sources farmers accessed, the lower the WTP for crop insurance.

The mean coefficient of Savings is positive and statistically significant at the five percent level

implying farmers who used their savings to cope with the flood damage of 2004 were willing to

pay more to purchase crop insurance. The coefficient of the variable Income Sources reflecting

the number of non-nature dependent income sources per farm household is negative in Models 1

to 4 but statistically significant at the ten percent level only in Model 2. This variable was used

as an indicator of farmers ex ante preparedness to cope with natural disaster losses. The negative

sign of the variable was expected. This suggests that farmers with higher number of non-nature

dependent income sources were willing to pay less for crop insurance. The variable Relief

measures farmers access to ex post disaster relief assistance. This variable was used as an

indicator of alternative ex post flood damage coping mechanism. Although the mean values of

the coefficient have the expected negative sign in Models 1 to 5 implying that farmers who

received post disaster relief assistance were willing to pay less for crop insurance, the coefficient

is not statistically significant at the ten percent level. Note that only eight percent of the farmers

claimed to have received any form of flood relief, which could a reason for the effect of variable

not being statistically significant.

Farmers familiarity with the concept of insurance or their education and other demographic

variables for example age, family size were not significant determinants of WTP for crop

insurance.

20
 DISCUSSION AND CONCLUSION

The main objective of this study was to empirically examine the influence of post disaster credit

availability on crop insurance take-up rate in a flood prone developing country. This relationship

is important in the context of the growing optimism in microinsurance solution to protect poor

households from weather related livelihood shocks and the recent trend of offering bundled

insurance contracts by microfinance institutions to increase insurance take-up rate.

We examined the relationship between post disaster credit and farmers willingness to pay for a

hypothetical crop insurance contract by exploiting household data that was primarily collected to

carry out a commercial viability test of a potential micro-flood-insurance market in rural

Bangladesh. Our results suggest that there existed a negative relationship between post disaster

credit market access and farmers willingness to pay for crop insurance. Farmers who accessed

either formal or informal or both credit sources during the 2004 flood event were willing to pay

less for crop insurance. Conversely, a negative relationship was observed between farmers

access to their savings and micro-crop-insurance demand. Those farmers who used their savings

to mitigate crop damage during the flood year of 2004 were willing to pay more to purchase crop

insurance.

We also found a positive relationship between environmental risk (both exogenous and

endogenous) and crop insurance demand. Farmers, who anticipated a higher flood return period

in future, experienced lower crop damage and who were located further away from the main

river were willing to pay less for crop insurance. Household wealth was positively related to crop

21
insurance demand, suggesting that financially well-off farmers were more likely to take

protective actions against natural disaster losses than less well off farmers.

These findings have important implications for the future of weather related microinsurance

products in developing countries. First, our results show that farmers with smaller farmland,

lower agricultural income and smaller number of non-nature dependent income sources are more

dependent on ex post credit facility to cope with climatic risks and hence are less willing to

purchase crop insurance. A compulsory microinsurance contract bundled with microcredit loan is

likely to adversely affect these group of farmers who are already more vulnerable to weather

induced income shocks. They are likely to be averse to compulsory insurance contracts simply

because they have low financial ability to purchase an insurance contract. Bundled insurance

contract, therefore, may work as an impediment to participation for poor farmers to the formal

credit market, thereby increasing their reliability to informal credit institutions that generally

charge higher interest rates.

Second, the results of our study show that relatively wealthier farmers with larger agricultural

land and higher agricultural income are more likely to rely on savings to cope with post disaster

damage. This particular group of farmers was also found to be more inclined to purchase micro-

crop-insurance. These results imply that insurance products bundled with savings schemes are

more likely to increase insurance take-up than those bundled with microcredit loans.

22
Finally, the results presented in the study provide guideline in terms of the potential geographical

outreach of a prospective insurance program. Households who lived closer to the main river and

who experienced more frequent natural hazard events were willing to pay more for crop

insurance. This implies that the demand for crop insurance is likely to be greatest where the

exogenous environmental risk exposure levels are the highest. Therefore, targeting these regions

that are exposed to high exogenous environmental risks for setting up of a crop insurance market

is likely to increase the probability of insurance take-up. However, note that a higher exogenous

hazard risk may potentially make risk sharing through the apparatus of insurance impractical as

environmental risks, after a certain level, may simply not be insurable. Therefore, it is imperative

to undertake commercial viability study before making any physical investments to facilitate the

setting up of an insurance market in a particular region.

23
Reference list

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market for crop insurance in rural Bangladesh?. Mitigation and Adaptation Strategies of

Global Change 14:215-229.

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Interval-data Models, Journal of Environmental Economics and Management 29:169-180.

Bangladesh Bureau of Statistics (BBS). (2005a). Statistical pocketbook of Bangladesh 2003,

Dhaka.

Bangladesh Bureau of Statistics (BBS). (2005b). Household income and expenditure survey

2005, http://www.bbs.gov.bd/dataindex/hies_2005.pdf

Botzen, W.J.W. and van den Bergh, J.C.J.M. (2008). Insurance against climate change and

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Brouwer, R., Akter, S., Brander, L. & Haque, E. (2007). Socio-economic vulnerability and

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Gine, X., Townsend, R. & Vickery, J. (2008). Patterns of rainfall insurance participations in

rural India. The World Bank Economic Review 22(3):539-566.

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35 (2):96 124.

Khandker, S. R. (2005). Microfinance and Poverty: Evidence Using Panel Data from

Bangladesh. The World Bank Economic Review 19(2):263-286.

Mechler, R. et al. (2006). Disaster insurance for the Poor? A review of Microinsurance for

Natural Disaster Risks in Developing Countries. ProVention/IIASA, Geneva.

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National Adaptation Program of Action. Final Report.

Rosenzweig, M. & Stark, O. (1989). Consumption Smoothing, Migration and Marriage:

Evidence form Rural India. Journal of Political Economy 97(4):905-926.

Shogren, J. & Thomas, C. (1991). Risk, Self-protection and Ex Ante Economic Valuation.

Journal of Environmental Economics and Management 20:1-15.

Smith, V. K. (1992). Environmental risk perception and valuation: conventional versus

prospective reference theory. In D.W. Bromley & K. Segerson (Eds.), The Social Response to

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25
Figure 1 Geographical location of the case study area.

26
Table 1 Summary statistics of respondent (household) demographic and socio-economic
characteristics.

Respondent (household) characteristic Sample National

average
(for rural areas)
Male headed household (%) 98 90
Respondent average age (median value) 46 (45) 42
Literacy rate respondent (%) Illiterate 45 60.95
Primary school 24
High school 13
6.2 (1-26) 5.19
Average number of family members
(min-max)
Average household income (US$/year) 1750 (1833) 1044
(st. dev.)
Median household income (US$/year) 1176
Average per capita income (US$/month) 23 (34.4) 14
(st. dev.)
Median per capita income (US$/month) 17

Households owning agricultural land (%) 97 65.60a

Average size land owned by household 1
(ha)
Average crop damage per household per 509 (624)
hazard event (US$) (SD)

a. National statistics considers farmers owning less than 0.5 hectare firm land as landless.

Source national statistics: BBS (2005)

27
Table 2 Descriptive statistics of the explanatory variables used in the regression model.

Variable Name Variable Description Mean SD

Flood Frequency Expected return period of flood in 5 1.80
future (in years)
River Distance Distance of the main river from 3 3.10
households (in km)
Crop Damage Crop damage during the 2004 flood 10 2.20
event (in thousand BDT)
Income Sources Number of non-nature dependent 0.3 0.56
income sources per household
Relief (0,1) Households have access to post disaster 0.08 0.30
relief (1=Yes, 0=Otherwise)
Wealth Value of the assets owned by each 72 79
household at the time of the survey (in
thousand BDT)
Credit (0,1) Households borrowed money from 0.6 0.50
either formal or informal or both credit
sources to mitigate the damage incurred
during 2004 flood (1=Yes,
0=Otherwise)
Formal Credit Households borrowed money from 0.15 0.36
(0,1) formal credit sources to mitigate the
damage incurred during 2004 flood
(1=Yes, 0=Otherwise)
Informal Credit Households borrowed money from 0.49 0.50
(0,1) informal credit sources to mitigate the
damage incurred during 2004 flood
(1=Yes, 0=Otherwise)
Credit Sources The number of credit sources accessed 0.69 0.69
by the household to mitigate the
damage incurred during 2004 flood
Savings Households used savings to mitigate the 0.78 0.41
damage incurred during 2004 flood
(1=Yes, 0=Otherwise)

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Table 3 Summary of WTP responses

Category WTPL WTPH WTP category % of

respondents
Rejected both bids 0 Bidl 1 8

Rejected start bid but Bidl Bid0 2 24

accepted follow up bid
Accepted start bid but Bid0 Bid2 3 9
rejected follow up bid
Accepted both bids Bid2 4 59

29
Table 4 Results of interval regression

Variables Model 1 Model 2 Model 3 Model 4 Model 5

Wealth 0.05** 0.06*** 0.06** 0.05** 0.06**
(0.02) (0.02) (0.02) (0.02) (0.02)
Ln Crop Damage 1.45*** 1.51*** 1.42*** 1.28*** 1.39***
(0.34) (0.34) (0.34) (0.34) (0.36)
Flood Frequency -1.32* -1.0 -1.23 -1.40* -0.98
(0.749) (0.76) (0.76) (0.75) (0.77)
River Distance -0.54* -0.60** -0.55** -0.58** -0.56**
(0.28) (0.28) (0.28) (0.27) (0.28)
Embankment 10.22*** 9.14*** 9.92*** 9.46*** 9.16***
(2.57) (2.56) (2.60) (2.57) (2.62)
Credit -8.05*** Z

Z
(2.18)
Formal Credit Z -6.06*** Z Z Z
(2.26)
Informal Credit Z Z -7.54***
Z
(1.98)
Credit sources Z Z Z -7.08*** Z
(1.4)
Savings Z Z Z Z 4.802**
(2.19)
Income Sources -3.0 -3.31* -2.52 -2.40 -2.71
(1.9) (1.9) (1.9) (1.9) (2.0)
Relief -2.58 -2.80 -3.0 -1.87 -2.33
(3.0) (3.1) (3.0) (3.0) (3.23)
Familiarity -0.61 -0.06 -0.10 -0.43 -0.24
(2.73) (2.75) (2.75) (2.68) (2.76)
Education 0.61 0.56 0.63 0.35 0.52
(2.41) (2.41) (2.38) (2.37) (0.24)
Constant 38.68*** 32.31*** 36.58*** 41.09*** 28.85***
(5.51) (5.11) (5.37) (5.40) (5.103)
Observations 564 564 564 564 564

Standard errors in parentheses

*** p<0.01, ** p<0.05, * p<0.1

30