We present results of experimental games with smallholder farmers in Tigray, Ethiopia, in 2010, in which participants in the games allocated money across risk management options. One of the options was index insurance that was the same as commercial products sold locally. Participants exhibited clear preferences for insurance contracts with higher frequency payouts and for insurance over other risk management options, including high interest savings. The preference for higher frequency payouts is mirrored in commercial sales of the product, with commercial purchasers paying substantially higher premiums than the minimal, low frequency option available. This combined evidence challenges claims that the very poor universally choose minimal index insurance coverage and supports concerns that demand may outpace supply of responsible insurance products.

This paper proposes a framework for ex ante evaluation of sovereign disaster risk finance instruments available to governments for funding disaster losses. The framework can be used by governments to help choose between different financial instruments, or between different combinations of instruments, to achieve appropriate and financially efficient strategies to fund disaster losses. In doing so, the framework takes into account the risk of disasters, economic conditions and political constraints. The paper discusses the framework in the context of a hypothetical country, with parameters selected to represent a disaster-prone small island state. The paper shows how a mix of instruments can be chosen to minimise the economic opportunity cost given the underlying disaster risk faced and prevailing economic and financial conditions.

Index triggers have enabled the extension of insurance to a wide range of risks, by providing a simple mechanism to determine payment. However, the resulting coverage generates basis risk, the variability over time in the level of insurance payouts relative to the level of losses. We analyze basis risk to rank binary and multivalue indices for any risk-averse individual. Our ranking provides methods to select an index that is optimal for a heterogeneous group and illustrates that higher correlation between loss and index, does not necessarily equate to a better index. 1 861 861Vol. 86, No. 4, 861-885 (2019).

Safety net assistance and insurance exist to manage risk and improve welfare. This shared goal may lead to crowding out. In a new approach, this paper analyzes the interaction of assistance with two dimensions of insurance design: level of coverage and types of risks covered. In a society of risk averse vulnerable individuals and risk neutral assistance providers, Pareto improvements in welfare are achieved through incompleteness in the types of risks covered. The results imply that safety nets promote demand for and the emergence of incomplete insurance. These results have a wide application to insurance markets where safety nets are available, including health care, disaster aid and social welfare.

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