Literacy and the quality of index insurance decisions

Abstract

There is widespread concern in developing countries with the expansion of formal insurance products to help manage significant risks. These concerns arise primarily from a lack of understanding of insurance products, general failures of financial literacy and the need to use relatively exotic products in order to keep costs down for poor households. We investigate the importance of incentivized measures for general understanding, as well as domain-specific knowledge of the decision context on the purchase and the quality of index insurance decisions. We evaluate the quality of financial decisions by comparing the individual expected welfare outcomes of a number of decisions each individual makes to purchase index insurance or not. We find that excess purchase is an important driver of welfare losses, and that our incentivized measure of domain-specific literacy plays a critical role in bringing about better quality index insurance decisions.