How Basis Risk and Spatiotemporal Adverse Selection Influence Demand for Index Insurance: Evidence from Northern Kenya

Basis risk – the remaining risk that an insured individual faces – is widely acknowledged as the Achilles Heel of index insurance, but to date there has been no direct study of its role in determining demand for index insurance. Further, spatiotemporal variation leaves open the possibility of adverse selection. We use rich longitudinal household data from northern Kenya to determine which factors affect demand for index based livestock insurance (IBLI). We find that both price and the non-price factors studied previously are indeed important, but that basis risk and spatiotemporal adverse selection play a major role in demand for IBLI.