The Effect of Index Insurance on Returns to Farm Inputs: Exploring Alternatives to Zambia's Fertilizer Subsidy Program

A significant volume of research has investigated input subsidy programs in Africa, where government expenditures on such programs are non-trivial. This paper uses panel data from a sample of farm households in Zambia to compare how fertilizer use decisions change in the presence of a formal insurance market. If returns to fertilizer improve under an insurance regime, the use of index insurance can be an alternative to or complement of existing input subsidy programs in the country. After estimating the cost of a simple zero-one, actuarially fair index insurance product that is mandatory for farmers who purchase fertilizer, we run simulations to explore the effect of insurance on household investment in fertilizer. Results show that index insurance, by reducing the disposable wealth of households in years where no payouts occur, can dampen demand for fertilizer at the farm level.