Do the poor insure? A synthesis of the literature on risk and consumption in developing countries

How well do rural households in developing countries mitigate the income risk of the rural sector? There are several sensible reasons why households cannot fully insure consumption against income fluctuations. The well-known problems of moral hazard, information asymmetries, and deficient ability to enforce contracts may result in no or incomplete insurance markets - and certainly there is a dearth of formal insurance markets in developing countries. Yet the literature indicates that these households do mitigate risk. Alderman and Paxson survey the literature on strategies for insuring consumption against fluctuating income and examine evidence on how effective these strategies are. Strategies for risk management include crop and field diversification; a portfolio of occupations; and the strategic migration of family members. Strategies for coping with risk include those that smooth consumption over time (through saving behavior, including borrowing and lending in formal and informal markets, accumulating and selling assets, and storing goods for future consumption) and those that smooth consumption across households (through risk sharing). Alderman and Paxson focus on, and discuss the relative effectiveness, of different risk-sharing arrangements. Risk sharing arrangements may be through formal institutions (such as insurance and futures markets, and forward contracts for harvests) and informal mechanisms (including state-contingent transfers and remittances between friends and neighbors). A number of institutions may offer"disguised"insurance . For example, share tenancy, credit contracts with state-contingent repayments, and long-term labor contracts may each contain an insurance component, although none are explicitly insurance contracts. Alderman and Paxson examine the literature on these strategies. The few pieces of evidence available suggest that the effect of risk on production and investment decisions depends on how well households can cope with income risk. Poorer households, in particular, appear to forgo potential earnings to reduce risk. As such, there is a convergence of efficiency and equity issues.