Is Consumption Insured against Illness? Evidence on Vulnerability of Households to Health Shocks in Rural Ethiopia

Low and volatile incomes and absence of well-developed financial markets make consumption smoothing an important issue in low-income countries. Based on the theory of full insurance and using 2 years of panel data, this study examines the impact of illness on the consumption of rural households and the capacity of existing risk-sharing mechanisms in insuring consumption against health shocks in the rural areas of Ethiopia. The results show that illness has a statistically significant negative impact on the stability of consumption and the capacity of households or existing intra- and interhousehold risk-sharing arrangements in insuring consumption against illness varies across different consumption items. The regression results show that the hypothesis of consumption insurance cannot be rejected in the case of total food consumption, implying that basic items that come from own production and from external sources (gifts) are better insured and insensitive to the illness of the head. However, the implication of risk sharing is rejected in the case of nonfood consumption items. The restriction test results reveal that the movement of the household head from a healthy to an unhealthy status would lower the growth rate of quarterly nonfood consumption items of the household by more than 24 percentage points. This clearly demonstrates that there would be a significant amount of welfare gain if existing endogenous risk sharing arrangements can be strengthened or some kind of community health insurance scheme can be introduced in the rural areas of Ethiopia.