The Impact of Microinsurance on Consumption Smoothing and Asset Protection: Evidence from a Drought in Kenya

When natural disasters strike in developing countries, households are often forced to choose between preserving assets or consumption: either can result in permanent consequences. In this paper we ask: can insurance transfer risk in a way that reduces the need for households to rely on costly coping strategies that undermine their future productivity? Since 2010, pastoralists in northern Kenya have had access to a novel index-based drought insurance product. We analyze the impact of a drought-induced insurance payout on consumption smoothing and asset protection in this setting. Our results show that insured households are on average 36 percentage points less likely to anticipate drawing down assets, and 25 percentage points less likely to anticipate reducing meals upon receipt of a payout. Empirical evidence of a poverty trap in this setting suggests that these average impacts may mask a heterogeneous behavioral response and subsequent heterogeneous impacts of insurance. For this reason we use Hansen's (2000) threshold estimator to estimate a critical asset threshold around which optimal coping strategies bifurcate. Using this approach we find that that households holding assets above a critical asset threshold, who are also most likely to sell assets, are 64 percentage points less likely to anticipate doing so when an insurance payout is available. Households holding assets below the estimated threshold, who are likely to destabilize consumption, are 43 percentage points less likely to anticipate doing so with insurance. Together, these results suggest that insurance can help households to protect assets during crises, without having the deleterious effect on human capital investments.