Paying Premiums with the Insurer’s Money: How Loss Aversion Drives Dynamic Insurance Decisions

This paper anlyzes the dynamic nature of rainfall insurance purchasing decisions, specifically looking at whether and why receiving an insurance payout induces a greater chance of purchasing insurance again the next year. Using customer data from the Indian micro-finance institution BASIX, I find that receiving an insurance payout is associated with a 9-22% increased probability of purchasing insurance the following year. These empirical results are consistent with the predictions of a loss aversion model where receiving insurance payouts shifts a customer’s reference point, resulting in higher risk aversion and therefore greater demand for insurance. I do not find significant support for other potential mechanisms, such as previous weather directly affecting insurance decisions or payouts increasing trust in the insurance companies. Overall, low repurchasing rates even after payouts suggest that current rainfall index insurance products are likely to continue struggling in their current form.