Strategic competition in informal risk sharing mechanism versus collective index insurance

TL;DR

This paper models the competition between formal index insurance, informal risk sharing, and non-insurance using an evolutionary game, revealing how risk factors influence insurance adoption and market dynamics.

Contribution

It introduces a three-strategy evolutionary game model to analyze the competitive interactions between index insurance, informal sharing, and non-insurance, incorporating profit calculation methods.

Findings

Index insurance popularity increases with low basis risk and high loss ratios.

Informal risk sharing is favored when loss ratios are moderate.

Low loss ratios lead to individuals avoiding insurance altogether.

Abstract

The frequent occurrence of natural disasters has posed significant challenges to society, necessitating the urgent development of effective risk management strategies. From the early informal community-based risk sharing mechanisms to modern formal index insurance products, risk management tools have continuously evolved. Although index insurance provides an effective risk transfer mechanism in theory, it still faces the problems of basis risk and pricing in practice. At the same time, in the presence of informal community risk sharing mechanisms, the competitiveness of index insurance deserves further investigation. Here we propose a three-strategy evolutionary game model, which simultaneously examines the competitive relationship between formal index insurance purchasing (I), informal risk sharing strategies (S), and complete non-insurance (A). Furthermore, we introduce a method for calculating insurance company profits to aid in the optimal pricing of index insurance products. We find that basis risk and risk loss ratio have significant impacts on insurance adoption rate. Under scenarios with low basis risk and high loss ratios, index insurance is more popular; meanwhile, when the loss ratio is moderate, an informal risk sharing strategy is the preferred option. Conversely, when the loss ratio is low, individuals tend to forego any insurance. Furthermore, accurately assessing the degree of risk aversion and determining the appropriate ratio of risk sharing are crucial for predicting the future market sales of index insurance.