Strengthening Local Credit Markets Through Lender‐Level Index Insurance

Benjamin Collier

Journal of Risk & Insurance, 2020, vol. 87, issue 2, 319-349

Abstract: This article considers lender‐level index insurance as a means of expanding access to credit in disaster‐prone communities. In this approach, the lender transfers the disaster risk of loans in its portfolio by contracting on an observable measure of the catastrophe. I develop and calibrate a dynamic, stochastic model using data from a community lender in Peru that is vulnerable to El Niño–related flooding. The modeled lender can insure against El Niño using an index‐based product that is available for purchase by financial intermediaries in Peru. I examine how premium rates, basis risk, and background risk may influence the lender's insurance decision and credit supply. Overall, the results suggest that lender‐level index insurance holds promise for reducing disaster‐related credit supply shocks and expanding credit access in vulnerable communities.

Date: 2020
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