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Abstract

Previous literature suggests that weather based index insurance has the potential to greatly benefit poor rural households that are exposed to significant sources of systemic risk. This study proposes a simple model of how providing index insurance may reduce moral hazard problems inherent in microfinance contracts. Through increasing the value of the dynamic incentive of repayment, the model demonstrates that providing index insurance can increase endogenous effort choice, particularly for joint liability loans, provided that insurance premiums are sufficiently low.

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