Abstract

Index-based insurance can have welfare-enhancing effects through two pathways: by inducing policyholders to change their investment and risk-management decisions or by mitigating weather-related shocks through payouts. Most studies fail to distinguish between these two; thus, we know little about which effects dominate and their long-term welfare implications. This study uses a random distribution of discount coupons and drought events that trigger payouts as exogenous variations in order to identify both the ex ante risk-management and ex post payout effects of index-based livestock insurance in a pastoral-dominant society of northern Kenya, where the literature has detected asset-based poverty traps, represented by bifurcated herd-size dynamics. We find that, first, both risk-management and payout effects help reduce the probability of distress sales of livestock. Second, payout effects also reduce the slaughter of livestock. Finally, while payout effects remain robust for the sub-sample of poorer households below the poverty-trap threshold, statistically significant risk-management effects on reduced livestock sales disappear for them. Overall, our results suggest that insurance payouts can help the poor escape poverty traps, while the impact of behavioural changes accompanied by insurance purchases is more subtle in our settings.