Actuarially Equivalent Cash Promises as Control Design
RCTClinical Trial
Providing free insurance policies in field experiments introduces a potential positive wealth effect equal to the expected value of the policy, threatening to confound state-contingent risk-hedging behavior with simple income-expansion effects.
Picture this
To test if a specialized raincoat makes someone walk in the rain because it keeps them dry versus simply making them feel richer because they received a $20 gift, you give half the group the raincoat and the other half a $20 cash promise delivered at the exact same time.
What the evidence says
Methodological isolation ensured that observed increases in cash crop allocation (6 percentage point increase in probability, p = 0.041) [7] were strictly attributable to state-contingent risk transfer rather than income/wealth expansion [5, 6].
- Who was studied
- N = 1,479 agricultural firms in Andhra Pradesh, India.
- How
- Randomized Controlled Trial (RCT) where the treatment group received 10 rainfall index insurance policies (~Rs. 1,000 market value) and the control group received an actuarially equivalent cash promise (~Rs. 350) scheduled for delivery on the exact same payout timeline [5, 6].
What to do
Incorporate actuarially equivalent cash promise arms in randomized insurance trials to isolate true state-contingent risk management effects from unconfounded wealth transfers [5, 6, 8].
From the source
"The control group was instead promised a fixed cash payment equal to an estimate of the actuarial value of the insurance policy (Rs. 350, or around $8 US) to be paid at the same time as insurance payouts. We then study differences in subsequent production decisions during the monsoon between these two groups." [5]
How Does Risk Management Influence Production Decisions? Evidence from a Field Experiment