More than 3 million households in northern Kenya’s arid and semi arid lands depend primarily on livestock as their main livelihood. The risk of drought renders these pastoral-ist households vulnerable to large herd mortality shocks, and thereby large income shocks as well. Index-based insurance products over great promise for managing climate related risks that vulnerable households face. This project proposes a theoretical dynamic demand analysis of the index based livestock insurance (IBLI) pilot in Marsabit district of northern Kenya. We use dynamic programming techniques to generate an option value measure of welfare gains attributable to IBLI for individuals with various levels of herd size. In particular, we analyze how insurance inuences dynamically optimal behavior near a poverty threshold. Similar to other studies, we nd that households with asset levels below a critical asset threshold may not choose to purchase insurance. However, unlike previous studies, we show that the very presence of a formal insurance market actually encourages greater investment by trapped households, which may result in decreased poverty levels over time.
