Proceedings of the 19th IAHR-APD Congress 2014, Hanoi, Vietnam

ISBN 978604821338-1

Self-protection and information sufciency in flood risk sharing network

M.SC.KHIEM.DAO VAN(1),C, HUNG.NGUYEN MANH(2), KHIEM.TRAN VAN(3)

(1)
Water Resources University, Hanoi, Vietnam, Email: bicon97@gmail.com
(2)
Toulouse School of Economics , Toulouse. France. E-mail: mhnguyen@toulouse.inra.fr
(3)
Hydraulic Construction Institute Vietnam Academy for Water Resources, Hanoi, Vietnam, E-mail: trankhiem46@gmail.com

ABSTRACT

This paper investigates the existence and the eciency of a ood risk sharing network in rural Vietnam. We develop a
model where the probability of loss is a subjective risk perception function based on risk information and self-protective
costs. We study the interaction of informal insurance with limited commitment through risk communication inuencing
on households decisions and behaviors where risk information be treated as the public good in a risk sharing network.

Keywords: Self-protection, self-insurance.

1. INTRODUCTION self-protection is nowadays dened as signicant

Vietnam has been identied as one of the fth worst
aected countries by climate change (WorldBank 2005)
and ranked the seventh most exposed country in the
world to natural disasters. Within natural disasters, ood
is the single most important cause of damage, accounting
for 49 percent of the total economic losses. According to
the Vietnamese Central Committee for Flood and Storm
Control, natural disasters have resulted over the past 20
years, on average each year, in 650 deaths, in damage on
340,000 ha of paddy (rice) and in a total destruction of
36,000 houses.The social cost of oods is especially high
due to the uneven repartition of the population over the
territory. In Vietnam, most of the population (70%) lives
in coastal areas, the majority being located in the Red
River Delta in the north and in the Mekong Delta in the
south, (World Bank, 2011). The population along the
coast is then particularly vulnerable to typhoons and
oods since people usually live only a few meters above
the sea level (Mai, Stive, and VanGelder 2009).
Vietnamese people living in mountain areas (30%) are
also vulnerable to ood disasters. Due to the steepness of
the land, river beds are easily lled by the monsoon rains
and thus frequently lead to ash oods. This explains
why oods have also resulted in a substantial number of
deaths and injuries in mountainous areas. Due to the high
frequency of weather events, disaster management has a
long institutional tradition within the country.
Nowadays, both structural (dikes,
seadikes,channelization) and non-structural strategies
(oodplain management, ood and disaster warning
systems,education, and preparedness programs) are
implemented in Vietnam, at central or local levels
(Pilarczyk and Nuoi 2005). Even if there has been recently
a noticeable change in the ood control and management
practices from mainly large-scale structural or
engineering measures to non-structural measures,
population preparedness to ood is still limited
especially in mountainous areas of Vietnam. Households
measures to keep people more stably protected from
adverse consequences of ood. Although ooding poses
a serious damage to the Vietnam, people are not very
inclined to engage in self-protective behaviors. Current
ooding risk information tries to enhance these self-
protective behaviors among citizens, but is nonetheless
not very successful. Moreover, while the formal
insurance mechanisms of ooding are hardly accessed,
people in low-income rural communities often mitigate
risk by making insurance arrangements among
themselves. Therefore, the main purpose of this research
is theoretically determining the factors such as ood risk
information and informal insurance that might enhance
or lessen the intention to engage in self-protection among
citizens in Vietnam.
2. THE MODEL
We develop a model where the probability of loss is a
subjective risk perception function based on risk
information and self-protective eorts. The model
includes household income, level of self-protective
measures and expenditures, risk perceived information,
prices and quantities of protective behavior along with
levels of ood risk attributes. The model also studies the
interaction of informal insurance with limited
commitment through risk communication inuencing on
households decisions and behaviors in a network where
risk information be treated as the public good supply.
The empirical implementation of the conceptual
framework requires intensive data collection eorts. A
number of attributes as ood risk perceptions and self-
protective measures have been collected from a survey
conducted in Nghean in Spring 2012.
Consider a representative household who faces a damage
of ood risk and the loss magnitude is denoted by L.
When we study self-protections eect to the probability
of loss, L is assumed to be exogenous.
1
 i)Cost of self-protection
If household does not take protective actions, the
n
probability loss is p . If she takes self-protection, she has
a choice set of dierent self-protective actions, indexed by
{ A1 ,..., AJ } 1: At state Aj ; when household invest in self-
protection with the cost c j ; the probability of loss is
p j (c j ) where 0 c j L : For an amount of total investment
C; the household can choose a subset of K { 1,..., J} to
can be offered to her 3. At the moment, we assume that
information is costless. More investigation will come in
the next section where information is costly to
households.
Let denote the reward a be an increasing concave
function of I and a ( I ) L and p = p(C , I ) . When cost is
zero and risk information is only valuable to ones taking
protection, we have p(0, I ) = p . Because protective
n

apply protective measures, the nal probability of loss actions may lower likelihood of loss, p(C , I ) is non-
will be increasing to both arguments.
p(C ) = p( A1 ... AJ ) = ( -1) J [p( A1 ... AJ )
We introduce two forms of P. In reality, discrete
J
[1] investments in protective measures often obtained from
-p( A j ) + p( Ai A j ) - p( A A i j Ak ) + ...]
j=1 1 j < i < k J 1 j < i J empirical data but not be usually used in theoretical
Where jK
c j C . models in the literature due to the difficult of
discontinuities.
Remark: In the case of independent probability of actions,
Assumption 1. (Discrete values) The probability of loss is
p(C ) = jK p j (c j ) This can be applied when we study
a step function.
only one type of risk which aects to dierent losses2.
Given c 1 ,..., c J 4 and I
If C is known, household then choose which of
{ A1 ,..., AJ } with respective investment costs { c1 ,..., c J } to be p 0 if 0 C c 1
self-protective actions. Household want to minimize 1
p(C ) dened in [1] to obtain the lowest probability of p if c 1 C c 2
p(C , I ) =
loss. She then has to solve the following problem M
J
inf p(C ) such that x c j j C , x j { 0,1} . p if c J C
xj j
jJ
where p [0, pn ] The value c 1 can be considered as the
This problem is well-known and there exits algorism to xed cost: insufficient level of investment cost leads to
solve it. If x j = 1 then A j is applied and not if x j = 0. We inefficient protective measure.
will provide examples at the empirical sections
Assumption 1'. (Continuous values) Assume that p(C , I )
ii) Risk information
is continuously twice differentiable and
Denoted by I the available information of ood risks
p1 < 0, p11 > 0, p2 < 0, p22 > 0 and lim C p = 0 . That is, as
perceived by households who care on protection. Risk
information is related to households perception of risk risk sharing information and the investment in protection
(which eects to the loss probability) and ecient increases, the loss probability decreases at a decreasing
capabilities to take self-protection to reduce the loss rate. And by investing suciently large, the probability
(which eects to utility). People who know deeper risk of loss will close to zero.
information can be able to create higher quality of self-
2.1 Optimal investment
protection. In this model, we assume that household only
get a reward if she has risk information and apply to Denoted M the initial total wealth of the household:
protective measures to reduce the loss when oods Suppose that the utility function u is increasing,
happen. The reward also can be explained, for example, continuous and strictly concave. As a results, if
if a household get a good information of ood risks, with household take no care on protection; her expected utility
the same cost for self-protection measure as others, she will be
can lower ood damage. Moreover, she can learn from
Eun = p n u( M - L ) + (1 - pn )u( M ).
neighbors for more ecient protective measures.
Otherwise, the expected utility can read
In the context of formal ooding insurance is hardly
accessed in Vietnam (Reynaud et al, 2013), informal Eu = p(C , I )u( M - L - C + a ( I )) + (1 - p(C , I ))u( M - C ).
insurance and self-protection can be complement. The In this case, she has to nd a set of optimal investments
insurer may offer different contracts for different type of C * to be the solution of
risks where the premiums depend on the levels of self-
protection taken by of households . So the reward for max{pu( M - L - C + a ) + (1 - p )u( M - C )}. [2]
C
households who have good risk information can help.
Before issue the premium, the insurer may test the risk
perception of households. If the household has good
3
knowledge and information on ood, a premium rebate Moral hazard can happen when insurers do not know
households who buy low premium but do not take or
1
The model is built to be consistent with our database as take fewer protective measures
4
a choice set of several self-protective measures Imagine that a village builds a dike to prevent oods.
2
For example, in a recent our study (Reynaud et al, The feet tall of the dike depends on the money spend on
2013), we focus on three dierent cost invested in investment. And the frequency of ooding depend on
reducing the loss from agricultural productions, home height of its ood barrier. As a result, it depends on the
contents and death. money we invest in.
2
Under assumption 1, if if c i C < c j then p(C ) = p i It is Eu[M - C - p(L - a ) + X ]=u[ M - C - p(L - a ) - p ( p )].
easy to see that Hence
Eu = pu( M - L - C + a ) + (1 - p )u( M - C ) pu( M - C - L + a ) + (1 - p )u( M - C ) = u( M - C - p(L - a ) - p ( p )).
= p u( M - L - C + a ) + (1 - p )u( M - C )
i i [3]

p i u( M - L - c i + a ) + (1 - pi )u( M - c i ) = Eu(c i ).
Therefore, the solutions of [2] belong to {0, c 1 , c 2 , ..., c J } .
Notice that when C * = 0 then no investment, household
only take protective action if Eu(C *) > Eu(0) = Eu n .
Since y be the money that household is ready to pay for
escape the risk, u( M - C - y ) = u( M - C - p(L - a ) - p ( p )),
y = p( L - a ) + p ( p ) [4]
Similarly, if denote by p ( p ) the risk premium when the
n

Suppose that household take some self-protective n

loss probability is p we have
measures. Since there are nite numbers of c 1 , c 2 , ..., c J we
can nd a C * {0, c 1 , c 2, ..., c J } such that p n u( M - L ) + (1 - pn )u( M ) = u[ M - p nL - p ( p n )] [5]

p(C *, I )u( M - L - C *) + (1 - p(C *, I ))u( M - C *) From [3] and [4], if

p u( M - L - c i ) + (1 - p )u( M - c i ),
i i
u[ M - pnL - p ( p n )] < u[ M - C - p(L - a ) - p ( p )].
"ci {c 1 , c 2 , ..., c J }.
then household invest in self-protection: This implies
Proposition 1 Under assumption1.
C < ( p n - p )L + a ( I )p + p ( pn ) - p ( p) := C [6]
i) There exists a threshold value of cost C such that the
household invest in self-protection if C * < C and not ( p n - p )L + p ( p n ) - p ( p )
invest if C * > C . ii) It follows from [6] that a ( I ) .
p
ii) There exists a level of risk information which allows As a '( I ) > 0 , there exist
household invest in self-protection.
( p n - p )L + p ( pn ) - p ( p ) - C
Proof: I * = a -1 [ ] such that if I I *
p
i) Since u is continuous and concave, there exists then household will invest in self-protection. When I
b [ 0,1] and a point belong to the interval increases, I * will increases, condition [6] holds. It
[M - C - (L - c i ), M - C ] such that explain the role of information as an incentive for
investment in self-protection.
pu( M - L - C + a ) + (1 - p )u( M - C )
= u[b ( M - L - C + a ) + (1 - b )u( M - C ) 2.2 Incentive of self-protection

= u[M - C - b ( L + a )] = u[M - C - y ] From Lemma1, if denoted T the premium of full

where y = b (L - a ). If there is a loss households wealth
decreases from M - C to M - C - ( L - a ). It means y y is
the money that household is ready to invest to escap e the
risk of loss where the loss probability is p and initial
coverage, we have
i) When household does not take protection,
y = pn L + p ( p n ) is the money that household is ready to
pay for escape the risk. (Recall that p ( p ) is risk premium
n

evaluated at ( p , M ) ). It is the maximum acceptable

n
wealth is M - C . Moreover, since u is strictly concave,
Jensen inequality implies premium for household to get full coverage and no need
to invest in protection. If T y then household accept the
u( M - C - y ) = pu( M - L - C + a ) + (1 - p)u( M - C ) contract to get full coverage. Then the maximized utility
< u( M - p( L - a )). will be u( M - T ).
It follows that M - C - y < M - p(L - a ) or y > p(L - a ). ii) When household takes self-protection, since
Recall that the risk premium p is the maximal amount of ( p - p)L + a ( I )p + p ( p ) - p ( p) = C
n n
we have
money that a household is ready to pay to escap e a pure p L + p ( p ) = C + pL + p ( p ) - a p. In this case, expected
n n

risk X where EX = 0. Let denote p ( p ) be the risk utility of household is u ( M - C - pL - p ( p ) + a p).

premium evaluated at the initial wealth M when the loss
Therefore, given insurance premium
T, if
probability is p : Then Eu( M + X ) = u( M - p ( p)).
u( M - C - p L - p ( p ) + a p ) > u( M - T ) which implies
y y y

Dene a random variable X such that

C < T - p yL - p ( p y ) + a py
P[ X = ( L - a )( p - 1)] = p
then household takes self-protection and not buy
P[ X = ( L - a )p ] = 1 - p. insurance.
Then we have EX = p(L - a )( p - 1) + (1 - p )(L - a )p = 0 It should be note that, when the reward a
is big enough, household always take self-protection.
And This explains the importance of households risk
Eu[M - C - p(L - a ) + X ]=pu( M - C - L + a ) + (1 - p )u( M - C ). information as the incentive to take self-protection.

By denition of risk premium p ( p ) evaluated at

M - C - p(L - a ) we have

3
iii) If T - p y L - p ( p y ) + a p y < C then
u ( M - C - p L - p ( p ) + a p ) < u( M - T ) : the households
y y y
will buy insurance.
As we know, if the premium is independent to
investment in self-protection, insurance may cause a
negative incentive to self-protection. Moral hazard also
occurs when households are fully covered by insurers,
they do take protective measures, even they cause the
loss then get indemnity. We now apply our model to
explain a kind of risk sharing arrangement as the
informal insurance in a small group of households. A
premium rebate is oered to low risk households
Moral hazard can happen when insurers do not know
households who bought low premium but do not take
protective measures. In this case a = 0 in ( I , N ) .
2.3 Income effects
Suppose that now information is costly. Let dene the
budget constraint M = tx X + Y + tc + tI I where tx , tc are
prices for non-market goods X , self-protection cost and
information. Y is other composite goods. Consider the
maximized problem of household above
max {p(C , I )u1 ( X , Y ) + (1 - p(C , I )u 2 ( X n , Y )}
I ,C , X ,Y

corresponding to the high level of self-protection and a subject to M = tx X + Y + tc + tI I .

premium loading is imposed to high risks households
The loss now come into the good X . For example, if X
with low level of self-protection. Once household choose
is agriculture productions, then if there is a loss, we have
the premium rebate, she has to commit to invest at that of
corresponding level of self-protection. This kind of X = X n - L.
insurance may happens in a group in village in Vietnam.
Assume that Assumption 1 holds. The Lagrangian is
The insurer is formed by some members of the group so dened as
the insurer can observe the protection level of the
L = p(C , I )u( X , Y ) + (1 - p(C , I ))u( X + L , Y )
insured. As explained above, for those who have good
ood risk information, they get some reward so + m ( M - t x X - Y - tc - tI It x , tc ).
a implicitly included in a reduction of premium. Denoted u1 ( X , Y ) = u( X ,Y ), u 2 ( X n , Y ) = u( X + L , Y ),
Therefore, the premium for her is T - a ( I ). For those p
p u u
who does not take protection, the premium T + a . p1 = , p2 = , u1 = , u1 = . The F.O.C evaluated

C I
X
Y
Proposition 2 at optimal solutions ( X *, Y *, C *, I *) :
If the premium reward a > C - (p ( p ) - p ( p )) - ( p - p )L
n n

then the insured always takes self-protection. Otherwise, she p1u1 - p1u2 - mtc = 0
does not invest in self-protection. p2 u 1 - p 2 u 2 - m t I = 0
Proof: pu11 + (1 - p )u12 - mt x = 0
We restrict our model where two groups can buy pu21 + (1 - p)u22 - m x = 0
insurance. The households who have good risk
information and take self-protection with low premium Then
and those who do not take self-protection with a high C 1
u1 - u 2
= = 1 [7]
premium. As in the model setting, if households are not p p1 pu2 + (1 - p )u22
interested in insurance, they can choose self-protection or
Note that
not. So far, we have 4 groups, which will be denoted as
(I,Y), (I,N) (NI,Y), (NI,N) where I=Insurance; NI= No u( X , Y )
u( X , M - t x X - tcC - t I I ) dM u( X , Y )
= = [8]
insurance, Y=Yes to protection, N= No to self-protection. Y M dY M
Denote by B the indemnity from insurers. The utilities of Moreover, our maximized utility can b e read
4 cases are
EU = pV 1 ( M , tx , t y , t I , L) + (1 - p )V 2 ( M , t x , t y , t I , L )
u( I , Y ) = pu ( M - C - L - (T - a ) + B + (1 - p )u( M - C - (T - a ))
u( I , N ) = p nu( M - L - (T + a ) + B + (1 - p n )u( M - (T + a )) Where
u(NI , Y ) = pu ( M - C - L ) + B + (1 - p )u( M - C - (T - a ))
V 1 ( M , t x , t y , tI , L ) = u1 ( X * ( M , tx , ty , t I , L),Y * ( M , tx , t y , t I , L )),
u(NI , Y ) = p nu( M - L) + (1 - p n )u( M )
V 2 ( M , tx , t y , t I , L ) = u 2 ( X * ( M , t x , t y , t I , L ), Y * ( M , tx , ty , tI , L ))
From Lemma1, we will use the equation
pu( x0 - x ) + (1 - p )u( x0 ) = u( x0 - px - p ( p)) where p ( p )
M V1 -V2
Therefore, =
is the risk premium when the loss probability is p p p 1
V /M + (1 - p )
V2 /
M
evaluated at x0 Then we have
C M
It follows that =
u( I , Y ) = u ( M - C - (T - a ) - pL + p B - p ( p ))
n p
p
u( I , N ) = u( M - (T + a ) - p nL + p nB - p ( p n )). Thus we see that marginal self-protection expenditure
equal to WTP for risk reduction. Similarly,
If u( I , Y ) > u( I , N ) then C < p ( p ) - p ( p ) + ( p - p )L + a .
2 1 n

If C > p ( p ) - p ( p) + ( p - p)L + a then u( I ,Y ) < u( I , N ) ,

2 1 n
I 1 u1 - u 2
M
insured does not take self-protection. tI = = 1 = .
p p2 pu2 + (1 - p)u22
p

2.4 Risk-sharing in the network

4
Consider a group of n households indexed by Proposition 5 With risk sharing information, each
i = 1,2,..., n. In this setting, when formal insurance household's optimal cost of self-protection C i* is less than or
mechanisms are hardly accessed, we develop a mo del equal to the optimal cost of self-protection C i without risk
where household invest in self-protection but also in risk sharing information, C i* C i . If p12 (C , I ) > 0 we have
sharing information. It is costly to form such an C i* < C i .
relationship as the expenditures of monitoring and
Proof: Consider problem with sharing information
maintaining the network and the cost for risk sharing
information as the private provision of public good.
max{p(C i , I )ui ( M - Li - Ci - ( I i - I -* i ) + a ( I ))
Ci , I
Suppose that household i shares risk information to other
+ (1 - p(C i , I )ui ( M - C i - ( I i - I -* i ) + a ( I ))}
member in the network and the expenditure of this
information is I i . The total shared information I = i = 1 I i
n
The rst order condition yields
can be considered as the total supply of provision of
0 = p1ui 1 - puci 1 - p1ui 2 - (1 - p )uci 2
public good. Assume that the loss probability of
household i is p(C i , I ) satises the following assumption + p2 ui 1 - (1 - a 'I )uIi 2 - (1 - p)(1 - a 'I )uIi 2
where u = u ( M - Li - C i - ( I i - I - i ) + a ( I )),
i1 i *
The utility maximization of household i
ui 2 = ui ( M - C i - ( I i - I -* i ) + a ( I )), ui 2 > ui 1 .
max{p(C i , I )ui ( M - Li - C i - I i + a ( I ))
Ci , Ii
From F.O.C we know
+ (1 - p(C i , I )ui ( M - C i - I i + a ( I )))}
Denition 1 The Nash-equilibrium in this model is a vector of (1 - a 'I )uIi 1 + (1 - p )(1 - a 'I )uIi 2
p(C i* , I * ) = - p2 -
risk information investment (I 1* , I i* ,..., I n* ) such that for each ui 2 - u i 1
household i solves the problem i1
puc + (1 - p)uc i2
-
max{p(C i , I + I -* i )ui ( M - Li - C i - I i + a ( I )) ui 2 - ui 1
Ci , Ii
Consider problem without sharing information
+ (1 - p(C i , I + I -* i )ui ( M - C i - I i + a ( I )))}
n max{p(C i ,0)ui ( M - Li - C i ) + (1 - p(C i ,0)ui ( M - C i )}
where I - i = j = 1, j i I - j .
* *
Ci , I

It is standard in public good literature that the utility we have

maximization problem is equivalent to i1 i2
puc + (1 - p )uc
max{p(C i , I )u ( M - Li - C i - ( I i - I ) + a ( I ))
i *
-i p1 (C i ,0) = - p 2 - i2 i1
.
Ci , I i
u -u
+ (1 - p(C i , I )ui ( M - C i - ( Ii - I -* i ) + a ( I ))}
Thus p1 (C i* , I * ) p1 (C i ,0) Since p12 (C , I ) > 0,
which can be written as
*
p1 (C i ,0) p1 (C i , I ). This implies p1 (C , I ) p1 (C i , I * )
*
i
*

max U i (C i , I ) which implies

Ci , I i

s.t C i + I - a ( I ) = M - Li + I *
-i
*
I I -i
Let denote the demand function for G of household i ;
then G = max{ f i ( M - Li + I - i ), I - i } + a ( I )
By using a xed point theorem, we have
Proposition 3 If a '( I ) < 1 then there exists a Nash
equilibrium
Prop osition 4 There exist a constant b [ p ,1] such that
-b p(1 - a '( I ))
= p1 (C i* , I * ) + p2 (C i* , I * ) -
Li Li
If household is risk neutral, we have
1 - a '( I )
p1 (Ci* , I * ) + p2 (C i* , I * ) = -
Li
Assume that p12 (C , I ) 0, it means the spill-over from
increased total sharing information decreases or leaves
unchanged the marginal benet of self-protection
expenditure for reducing loss probability. When I * = 0,
when dene C as the optimal cost of self-protection
without risk sharing information.
C i* C i .
Empirically based on a survey conducted in Vietnam
(Reynaud and Nguyen, 2013), we nd the evidence on
the existence of the network as farmers form
relationships to mitigate risks. The willingness to pay for
ood risk reduction in the network and the behavior
changes of farmers investing in self-protection and risk
information seeking as the effective mechanisms are
evidences of networks efficiency.
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