Tuesday
April 27
2010

Manuel Bueno

Microinsurance: The Ugly Duckling in Financial Services to the Poor

Being poor means not only surviving with a tight budget, but also managing the unpredictability of an irregular income. Coping with such variability is a fundamental challenge that is often overlooked by financial service providers in low income markets. This state of affairs is made worse when poor households suffer external shocks like the death of a family member, natural disasters or health emergencies. The poor’s inability to mitigate risk often forces them to sell their assets, take on high-interest loans, or exhaust their savings.

The negative impact of external shocks is compounded by the fact that poor households have very low asset bases. Just one shock is often enough to push them deeper into poverty. Even the potential of uninsured shocks has costs on the poor. To limit their exposure, low-income households may forgo riskier, profitable business opportunities. They might diversify their economic activities, or keep assets more liquid – both of which imply an opportunity cost of being poor.

These are low-risk and rational choices designed to avoid falling further into poverty but that perversely also prevent them from pulling themselves out of the Bottom of the Pyramid. For instance, poor farmers may prefer low-risk and low-return crops over more profitable and riskier ones. They may choose to plant many different crops instead of sticking to the crop they know best (not to mention foregoing possible economies of scale), or may decide against investing in machinery designed to increase the productivity in the longer term.

In the absence of formal insurance, poor people often resort to risk-pooling schemes (for example, funeral and burial societies), income support (for example, credit arrangements), and consumption smoothing arrangements (for example, grain banks) (Bhattamishra and Barrett 2008). In nearly every case, these systems take place at the local community level and rely on personal relations between participants, so they are hard to scale up. Furthermore, these approaches offer limited protection and are prone to break down during emer-gencies that affect the whole community.

At its most basic, formal microinsurance tries to cover this need by reducing the vulnerability of the poor to external shocks. There are three main characteristics to insuring household risk: frequency, intensity and correlation (World Bank, 2008). A risk can be of low frequency but of high economic impact or vice versa. Additionally, it may affect only individual households (for instance, healthcare risks due to bad household cleaning) or may affect to all people in the same area (for instance, floods or droughts). In this second case, the risk is said to be correlated across individuals and is called a covariate risk. Community level informal schemes that are often used in the absence of microinsurance offerings are especially weak against covariate risks.

Microinsurance firms can offer better risk management alternatives to poor households by pooling the risks of individuals of a similar risk class and transferring it to a larger and more diverse group of insured participants. The products offered can be designed in myriad ways. Depending on the risk insured, activity levels, employed assets and risk exposure, different insurance types may be more appropriate than others. Nonetheless, microinsurance products are generally grouped in three categories:

  1. Health insurance: To address disease, reduce mortality, and improve health in low-income households. Although the World Bank identifies health insurance as an important complement to poverty reduction efforts, it is one of the most notoriously difficult microinsurance products to implement, because it requires significant managerial and actuarial expertise.
  2. Life insurance: The death of a household’s main breadwinner can severely impact household welfare. If well designed, life insurance can mitigate the financial shock of this death by providing income assistance to the family and/or covering funeral expenses. Usually life insurance can be easily bundled with other types of insurance and so it may also include the repayment of pending debts when the family’s breadwinner dies.
  3. Agricultural and livestock insurance: Livestock insurance covers losses resulting from death, disease and accidental injury to livestock (either at the individual or at the herd level). Crop insurance tends to be more complex, because negative external shocks to crops can arise due to yield loss (a lower than anticipated yield), quality loss (crops of lower quality than anticipated) or revenue loss (due to fluctuations in the market prices paid for the crops).

Agricultural and livestock insurance was the source of one very important recent innovation in the field of microinsurance: index-based insurance (IFPRI, 2009). The payment structure in index-based insurance is determined by an index (usually rainfall) which is highly correlated with a particular crop yield or livestock mortality rate. The use of this index decreases the administrative and transaction costs for identifying losses and it limits the influence of the insured in affecting the outcome, since the index is independent of individual actions.

Thanks to its relative simplicity life insurance is the most popular microinsurance product in low-income markets, followed by health products and agricultural/livestock insurance. However, in spite of its increasing sophistication, it is surprising that microinsurance services have received much less attention than other financial services (such as credit or saving) offered in low-income markets. As a result, their market penetration is much lower than would be expected. For instance, a study of the microinsurance market in Africa estimated that life insurance covered only 2% of its potential market, while health and agriculture insurance services barely reached 0.3% and 0.1% of the low-income population (ILO, 2009).

One of the reasons advanced for such meager numbers is the lack of coordination between microfinance institutions (MFIs) and insurers. This is unfortunate, since the potential for overlaps and savings between both business models is evident, given their intimate knowledge of their clients and the similarities in their respective products and processes. A stronger partnership between both economic actors would directly reduce the cost of coverage because it would make available better quality information about the customer. Many microinsurance providers would benefit from partnering with an organization experienced in risk management, product development and efficient information management systems.

Additionally, MFIs can also offer good local knowledge and access to local networks through their extensive platforms. For instance, credit life insurance products can and often are sold together with loans. The premiums are then collected with loan repayments in order to reduce administrative costs. Unfortunately, the reality is that although some MFIs have already added insurance services to their product portfolio, they are rarely bundled together and thus the potential for cross-selling usually remains unrealized.

It may well be the case that commercial banks, which are now starting to offer microfinance services alone and which are much more experienced in product cross-selling, will end up spearheading the drive to offer microinsurance products coupled with other financial services. Another possible alternative would be to develop insurance products as a natural extension of health care services or other assistance or advisory services. Therefore MFIs are not the only possible partners for microinsurance firms and many possible competitors could take the baton of microinsurance in the near future.

A second and very important unrealized development in the microinsurance landscape is the neglect of women in the design of their insurance products. Although women comprise 70% of the world’s 1.3 billion poor (Millennium Campaign), very few insurers have taken a gendered approach to microinsurance. However, women have needs that are not met with standard insurance services. Women face special health risks, such as those related to pregnancy and childbearing or those arising from greater vulnerability to diseases such as HIV/AIDS, which are very rarely covered. This represents a missed opportunity which should not be hard to tackle.

A recent paper by the Women’s World Banking organization argues that female targeted insurance products should include a) affordable coverage for specific health problems faced by women, especially maternity coverage; b) extended health insurance cover for the whole family, especially for the death of the spouse; c) property and assets insurance, including marital property, that assures that the title is in the woman’s name and prevents assets being seized by a husband’s relatives in the event of his death; and d) coverage that ensures that children benefit after a woman’s death.

All in all, the future of microinsurance is bright, not only due to the great unmet needs it would address, but also because the final product requires relatively little tampering with and it can be easily associated with other extensive and profitable platforms in low-income markets. For those interested in reading more about microinsurance, I suggest visiting http://www.microinsurancenetwork.org/ which is an excellent source of information with plenty of readily available articles and books about the subject.

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