Dynamics of Micro Insurance
“Our Grameen philosophy is: the less you have, the more you get. If you have nothing, you get the highest priority,”
- Mohammad Yunus, Nobel Peace Prize laureate
Crises are recurrent in the lives of the poor. It may be due to demise (of the bread-earner of the family), illness or accident, fire, theft or natural disasters. Such incidents often involve high expenditure for re-footing and they drive a poor family deeper into financial discomfit. Expenses incurred during such crises are met either by borrowing from moneylenders, sale or mortgage of assets or by drawing on scarce savings. The affected household suffers a simultaneous reduction in income and savings and an increase in debt and expenditure. Each crisis leaves a poor family weaker and more vulnerable. Women, who are invariably responsible for managing the household, bear the brunt of coping with such crises. It is the phenomena of life for all the under-privileged populations around the world.
You may recall a success story that appeared in a local daily towards the end of 2007 under the title ‘Rural Communities in the Driver’s Seat’. According to the story, for years, Min Bahadur Magar, a 48-year old farmer in the remote Ramechhap district in eastern Nepal, had to borrow money from a local money lender – paying a 50 percent interest rate - to make ends meet. Today his life has fundamentally changed. With training and money given by the World Bank-funded Poverty Alleviation Fund (PAF), Magar started a vegetable business. He now earns nearly US$ 100 a month from selling vegetables alone.
“I am able to feed my family all year round, and send all of my eight children to school,” said Magar. “Now I am borrowing from my community organization paying a small fee. The man I used to borrow from comes over to buy vegetables instead of collecting money from me.”
Balram Sunuwar, a farmer in the neighboring village, also received training and assistance from PAF and said this has turned his life around. “There were no resources available to assist a person like me before this programme. I received training which enabled me to set up my own nursery.”
There are so many Min Bahadurs and Balarams, but who will make them real Bahadur (courageous)? Is there any insurance scheme to protect their assets and health in the bad days?
Microinsurance = Macro Social Protection
Social protection is, first and foremost, the legitimate right of every individual. It is also a condition for social and economic progress. In many developing countries formal social security systems are rarely giving adequate coverage to people who are working in the informal economy, even if the legislation promotes social protection for all. The issue of identifying ways to extend social protection to workers in the informal economy is a new challenge. The need to determine appropriate mechanisms for providing social protection, especially in health, has to be identified and tested. Micro-insurance has been identified as one of many ways to provide better access to health care services to the excluded and also to provide social security to informal economy workers, those who are excluded, and to the poor.
Community-based microinsurance schemes combine the fundamental principles of insurance, participation and solidarity. They use the basic principles of insurance because, by paying specific contributions, the members receive (from the group as a whole) specific services when they fall ill, when they have an accident or any other setback, as agreed to in the microinsurance scheme. Community-based microinsurance can also serve as a mechanism for empowerment, especially of women. It can serve to increase the awareness of communities of their health needs and of the resources being used to address those needs. It can also contribute to stronger social organization to meet the needs, a task typically borne disproportionately by women and girls.
Despite a sophisticated and resourceful global insurance industry, many developing countries remain largely unprotected and more particularly exposed to high levels of disaster risk. The challenge is how to develop sustainable insurance and risk transfer schemes in hazard-prone developing countries and make coverage accessible to the poor and “uninsurable”. Recent initiatives have shown the potential benefits of financial risk transfer mechanisms, which through traditional insurance structures and newer developments such as catastrophe bonds, weather derivatives and micro-insurance, provide the flexibility to adapt to individual country and peril settings.
Can poor people be insurance buyers?
Consumer education is a big need. The more people understand how insurance works and the fact that insurance is not just for the rich people, the greater the demand will be. If we inject more effort into consumer education some significant results will surely be visible.
But whose responsibility is this? Insurance companies are not likely to want to do it on a generic basis because that could benefit competitors. Then is it the government’s responsibility to educate consumers? Maybe. Another potential source of consumer education would be trade or industry associations. Because they have so many other things to worry about they need a social security net. The risks faced by the poor are much the same as those for most other individuals, but research has shown that they experience those risks with greater frequency and with a relatively greater financial impact and that they are well aware of this fact.
For example, poor people often live in areas prone to flooding or work in factories under very hazardous conditions. The fact that they have little money to respond to those risks makes them even more vulnerable. Microinsurance is a form of risk management for these poorest of the poor.
How to reach poor house-holds?
The delivery models used for providing microinsurance services are more diverse than for “regular” insurance that uses the full-service model. As identified by Cohen and McCord (2003), four institutional models may be distinguished for providing micro-insurance:
• Full-service model: Commercial or public insurers provide the full range of insurance services from the initial development of the product through distribution to absorbing the risk.
• Partner–agent model: Commercial or public insurers, together with microfinance institutions or non-governmental and other organizations, collaboratively develop the product. The insurer absorbs the risk and the agent markets the product through its established distribution network. This lowers the cost of distribution and thus promotes affordability.
• Community-based model: Local communities, Micro-finance Institutions (MFI), Non-Government Organizations (NGO), and/or cooperatives develop and distribute the product, manage the risk pool and absorb the risk. As with insurance mutual, there is no involvement on the part of commercial insurers in this model.
• Provider model: Banks and other providers of microfinance can directly offer or require insurance contracts. These are usually coupled with credit, for example, to insure against the risk of default.
The insurance penetration even in the traditional sector of Nepal is very minimal due to high distribution costs involved in the hilly geophysical condition of the country. It is a Herculean task to bring the people under the fold of insurance only through insurance companies. Neither is it a practical economic proposition. Then should they be left uncovered against unforeseen misfortune?
Community-based microinsurance schemes can be set up through different organisational structures. They may be initiated by community-based organizations, by associations of micro-entrepreneurs, workers’ organizations or by NGOs promoting improved health or poverty reduction programmes.
There are 15,000 NGO’s registered with the Ministry of Social Welfare of Nepal. Also registered are 17 commercial banks and other banking institutions (OBI) which include all deposit-taking financial institutions other than commercial banks (viz. 20 Development Banks, 5 Regional Development Banks, 59 Finance Companies, 21 Financial Co-operatives, 44 Financial NGOs and 116 Postal Saving Banks). In Italy, the post office network has proven a dominant and stable channel.
Disaster Insurance and Distressed Poor
Disaster micro-insurance can cover sudden-onset events, such as earthquakes, floods, and cyclones, as well as slow-onset events, such as droughts. Traditionally, insurers have paid claims based on actual losses to households, businesses and farmers. This requires extensive networks of claims adjusters who assess individual losses following an event. We refer to this as indemnity-based insurance.
Recently, index-based schemes for slow-onset events have emerged. Index-based insurance is distinguished from indemnity-based insurance in that it features contracts written against a physical trigger (parametric insurance), such as rainfall measured at a regional weather station. In the case of weather derivatives for crop risks, farmers collect insurance compensation if the index reaches a certain measure or “trigger,” regardless of actual losses. These schemes may offer a viable alternative to traditional crop insurance, which has failed in many countries, mainly because of the high costs associated with settling claims on a case-by-case basis. A major factor bankrupting these programs has been natural disasters such as droughts (Brown et al., 2000).
At the heart of micro-insurance is the provision of services to those not reached by regular commercial insurance. Thus, it is imperative to ask how premiums can be made affordable to low income households and businesses. Major cost factors in the insurance industry involve payment of claims (about 55% of premium income) and transaction and capital/reinsurance costs (about 45% of premium income) (Abels and Bullens, 2005). As necessary as reinsurance is for provider viability, it adds a “load” to the actuarial value of the contract. Commercial catastrophe insurance premiums, while fluctuating widely, are often higher than the “actuarially fair” value. This means that, by insuring individuals in developing countries, they may pay substantially more than their expected losses over the long term.
The strategies for reducing the costs of disaster insurance are discussed below:
• Transaction costs can be lowered, for example, by offering simple products to client groups; relying on community pressure for timely payments; enlisting the services of nonprofit organizations that do not charge high commissions; and streamlining administrative costs (e.g. by integrating them into existing systems). NGOs and MFIs provide low-cost administrative assistance to existing systems by distributing the product and assessing claims, among other services. The index-based insurance systems now operative throughout India and in Malawi are particularly promising, as they substantially reduce the expense of claims handling and also simplify the risk assessment process.
• The national government and/or international donor community can provide capital reserves or reinsurance. For example, the World Bank is supporting the Turkish Catastrophe Insurance Pool (TCIP) by providing some reinsurance in the form of a contingent credit.
• The national government and/or international donor community can directly subsidize disaster claim settlements or premiums for the poor.
• Alternatively, external support can come in the form of technical/organizational assistance, for example, for conducting feasibility studies, providing access to data, carrying out risk assessments, designing products and facilitating public–private partnerships. Indeed, many international donors are opposed to direct subsidies because of the disincentives they impose and because they may be unreliable in the long term. They advocate instead technical support in the start-up phases. This support has been forthcoming from sponsoring institutions such as the World Bank, the ProVention Consortium, the Caribbean Development Bank and Oxfam.
• The premiums paid by the poor can be reduced through cross-subsidies in the insurance system, as is successfully demonstrated by the Indian pro-poor regulatory requirement for formal insurers to take on an increasing quota of low-income clients.
Currently, only 1% and 3% of households and businesses in low- and middle-income countries, respectively, have insurance coverage against catastrophe risks, compared with 30% in high income countries (Munich Re, 2005). Instead of insurance, the poor often rely on savings, depleting or mortgaging their land and assets, and emergency loans from micro-credit institutions or money lenders. Alternatively, they rely on family support, which is not always forthcoming for catastrophes that affect people simultaneously throughout a region or country (referred to as covariant risks). Furthermore, the poor are often exposed to multiple shocks such as illness and natural hazards at the same time. Without savings or family support, disasters may lead to a “cycle of poverty,” as victims take out high-interest loans or default on existing loans, sell assets and livestock, or engage in low-risk, low-yield farming to lessen their exposure to extreme events.
Regulatory Role on Future Micro-insurance
Regulation and supervision of micro-insurance is a key factor for the future growth and success of micro-insurance activities. The regulatory framework consistent with insurance principles protects the rights of policyholders. Furthermore, it enables the development of the insurance market by making insurance affordable and accessible. Well-adapted regulation helps in designing appropriate products for the low-income segment of the population besides ensuring the long-term stability of micro-insurance providers.
Regulation of micro-insurance is a challenge for most supervisory authorities. Data on the performance of micro-insurance is scarce and a micro-insurer’s business process differs from established insurance operations. Many of the micro-insurance providers do not have experience with the technical and legal aspects of insurance. Thus, they need comprehensive guidance and support in implementing legal and prudential requirements. The risk parameters used by the regulators are designed for the high-premium and high-volume business of typical commercial insurers. Micro-insurers, however, handle small policies and premiums and often work with fragmented underwriting and claiming processes.
There are two different regulators governing Bank and Insurance. Keeping in view the global trend of microinsurance as well as micro-finance, both regulators should critically examine suitability in the perspective of Nepal and accordingly plan the future path of mass protection match sustained economic growth.
It will be helpful while regulating the micro-insurance to remember the suggestion of the Nobel Peace Prize laureate and the father of Grameen Bank, Mohammad Yunus on Micro-finance Regulation : “The existing regulations are designed with Commercial Banking in mind, but micro-finance requires a dedicated regulator and a relevant set of rules. Commercial banking is like a super tanker whereas micro-finance is like a dinghy boat with which you can reach small corners. If you design a dinghy boat with the architecture of a super tank, it is sure to fail.”
Macro Challenges
A large section of the Nepali nation remains a poor agrarian society characterized by underemployment and low labour productivity. Nearly nine tenths of the nation’s population live in villages and nearly four fifths of the labour force work in the agricultural sector. The heavy dependency of the rural economy on agriculture and the poor performance of the agricultural sector have aggravated rural poverty. Several factors are responsible for the continuing poor performance of the agricultural sector: (i) the sector’s heavy dependency on the vagaries of weather, since only 20 percent of cultivable land is perennially irrigated; (ii) the insufficient delivery of key inputs to farmers; and (iii) the inadequate institutional capacity (World Bank 1997). Asian Development Bank’s current annual report ‘Asian Development Out-look’ (ADO) highlights the importance of agriculture in economic development in Asia but the agriculture productivity in Nepal has decelerated to 0.7 per cent from last year’s 1.1 percent.
Access to financial services remains limited for most people in Nepal and has declined in recent years, according to the World Bank and DFID’s 2006 report on Access to Financial Services Survey. Only 26 percent of Nepali households have a bank account, and banks’ procedures are perceived as being the most cumbersome among financial institutions. Accordingly, clients prefer not to save in them. Financial NGOs and cooperatives run a close second as the largest providers of deposit accounts, serving 18 percent of households. These institutions are the preferred provider for low-income households, but are also popular among the wealthier households. Microfinance and regional rural development banks are a distant third provider of deposit accounts, serving only 4 percent of households—mainly the rural poor.
Against this backdrop, there are certainly challenges in developing micro-insurance involved in serving the low-income market, requiring innovations in product design, delivery mechanisms and marketing. The success of many micro-insurance programmes in providing coverage to the poor throughout the country has shown that these challenges can be overcome by creatively designing demand-driven products along with client friendly collection and delivery mechanisms. In the beginning, “it always seems impossible until it’s done.”
(Dr. Ghosh is the CEO of National Insurance Company Ltd. in Nepal)
