Micro Insurance: A Safety Net With Too Many Holes?

Developing and developed countries may have a lot more in common these days than many people think. Take health care. As the U.S. Congress continues to debate President Obama’s controversial national health care plan, an innovative program similarly aiming to improve the lives of the poor is being launched on the other side of the globe in Bangladesh.

As part of a $34 million grant-giving facility launched last year by the Bill and Melinda Gates Foundation and the International Labor Organization (ILO), the Bangladeshi pilot is rolling out a micro insurance product specially tailored to the country’s low-income rural residents, most of whom live on less than $2 a day. Designed for poor people who are not served by typical social or commercial insurance schemes, micro insurance — risk-sharing products characterized by low premiums and coverage limits — generally covers everything from life and health care to weather, property, agriculture, livestock and catastrophe.

The Bangladeshi pilot product — which involves six NGOs (non-governmental organizations) and Bangladesh-based Pragati Life Insurance Ltd. — will include life insurance with some hospitalization coverage. It has an initial target of 26,000 Bangladeshis and plans to scale up significantly after two years. The coverage will be over three- or five-year terms.

“Normally, insurance companies wouldn’t go for such short terms — terms of more than 10 years is the norm,” says Mosleh Uddin Ahmed, a consultant and CEO of Micro Insurance Research Centre (MIRC) in the UK, who is in Bangladesh to help launch the project. But given the precarious incomes of the target market, “it’s just too long for many Bangladeshis to commit to.” That is not the only twist. Under the agreement, policyholders will receive a refund of life premiums paid in addition to 5% of their investment income if they make no claims during the life of the product. If there is no claim on the hospitalization coverage, the premium will not be refunded but the price of subsequent premiums would be reduced by 10% for each year that there is no claim after that.

Such innovation is welcome news in micro insurance circles, and not just in Bangladesh. Unlike micro lending — the better-known side of micro finance — micro insurance has been a hard sell among the world’s poor. The reasons why include a lack of understanding of how insurance products work, the poor population’s general reticence to part with what little financial resources they have, badly designed products and a shortage of localized risk management knowledge among providers. Even in Bangladesh — the home of micro lending pioneer and Nobel Peace Prize winner Muhammad Yunus — micro insurance has been slow to take off, despite its fast-growing, yet largely poor population of 160 million. According to Ahmed, 11 licensed life insurance companies in the country offer micro insurance; by comparison, there are thousands of registered micro finance institutions (MFIs) providing loans to the poor.

It’s a similar story elsewhere, and now governments, NGOs, grassroots community groups, academia and governments alike say the slow acceptance of micro insurance needs attention sooner rather than later. Well before the global economic crisis and the sharp rises in commodity prices, the ILO reported that many governments were struggling to provide social safety nets for the poor, and estimated that less than 20% of the active population in many developing countries was included in public health care and other social security systems. As one of the ILO’s recent papers notes, the economic, food and fuel crises — “which had already stretched people’s reserves and undermined their resilience” — combined with local crises, like droughts in Kenya and Jamaica and flooding in Bangladesh and Indonesia, mean that developing countries have faced a “perfect storm” in recent months. For the first time, according to the paper, “more than one billion people are victims of hunger. In the last year alone, this number increased by 100 million people.”

Many development experts believe this is an ideal time for micro insurance to work alongside the more established micro finance lending and play a bigger role in alleviating the problem. “People work themselves out of poverty using micro lending; micro insurance helps prevent them from falling back into it,” says Dirk Reinhard, vice chairman of the Munich RE Foundation, the non-profit risk management educational arm of the German reinsurer. “This isn’t about the poorest of the poor, but the working poor who have something to lose. They have an income but are hovering around the poverty line, so that if their crop fails, they get sick or their shop burns down, they have to start from zero again.”

Why is micro insurance struggling, given that it is indeed a relatively untapped market? Kua Ka Hin, CEO of Singapore and Southeast Asia for Munich Re, notes that 80% of the world’s population lives in emerging markets, but those people “only account for 22% of global gross domestic product and 9% of insurance premiums.” One part of the solution lies in lessons from micro lending, which is further up the evolutionary curve, say development experts. The other part lies in encouraging innovation within micro insurance so that it can become both socially beneficial and economically viable.

Of Risks and Relationships

An important difference between micro lending and micro insurance is micro insurance’s need for large volume, says Neil Doherty, a Wharton professor of insurance and risk management. It’s one reason why “the history of micro insurance success has not been stellar,” he says.

He recalls how volume became a big issue for a micro livestock insurance network in Burkina Faso, which had initially shown a lot of promise. The product’s design, he says, was solid, addressing many of the weaknesses of other programs and avoiding what’s known in the insurance industry as “moral hazard” issues. For example, to prevent policyholders neglecting their livestock so that they could get a payout, they had to agree to have their oxen inspected every year. Also, if an ox died, the plan’s local head was responsible for buying a new animal on behalf of the policyholder rather than the policyholder receiving compensation directly, which would have required an additional layer of oversight. The problem, however, was scale: Many subgroups within the network had only a few members. “If something happened to several of their oxen at the same time, there was a problem,” Doherty says. “They needed the benefit of large numbers,” which might have been achieved if the plan’s providers had diversified into other types of insurance. The program eventually folded, a fate shared by many micro insurance plans, he adds.

Another critical difference exists between micro lending and micro insurance: While experts point out that both businesses are built around trust — between the provider and the customer — “the risk relationships are reversed,” explains Craig Churchill, head of the ILO’s Micro Insurance Innovation Facility, which runs the $34 million grant program. In micro lending, the provider puts up the capital and trusts the customer to pay it back; in micro insurance, the policyholder pays up front and hopes the provider keeps its promise to make a payment in accordance with the contractual terms. For a tranche of society that probably has never used — let alone heard of — these insurance products, it’s an enormous leap of faith. “Trust is so fundamental to micro insurance, and it’s a huge barrier,” says Churchill.

What needs to happen for micro insurers to win a customer’s trust? Unlike in developed countries, paying claims on time is only one of many factors. Flexibility is also important. That’s a lesson micro insurance can take from micro lending, suggests Santosh Anagol, a Wharton professor of business and public policy currently researching micro finance in India. Studies show that when a micro lender is flexible and willing to change repayment terms from, say, once a week to once a month in order to factor in the typically infrequent and variable cash flows of low-income householders, “there’s not a big difference in default rates,” he notes. Offering such flexibility, he adds, is a good way of building a deep relationship that’s critical “for creating that trust and getting in close touch with the lives of the poor.”

That goes hand in hand with tailoring products. A big criticism leveled at the micro insurance industry is that many products don’t reflect local risks, which can vary greatly from one village or livelihood to the next. Insuring a house might not be as high a priority as, for example, mitigating the risk of flood damage in a shop or a flock of sheep falling ill. “An insurer can’t just offer what they always do but at a reduced price,” says Churchill. “A product really has to be redesigned after assessing what the local needs are, and it has to be accessible.”

One product that meets these criteria is a life insurance initiative launched last year through Max Life, a joint venture between New Delhi-based Max India Ltd. and New York Life Insurance. “They’ve really done their homework,” says Churchill. Called Max Vijay, the insurance is also a long-term savings product for low-income Indians. With a newly announced ad campaign featuring Amitabh Bachchan, a popular actor known for playing a character called Vijay in several movies, the insurer said in September that it aims to cover three million households by 2012, having sold 70,000 policies in the first year.

To start off, a Max Vijay customer fills in a one-page form, provides a proof of identity and pays a minimum enrollment premium ranging from Rs. 1,000 to Rs. 2,500 ($20 to $52). Subsequent premiums over the 10 years of the policy are optional and investments are guaranteed. In the case of natural death, the claimant receives the guaranteed sum assured and the account value. In the case of accidental death, the claimant receives the account value and double the amount of sum assured.

Such simplicity and flexibility are key, but what has impressed Churchill most is the product’s distribution channel. Rather than requiring customers in remote parts of the country to travel long distances to make or receive payments, Max Life has signed an agreement with a national retail chain, I-SERV, to let policyholders manage their policies at 12,500 of its stores. Eventually, Churchill says, more micro insurance products could be run out of local “mom and pop shops” or over mobile phones to make “these products as accessible as possible.”

Yet of all the types of micro insurance policies, arguably the easiest to “localize” is life insurance. Harder to localize are health, weather, property, agriculture and catastrophe insurance products, which require more extensive on-the-ground knowledge in terms of not only a product’s design, but also its administration and monitoring. All that, of course, is a time-consuming, not to mention costly, burden for an insurer. One way around this are index-based products with group payments triggered by, for example, a particular amount of rainfall or crop yield. In other words, there are no assessments or individual claims to administer.

It’s an idea being tested in a public-private pilot product launched in May this year for city dwellers in the poor, flood-prone districts of Jakarta. Run by Munich Re, Indonesian insurance company Asuransi Wahana Tata and German consultancy GTZ GmbH (which is working on behalf of the German government), the pilot product insures low-income households in Indonesia’s capital against direct economic losses caused by severe flooding. Customers pay 50,000 Indonesian rupiahs ($5) each for a wallet-size Alert 1 Manggarai Protection Card. In return, they receive a guarantee of a one-off payment of IDR 250,000 ($25) if water at the Manggarai Water Gate in Jakarta rises to or above 950cm (31 feet), or what is known as Alert 1. But there is a downside, according to local consumers. As one local resident told a BBC reporter, “The problem is that floods happen here every year, but they’re just not big enough to trigger the payment.” Munich Re won’t disclose how many policies have been sold so far, but it has run some 100 educational seminars in the pilot area and is working on alternative products.

Bridging the Credibility Gap

While designing tailored products to woo prospective policyholders is one major challenge, getting all the parties involved in micro insurance working together is another. More so than in micro lending, close partnerships between financial institutions, NGOs and local self-help groups, as well as regulators, count for a lot in the micro insurance industry. “If it’s a lopsided relationship, it’s not going to work,” says Wharton’s Doherty. “Lots of products are developed by NGOs, which are in touch with people and [therefore] understand what’s crucial for their wellbeing. But they underestimate how to make it work from an insurance perspective, the actuarial discipline that” goes into constructing a viable contract, including calculating premiums and other pricing issues.

In contrast, the traditionally urban-based insurers suffer from what MIRC’s Ahmed calls “a credibility gap” when they try to sell directly to the rural marketplace. But leaving insurance to the microfinance institutions also has drawbacks. “They’re very good at fund management processes, but risk management is beyond their capacity,” he says. That’s why he believes partnership models work the best, from governance, efficiency and cost perspectives. According to Ahmed, along with marketing, service delivery is one of the most expensive parts of a new product’s roll out. A micro insurer can spend up to “90% of a premium on delivery and payment collections in the first year.” If a micro insurer partners with an MFI that already has a customer network, he predicts that those costs can be reduced by 10% — savings that “can then be used to reduce the premium.”

Although there is a general agreement about the mutual benefits that tighter insurer, MFI, NGO and community partnerships can provide, it’s often not clear where governments fit in. Some governments have been actively involved in providing micro insurance. That’s the case in India. Since 2002, as part of a national social inclusion plan to help the rural poor, insurers have been required by law to follow a quota system and allocate a certain amount of their business to micro insurance.

While that’s encouraged the likes of Max New York, ICICI Lombard, Bharati Axa and Future Generali to raise the bar and launch a host of micro products, the government has, since last year, been funding its own micro health insurance program, called Rashtriya Swasthya Bima Yojana. Some six million households have enrolled thus far, paying a token contribution to cover hospital and other medical expenses. The government, meanwhile, also offers subsidies for other insurance products via, for example, the state-owned Agriculture Insurance Company of India.

But there are questions as to whether such programs are the best use of government resources. “A one-off premium subsidy by the state has no long-term market creation value,”states Rupalee Ruchismita, executive director of the Institute of Financial Management and Research’s Centre for Insurance and Risk Management (CIRM) in Chennai, India. For her part, Ruchismita would rather see “smart subsidies” that increase the efficiency of the micro insurance industry. This could be funding individual ID cards to enable faster customer identification and reduce fraud-detection costs, or providing regional health, livestock and weather databases to collect much-needed data to help insurers develop and monitor products.

Under the Micro Scope

Yet with or without the subsidies, a critical success factor is education. “Data shows that with no specific effort to educate the insured households, insurers experience very low claims,” she says. But there’s also an educational gap among the providers. Earlier this year, CIRM — in collaboration with Doherty and other Wharton risk and micro insurance experts — spearheaded a global training program targeting the whole range of micro insurance providers. The aim: to develop greater technical and theoretical expertise in such areas as product pricing in data-scarce markets, localized contract design and the development of control systems. Taking place every six months over the next three years, the seven-day inaugural event was held in the spring of this year in CIRM lecture halls in Chennai and in the field in Hyderabad.

Despite all the barriers, micro insurance has a growing band of participants, including the investor community. LeapFrog Investment’s Financial Inclusion Fund, the first investment fund focused on micro insurance, recently announced that it raised $44 million, with backing from the likes of eBay founder Pierre Omidyar and the European Investment Bank. Luxembourg-based Leapfrog Investments was set up in 2008 and wants to invest $100 million in businesses that will bring insurance and financial services to 25 million low-income people in Africa and Asia.

Indeed, the growth prospects are promising. Michael McCord, director of consultancy Microinsurance Center in the U.S., is currently updating an overview of the market and estimates that in the world’s 100 poorest countries, the number of people using micro insurance has increased to about 135 million today from just under 80 million three years ago. In a global context, that’s still a small fraction of insurance reaching the poor, but McBride points out that his research universe doesn’t include countries with “significant” micro insurance businesses, such as South Africa or Mexico. Meanwhile, he says, it’s a positive trend that big global commercial insurers — Axa, Allianz and Prudential, to name a few — are now getting more involved in the industry.

Once micro insurance becomes more established, it will also be facing many of the same issues that micro lending does today — notably questions about whether it is indeed helping to lift people out of poverty. In micro lending, the jury is still out. For example, having studied the impact of micro loans on nearly 7,000 households in some 100 poor neighborhoods in India over 18 months, four MIT academics note in a paper published last May: “Our results show significant and not insubstantial impact on both how many new businesses get started and the profitability of pre-existing businesses. We also do see significant impacts on the purchase of durables.” Yet their study did not find “a discernible effect” on average consumption or on human development. Though they concede that it could take years rather than months for such benefits to be noticed, their study has helped fuel the debate about how helpful micro lending is as an anti-poverty measure. The paper is titled, “The Miracle of Microfinance: Evidence from a Randomized Evaluation.”

Similar studies into micro insurance are still a work in progress. But for now, experts say, what’s important is that micro insurance is gaining greater credibility. The good news, says Ruchismita, is that micro insurance has finally “moved from being a fancy conference theme to being a boardroom strategy.”

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