Microinsurance: The social finance and social protection nexus

By helping low-income households manage risk, microinsurance can assist them to maintain a sense of financial confidence even in the face of significant vulnerability. A new publication, Protecting the poor: A microinsurance compendium, contends that microinsurance has to be one of weapons in the arsenal of governments, donors, development agencies and others in combating poverty and achieving the Millennium Development Goals.

Workers in the informal economy and their families live and work in risky environments, vulnerable to numerous perils, including illness, accidental death and disability, loss of property due to theft or fire, agricultural losses, and disasters of both the natural and man-made varieties. The poor are more vulnerable to many of these risks than the rest of the population, and yet they are the least able to cope when a crisis does occur.

Poverty and vulnerability reinforce each other in an escalating downward spiral. Not only does exposure to these risks result in substantial financial losses, but vulnerable households also suffer from the ongoing uncertainty about whether and when a loss might occur. Because of this perpetual apprehension, the poor are less likely to take advantage of income-generating opportunities that might reduce poverty.

One way for the poor to protect themselves is through insurance. In November 2006 the ILO, Munich Re Foundation and the CGAP Working Group on Microinsurance launched a new book, Protecting the poor: A microinsurance compendium ( Note 1), edited by Craig Churchill of the ILO's Social Finance Programme. Based on an analysis of over 40 microinsurance schemes around the world, and drawing on the expertise of more than 35 authors, this book synthesizes key lessons about the provision of insurance to low-income households.

Where is the protection?

In many developing countries, neither governments nor insurance companies have been particularly effective in extending coverage to people in the informal economy. Where governments have social protection schemes, they are often delivered through formal sector employers, typically with the employers contributing on a cost-sharing basis. Naturally, such approaches do not reach unorganized workers, both employed and self-employed, in the informal economy.

Although some insurers are beginning to notice the vast under-served market of low-income households, numerous obstacles need to be overcome if they are to offer microinsurance. Like social protection schemes, the distribution systems of most insurers are not designed to serve the lowincome market. The system of brokers, agents and direct sales traditionally used by insurers does not reach the poor. In addition, the products generally available from insurers are not designed to meet the specific characteristics of the low-income market. Key product design issues include inappropriate insured amounts, complex exclusions and indecipherable legal policy language, all of which conspire against effectively serving the poor.

Profitable microinsurance requires large volumes of very small policies. The transaction costs associated with managing these small policies can be extremely high, especially when seen in proportion to the sum assured. For microinsurance to have any value to the policyholder, significant innovations are required to minimize the transaction costs, for insurer and policyholder alike.

Insurers often assume that the low-income market cannot afford insurance. Interestingly, when insurance first became widespread in the late 19th century, it was seen as a poor man's financial service. Many of today's large insurance companies began in the 1800s as mutual protection schemes among factory workers. The wealthy did not need insurance because they could essentially selfinsure. Somewhere along the way, as insurance became more sophisticated and the wealthy recognized their vulnerabilities, the perceptions reversed.

A major challenge in extending insurance to the poor is educating the market and overcoming its bias against insurance. Many are sceptical about paying premiums for an intangible product with future benefits that may never be claimed – and they are often not too trusting of insurance companies. Creating awareness about the value of insurance is time-consuming and costly.

To be fair, the bias goes in both directions. The people who work for insurance companies are usually unfamiliar with the needs and concerns of the poor. Similarly, the culture and incentives in insurance companies reward and encourage salespersons to focus on larger policies and more profitable clients, and discourage staff from selling insurance to the poor.

The two faces of microinsurance

Microinsurance is essentially a variety of strategies intended to overcome these obstacles. The book identifies two main motivations for providing microinsurance: one focused on extending social protection to the poor in the absence of appropriate government schemes; the other offering a vital financial service to low-income households by developing an appropriate business model that enables the poor to be a profitable (or sustainable) market segment for commercial or cooperative insurers.

Yet these two varieties have much in common. The book considers microinsurance like Janus, the ancient Roman god of gates and doors, also the god of beginnings, who is depicted with two faces, yet one body. Regardless of whether one is looking at microinsurance from a social-protection or a market- based approach, the body of the insurance scheme, its basic operations, will be largely the same. Hence a book on microinsurance operations must draw lessons and experiences from both.

Regardless of which face of Janus one uses to view microinsurance, the intention is to reduce the vulnerability of the working poor by enticing the public (social protection) and the private sector (new market), or both, to do what neither has been particularly effective in doing: providing insurance to the poor. Since these two faces have the same head, it is reasonable to explore areas of convergence to create alternative models or systems of protecting the poor, such as public/private partnerships, mutuals and cooperatives, and government-provided incentives to correct market failures.

Even though the book covers different insurance products delivered by a variety of institutional arrangements across four continents, a clear picture of microinsurance – both challenges and solutions – is beginning to emerge. The findings reveal that microinsurance is indeed viable, and even profitable under certain circumstances.

Whether the scheme covers its costs with the assistance of donors and governments, or from premium revenues and investment income, sustainability ensures permanent access to services. The sustainability dilemma boils down to a trade-off between three competing objectives. Microinsurers have to find a balance between 1) coverage, meeting the needs of large volumes of low-income people, 2) costs, operating costs and transaction costs for the insurer, and 3) affordability, representing the price and transaction costs for clients. Successful microinsurance schemes usually involve their members or clients in choosing the benefits and levels of coverage that they can afford.

Who is the book for?

The primary audience for Protecting the poor is insurance professionals and practitioners working in the field who are currently offering insurance to low-income persons or thinking about doing so. The book was written in the hope that they would be able to learn from the experiences of those who came before, both those who have succeeded and those who have failed.

Protecting the poor is also intended for persons who assist practitioners, such as technical assistance providers and donors. By having a better understanding of the challenges and potential solutions, these individuals and organizations can use their financial and human resources more effectively to expand access to insurance.

Policymakers and regulators represent a third category of readers. As a new field of activity, microinsurance often operates in an environment that was not designed for it, and which can even be characterized as hostile. By acquiring an appreciation for the key differences between insurance and microinsurance, and recognizing where microinsurance potentially fits into a broader social protection framework, regulators and policymakers can begin to craft an enabling environment to nurture and support the growth and development of microinsurance and to promote more inclusive insurance markets.

Protecting the poor covers a range of issues. Besides defining microinsurance, it provides insights into the risk-management needs of lowincome households and explains the critical social protection function of microinsurance. It analyses key lessons about health insurance, long-term life insurance and short-term insurance linked to savings and credit products, as well as the adaptation of insurance products to address the characteristics of women and children.

The book also explores microinsurance operations in detail. It includes chapters on product design, marketing, premium collection, claims, pricing, financial and risk management, governance, organizational development and loss prevention. It also considers a variety of institutional arrangements for delivering insurance to the poor, including partnerships between insurers and MFIs, the community-based approach, insurance companies owned by networks of savings and credit cooperatives, and distribution through retailers.

In addition, the book considers the role of different stakeholders, including donors, regulators, governments, insurers and reinsurers, and technical assistance providers. It summarizes the strategies to overcome the trade-offs between coverage, costs and price, and provides an outlook on future developments in microinsurance.

Overall, the book considers microinsurance as a "back to basics" campaign, to focus on the risk-management needs of vulnerable people, and to help them manage those risks through the solidarity of risk pooling. Although not all microinsurance schemes are true to these values, the book concludes that the closer they can come, the more likely they will benefit the people who need them most.

What is microinsurance?

How poor do people have to be for their insurance protection to be considered micro? Generally microinsurance is for persons ignored by mainstream commercial and social insurance schemes, persons who have not had access to appropriate products. Since it is easier to offer insurance to persons with a predictable income, even if it is a small sum, than to cover informal economy workers with irregular cash flows, the latter represent the microinsurance frontier.

Microinsurance does not refer to the size of the risk carrier, although some providers are small and even informal. There are however examples of very large companies that offer microinsurance, such as AIG Uganda, Delta Life in Bangladesh and many insurance companies in India, that have a product line that is appropriate for low-income persons.

Microinsurance also does not refer to the scope of the risk as perceived by the clients. The risks themselves are by no means "micro" to the households that experience them. Microinsurance could cover a variety of different risks, including illness, death and property loss – basically any risk that is insurable. This book, however, focuses primarily on life and health insurance, as demand research across many countries identifies illness and death risks as the primary concern of most low-income households.

Munich re Foundation and CGAP

Drawing on the vast experience and accumulated knowledge of its parent company, the reinsurer Munich Re, the Munich Re Foundation aims to put this knowledge at the service of humanity. Helping people to cope with risk and to improve their living conditions, it particularly focuses on risk situations intensified by the global challenges of population growth, diminishing resources, environmental pollution and climate change. The foundation is actively involved in areas encompassing education and training, science and research, disaster prevention, environmental protection and public healthcare. For further information see www.munichre-foundation.org.

The Consultative Group to Assist the Poorest (CGAP) is a consortium of 33 public and private development agencies working together to expand access to financial services for the poor in developing countries. The CGAP Working Group on Microinsurance includes donors, insurers and other parties interested in coordinating donor activities as they pertain to the development and proliferation of insurance services to low-income households. The main activities of the Working Group include developing donor guidelines, commissioning research, publishing a quarterly newsletter on microinsurance and managing the content of the Microinsurance Focus website www.microfinancegateway.org/section/ resourcecenters/microinsurance.

Note 1 - Protecting the poor: A microinsurance compendium, edited by Craig Churchill, copublished by the International Labour Office, Munich re Foundation and CGAP, Geneva, 2006.