Microinsurance: Solution to a Deadlock?
Microinsurance is insurance for the lower-income sector of our global community. It is an insurance sector tailored for the needs of those without access to means of financial inclusion such as banks, financial institutions, and insurance companies. The majority of microinsurance products (with the exception of a few) are currently either offered by small private firms or government entities and NGOs. But each sector is struggling with a variety of issues. The private sector lacks the investment funds and local information needed to enter this market. Governments and NGOs often have the funds necessary to subsidize this sector and also have the information needed to evaluate the risks but lack proper management and skills necessary to underwrite different types of risk. However, a PPP (Public-Private-Partnership) could be the solution to problems that each sector is facing.
Just like with standard insurance policies, microinsurance offers products ranging from life insurance, crop insurance, P&C (property and casualty) to even more enhanced products such as disability and unemployment insurance. Currently millions of people are using microinsurance products globally, with the majority of consumers concentrated in Southeast Asia such as India and Bangladesh. Climate change has made microinsurance an essential part of any economy that is reliant on agriculture, pushing more and more countries, especially those in Latin America, to enter this sector
According to the Microinsurance Network, microinsurance was first introduced in 1999 to provide insurance to the poor. (The concept of microinsurance is not new and can be traced back to Babylon and China as far back as 3000 BC.) In the 1990’s microfinance institutions (MFIs) began offering microinsurance as a tool to hedge their portfolios’ risk against their clients’ death. By providing credit life insurance policies, policies that pay off a borrower’s debt in the case of death, MFIs protected themselves against possible losses and the problems that come with collection from families. Most of these MFIs were active in south and southeast Asia, making these regions the birthplace of microinsurance, and subsequently expanded globally. According to research done by CGAP, the demand for microinsurance has been growing continuously over the years, yet we do not see enough investment in this sector, especially by larger global financial companies that have the means and tools of evaluating risks that are potentially impossible to evaluate by smaller entrants and governments. Swiss RE and AIG are amongst the first entrants offering a variety of insurance products.
Conventional vs. Microinsurance Policies
There are some major differences between conventional insurance and microinsurance products. Conventional insurance products are extremely complex, have certain often strict eligibility criteria, are long-term, with most companies familiar with risks they are insuring and a distribution channel that is separated from sales, which is often handled by brokers and agents. Microinsurance policies however, are somewhat the exact opposite of conventional ones. They are short-term, inclusive, have limited eligibility criteria, limited familiarity with risk by the insurer, and a single channel for sales, premium collection and claim payment. Microinsurance consumers need insurance policies that are specifically tailored to their needs (such as farming) yet affordable and simple in nature. For example, farmers’ cash flow is determined by the harvest season when they receive lump-sum payments, something conventional insurance companies are not comfortable with. Insurance companies prioritize returns, and seeking high returns they need to be very familiar with the risk they are insuring, market demand, and have a diverse pool of clients.
Some Thoughts on the Lack of Participation by Large Global Firms
There are several factors preventing large global firms from entering this market. First, it is the negative stigma that comes with microfinance products in general, including: high interest loans, high default rates, and personal hardships (e.g. publicized suicides in India in 2008). Second, there is almost no historical data that conventional insurance companies can use to accurately evaluate the risks associated with underwriting microinsurance policies. Another issue is the problem of delivery. Most microinsurance policies are issued for people living in very rural areas. Local brokers, which would ideally be the best method of delivery, are problematic due to high costs and also lack of supervision. In the case of microinsurance products, distribution channels need to go through low cost agencies on the ground often without any prior experience in providing insurance services. There are currently several distribution models that insurance companies use, each with its own pros and cons. The most common one is the use of agents or agencies on the ground. There are several problems with this model. First, the agent on the ground does not have incentives to sell good quality policies to his/her clients, and often just tries to maximize the number of policies sold, as the agency’s income is often commission based. More importantly, insurance companies cannot make many of these distribution models work without the help of local authorities, as most models rely on mandatory insurance policies for the whole community, village or city. Another obstacle that insurance companies trying to enter microinsurance markets face is the issue of local regulations. As noted, the business model for conventional line of insurance policies is very different than that of microinsurance mainly due to its inclusiveness and cost-efficiency properties. However, from the regulatory body’s point of view, they are both placed in the same bucket. Some countries like India have adopted new regulations that address both the vulnerability and limitations of microinsurance. However, this still remains an issue when it comes to other countries, especially the new entrants, such as Africa and Latin America.
Public Private Partnerships (PPP) Opportunities
An insurance PPP is defined as a contractual agreement between the public sector, represented by a ministry or local authority through a government program, and the private sector, represented by the insurance industry and its service providers and distribution partners, which combines business objectives with public policy goals in a cost-efficient and effective way. One of the reasons that PPPs can lead to an effective path forward for microinsurance is the policy objectives that many emerging economies hold when it comes to protecting the most vulnerable sectors of their societies. While insurance companies and governments often have different objectives, a collaboration between the two can ensure an effective and stable solution that would address the problems each sector is facing when it comes to microinsurance.
As mentioned before, insurance companies have business models that are short-term profit maximizing, often ignoring policy implications, distribution channels and regulatory restrictions. Governments are usually focused on long-term policy objectives, such as fighting poverty and vulnerability of those who are already at a disadvantage point due to lack of access to financial institutions. While governments have tried to act as insurance providers in the past, the result has been quite disappointing for the most part, mainly due to lack of efficiency and professional knowledge of insurance and risk assessment. However, governments usually have access to information insurance companies need to write effective policies. Also due to the lack of education and poor financial management, many local individuals would not voluntarily sign up for insurance policies, making them a de facto burden on the government in the case of catastrophes. With accurate information on hand, insurance companies can tailor microinsurance policies for the needs of each community or area, reducing the risk assessment costs significantly. Additionally, possible subsidies from the government can further bring down the prices of these already cost-efficient, high quality policies. Governments can also help insurance companies with distribution channels. While an insurance company would normally have to find local agents or agencies, risking moral hazard issues, going through already established government offices on the ground would reduce the risks and the costs significantly. Under this model, the government would act as a local agent with tremendous amounts of useful information on the risk the insurance companies would be insuring. Additionally, by passing regulations requiring farmers to insure their crop, the government would minimize its expenditures in the events of natural disasters and catastrophes.
While microinsurance PPPs are still relatively new and have only been implemented in a few countries, current evaluations conducted by the ILO show somewhat promising results. It appears that as long as governments and insurance companies can align their objectives, this sort of partnership can be achieved under different models for different types of insurance. Currently, for much of the emerging markets, the protection of the agriculture industry seems to be a priority. This is mainly due to limited government resources when it comes to helping farmers after a bad harvest, and is equally relevant to other insurance products such as health and life policies. It is important to note that for this model to be as effective in reality as it is in theory, there needs to be a solid legal and regulatory framework on the ground along with suitable infrastructure and data bases. (Amir Bolouryazad)