PAPER WRAP-UP: The Potential Market for Insurance Among Poor Households

By Warren Brown and Michael J. McCord, published by USAID MBP’s Virtual Conference on MicroInsurance, October 2000, 9 pages, download here.

This paper focuses on two main questions: 1) What is known about poor households’ interest in using insurance to reduce risk, and 2) What, from the providers’ perspective, are the boundaries or limitations on where insurance can and cannot be provided for poor households? Are there ways to overcome some of these boundaries?

It begins by defining insurance and differentiating it from other services that also protect against risk. In sum, insurance is different from risk-management savings or credit because it protects against unexpected losses by pooling the resources of the many to compensate for the losses of the few—while the policyholder benefits by paying only the average loss rather than the actual cost of loss.

Next, the paper transitions to the main challenges and issues of microinsuarnce. Given the high level of vulnerability of poor households, their high exposure to risk and the expenses thus incurred are a major cause of poverty. However, the author notes, high vulnerability does not directly translate to high demand for risk protection, i.e., insurance. The following factors affect demand for microinsurance: 1) Informal coping mechanisms are widespread but of limited effectiveness; that is, family or community networks act as risk cushions and may provide obstacles to formal micro-insurance, or opportunities if they can be incorporated into the formal scheme. 2) Savings with withdrawal access may be more effective against smaller losses—“self-insuring” by withdrawing savings against unexpected losses will be effectual as long as the loss is small. 3) Poor households are often uncomfortable with the risk pooling concept. Even if insurance can provide effective protection that other financial services lack, people may be reluctant to accept the idea, especially if they pay premium but do not need to make a claim. Reluctance to pay into a scheme to other’s benefit and not one’s own is a hard concept to swallow. 4) Initial studies indicate strongest interest in protection against health and death risks.

In addition to these four factors, the design of micro-insurance schemes also affects demand for the product. This includes the following: size of claim paid relative to actual loss; timeliness of claims payments; flexibility in size of coverage; flexibility in scheduling premiums; continuity of coverage.

Next, challenges and issues related to the provision of micro-insurance are addressed. The design of economically sustainable insurance products is centered on 5 key issues. The first is achieving scale. An insurance scheme must have a large number of households participating, relative to the total population exposed to the covered risk. This is important because it reduces the potential for adverse selection—that is, only households with higher risk buy into the scheme, thus making claims much higher than expected. As well, it is important because it increases the likelihood that the variance of actual claims will be closer to the expected average number of claims used in calculating premiums. The second issue of importance is limiting policyholders’ control over the insured event. When the risk of moral hazard is present—the insured intentionally or unintentionally taking advantage of the insurance provider if they have control over whether or not the insured event will occur—protection must be set in place, in order to allow microinsurers to strike a balance between sustainability and restrictions placed on coverage.

A third principle is that mass co-variant risks are uninsurable; risks that will affect a significant portion of the population at the same time place too great a burden on the resources of the insurer for viable coverage to be feasible. However, this poses an obvious problem: many of the risks that face the poor in developing regions are highly co-variant, such as natural disasters. A single insurer will face bankruptcy if they cover such events. Fourth, there is great difficulty of obtaining the necessary information to set prices. Prices should be based on the likelihood of risks occurring; how many claims will be made in a given year, and for how much? However, records of events that inflict loss are often limited or non-existent in poor communities and as such, setting prices can be tricky. A fifth and final key issue to providing sustainable microinsurance is the decline in affordability as coverage becomes more complete. That is, as the amount of protection an insurance organization wants to offer increases, so do premiums. Thus, the products become less affordable for the very households the microinsurer is trying to protect.

As this paper is a briefing paper for USAID MBP’s Virtual Conference on Micro-Insurance, the paper also leaves readers with two sets of questions to contemplate. The first is centered on demand-related challenges and issues; what have been participants’ own experiences? The second is insurance provision-related questions and issues; what are the best ways to deal with the above five issues?

–Chryssa Rask, MicroCapital Writer

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