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The Actuary The magazine of the Institute & Faculty of Actuaries
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Microinsurance: Small change, big reward

Microinsurance can be simplistically defined as insurance for the low-income population of developing economies. It has the potential to play a crucial role in reducing poverty and in improving living standards for low-income communities around the world. A decade into the 21st century, poverty is still a harsh reality for most of humanity. About 80% of the world’s population live on less than $10 a day and nearly 50% live on less than $2 a day (World Bank Development Indicators, 2008). The significant majority of people living on these incredibly low incomes have absolutely no access to financial services.
The Munich Re Foundation estimates that “of the four billion people [living on” less than $2 a day, fewer than 10 million have access to insurance”. Of course, a range of comprehensive strategies are required to try and reduce poverty. Providing access to financial savings and insurance services is only one, and arguably very important, piece of the proverbial jigsaw, which is where the field of microfinance is relevant.

What is microfinance?
Microfinance is the provision of financial services to the very low-income population, mostly living in developing countries. These people are often excluded from the mainstream financial services sector, or are unable to afford the terms offered by mainstream banks and insurance companies. Microfinance primarily focuses on unsecured lending of relatively small amounts usually for specific income-generating purposes. The loans are often given out to groups instead of individuals. This mechanism is supposed to help in utilising the loan most efficiently and in reducing default rates because of effective ‘peer monitoring’ among group members.

Current microfinance models have various strengths and weaknesses and these models are evolving on an ongoing basis. Microfinance institutions (MFIs) may operate with various objectives, ranging from a social, non-profit basis to a purely commercial basis. The Grameen Bank in Bangladesh is one of the most famous examples of an MFI. In 2006, the Grameen Bank shared the Nobel Peace Prize with its founder, Professor Yunus, who had started the bank in the 1970s by lending a sum of $27 to a group of 42 people.

Managing risks
As the recent devastating earthquake in Haiti and floods in Pakistan tragically show, the poor are particularly vulnerable to various risks, which threaten their property and livelihood. These risks include adverse weather, injury, death and poor health. The general importance of these risks also varies by country. For example, in Malawi, Bangladesh and Mexico, the risks of death due to HIV, flooding and earthquakes respectively are most important.

In the absence of insurance, people resort to informal risk management strategies. These strategies include accumulating buffer stocks; support from community, friends and relatives; and diversifying livelihoods. These strategies also include drastic measures such as reduction of household expenditure by removing children from school, migration to a different region and sale of vital assets such as livestock. These desperate measures often lead to a ‘poverty trap’, whereby people continue to live in poverty and suffer the consequences of an event many years after its occurrence. Hence there is an urgent need for more efficient risk management strategies to help the poor cope with various shocks. As the former UN Secretary General Kofi Annan said, “We cannot stop natural calamities, but we can and must better equip individuals and communities to withstand them”.

Features of microinsurance
Providing microinsurance is one such risk management strategy. Microinsurance products are often linked to microfinance loans. For example, the Jamii Bora Trust in Kenya realised that the cost of hospitalisation was one of the main reasons for its borrowers defaulting on loans. Consequently, it introduced a hospitalisation insurance cover linked to its microfinance loans.

Microinsurance often improves borrowers’ access to loans. Farmers in Malawi gained substantially better access to agricultural loans, after the introduction of a crop microinsurance product, with payouts linked to adverse rainfall. Microinsurance classes include health, agriculture, life, personal accident and unemployment covers.

A Lloyd’s Risk Insight report estimates that the potential market for microinsurance is 1.5 to 3 billion policies. One of the main challenges for the microinsurance industry is providing adequate cover for premiums that customers can afford and will be willing to pay. Since customers are primarily poor, microinsurance products should have relatively low premiums and correspondingly relatively low cover. The product design should be readily understandable to improve take-up and retention rates.

Two other important challenges are educating the poor about the need for insurance and distributing the product, often in remote geographical regions. MFIs help insurers tackle both these challenges. Like microfinance, microinsurance products are often sold to groups such as women’s associations, trade unions and self-help groups.

In Pune, India, an informal garbage collectors’ union quantified the economic benefits of the work done by their members in order to secure a group health insurance cover, funded by Pune Municipality. Community-based microinsurance products are often tailor-made, incur lower total expenses and may be relatively cheaper and more affordable than insurance for individuals.

Parties involved
Various parties are involved in the provision of microinsurance. For crop microinsurance an individual farmer may join a group (say, a farming collective), which interacts with an MFI. The MFI may be funded by members, governments and international organisations such as the World Bank. The MFI may be involved in various developmental projects and it may also sell insurance on a standalone basis or linked to microfinance loans. The MFI may be insured by an insurance company, which in turn may reinsure the risk. Reinsurers may further reinsure these risks or protect themselves using financial instruments such as catastrophe bonds. In general the risk may be financed by the pooling of individuals and groups, by MFIs, governments, insurers, reinsurers, cell captives and by using derivatives.

How can actuaries help?
The actuarial profession can play an important role in microinsurance. Rate-making may be particularly relevant since products have to offer ‘good value for money’ in order to be sustainable. The quality of data varies and often the data is of poor quality or is missing — these are situations that require actuarial judgment. Actuaries can potentially apply various pricing techniques to improve current methods, many of which may be relatively crude and overly prudent. Actuaries can also apply their skills in designing products, which reduces moral hazard and anti-selection, which are simple, more acceptable (by reducing or removing exclusions) and which also reduces basis risk by accurately compensating policyholders for the losses they incur.

An ongoing issue in crop microinsurance is the basis risk involved in the design of weather-indexed products, where benefits are linked to rainfall levels instead of the actual loss incurred by policyholders. Actuaries can also help in the risk financing, reserving and monitoring of microinsurance business. Furthermore, in collaboration with other professionals, actuaries can help in building an actuarial toolkit — consisting of simple models and guidance documents — which could be freely accessible to groups of policyholders, MFIs and all the other parties involved in microinsurance. Such a toolkit may go a long way in reducing the knowledge gap that often exists in this field.

When the insurance industry developed in Europe and the United States it often involved models that are strikingly similar to today’s microinsurance case studies. Historical examples include the ‘industrial life insurance’ sold door to door in the UK and fire insurance sold to low-income workers in Sweden.

The actuarial profession has an exciting chance of repeating history by participating in the provision of essential insurance to the poorest half of humanity, who need it the most.

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The Working Party’s paper on crop microinsurance was awarded the Brian Hey prize for the best paper presented to GIRO 2010.

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Agrotosh Mookerjee works with Aviva and chairs the UK Actuarial Profession’s microinsurance Working Party