Microinsurance refers to insurance designed to protect low-income people against specific perils in exchange for low premiums. Microinsurance products aim to protect people from the risks most commonly faced by poor people. Premiums tend to be low yet proportionate to the likelihood and cost of the risk involved.
Microinsurance can be delivered through a variety of channels, including small, community-based organizations, credit unions and other microfinance institutions, utility companies, schools, churches, retail stores, and many others. Providers can range from small informal schemes to large, global insurance companies.
Poor people live and work in risky environments, vulnerable to illness, accidental death and disability, loss of property due to theft or fire, agricultural losses, and natural and man-made disasters. Not only can exposure to these risks result in substantial financial losses, but vulnerable households suffer from the ongoing uncertainty about whether and when a loss might occur. The poor are less likely to take advantage of income-generating opportunities that might reduce poverty because of this perpetual apprehension. Although there is little evidence-based knowledge of the impact of insurance on poverty reduction, microinsurance can help reduce the vulnerability that poor households face and as a consequence, enable the poor to improve their lives.
One of the greatest challenges for microinsurance is the actual delivery to clients. There are four main methods for offering microinsurance: partner-agent model, community-based model, full-service model, and provider-driven model. There are also a number of hybrid models. Each of these models has its own advantages and disadvantages.
- Partner-agent model: The MFI acts as the agent, marketing and selling the product to its existing clientele through a distribution network it has already established for its other financial services. The insurance provider acts as the partner, providing actuarial, financial, and claims-processing expertise, and the capital required for initial investments and reserves as required by law. The insurer also absorbs the risk.
- Community-based/mutual model: The policyholders or clients are in charge, managing and owning the operations, and working with external healthcare providers to offer services. This model is advantageous for its ability to design and market products more easily and effectively, yet is disadvantaged by its small size and scope of operations.
- Full service model: The MFI providing insurance services is in charge of everything; both the design and delivery of products to the clients, sales, services and claims assessment. The MFI works with external healthcare providers to provide the services. The insurers (MFIs) are wholly responsible for all insurance-related costs and losses, but they also retain all profits. This model has the advantage of offering MFIs full control, yet the disadvantage of higher risks and an eventual lack of insurance technical knowledge.
- Provider-driven model: Under this model, the service provider and insurer are the same. Similar to the full-service model, the insurer is responsible for all operations, delivery, design, and service. There is an advantage once more in the amount of control retained, yet disadvantage in the limitations on products and services.
- Credit life insurance is the most common and ensures the “debt dies with the debtor.” It is actually used to protect lenders, not the families, from the death of their clients and is often offered directly by MFIs
- Term life or personal accident insurance is often offered alongside credit life insurance to cover the family if a borrower dies.
- Savings life insurance is often used to stimulate savings.
- Health insurance is probably the product in greatest demand among poor and low-income households; however, it is also the most complex risk to cover due to higher information asymmetries between the insurer and insured. These information asymmetries lead to potential higher risks of moral hazard and adverse selection, which have so far proven tricky for commercial insurers. As a result, many often write-off health as an area where it is difficult to provide microinsurance on a viable basis, and prefer to focus on the simpler products described above. However, organizations following the mutual model can leverage local information and peer pressure to address moral hazard issues, and by affiliating “en-bloc” can greatly reduce the risk of adverse selection.
- Property insurance is nearly always linked to a loan and may help a borrower continue repaying his or her loan only if something happens to the property (usually livestock). In some cases, replacement of the property is also covered. Endowment policies combine long-term savings and insurance with emergency loans against the savings balance. In this case, the premium payments accumulate value.
- Agricultural insurance is particularly tricky, and little evidence exists of viable programs. The problem is that insured farmers are less likely to pursue sound practices and therefore are more likely to lose their crops. It is difficult to calculate the probability of loss because so many factors can influence crop yields. At the same time, premiums that farmers can afford are not usually sufficient to cover claims and administrative costs. Recent innovations that link insurance to rainfall and other weather conditions are promising, because they may be more measurable, objective, and viable.
Designing a sound microinsurance scheme is challenging and complex, requiring specific technical expertise and/or data that most MFIs and community based organizations do not possess. Trial and error often help institutions to arrive at the right combination of prices and services, but technical assistance can help resolve this issue and avoid costly errors.
In poor areas, demand is often thin due to the regular premiums members must pay, lack of education on insurance and bad image of insurers vis-à-vis the poor. If the pool of policyholders is too small, volatility in the number of claims can lead to an unexpected increase in claims, thereby bankrupting the plan. Although no precise minimum number of policyholders can be established, fewer than 1,000-2,000 people are likely to create undue risk for the provider.
Covariant risk is another challenge for insurers. Risks covered by insurance should affect only a relatively small portion of the total insured population at any given time. If a risk such as a flood or HIV/AIDS is likely to cause similar damage to a large portion of an MFI’s clients at the same time, a single occurrence of the risk would bankrupt the plan.
Moral hazard and adverse selection also make it difficult to provide insurance. Moral hazard arises when individuals can take advantage of the insurance to deliberately overvalue their assets and make claims for losses that they help incur. Adverse selection occurs because individuals with health problems or expectations of health problems are more likely to purchase insurance. This raises the cost of insurance provision.