Universität Passau

Formal Microinsurance in Indonesia - an advantage over informal risk mitigation strategies for low-income people?

Daniel Weiss

Table of Contents

1. Introduction ... 1

2. Scope, methodology and structure of the study ... 3

3. An introduction into microinsurance ... 5

3.1 Microfinance ... 5
3.2 Microinsurance as a microfinance service ... 6
3.3 The principles of providing insurance ... 7
3.4 The framework for microinsurance in Indonesia ... 8
3.5 Microinsurance products ... 10
3.6 Critical issues for microinsurance providers to effectively serve the poor ... 11
3.6.1 The minimum required pool size ... 11
3.6.2 Group or individual insurance ... 12
3.6.3 Minimizing transaction costs – possible distribution channels ... 13
3.6.4 Setting prices and valuing losses ... 16
3.6.5 Protecting against adverse selection, moral hazard and fraud ... 18
3.6.6 Claims management ... 20
3.6.7 Premium payment ... 21
3.6.8 Marketing and market education ... 22

4. Traditional risk mitigation of the poor in Indonesia ... 23

4.1 Background ... 23
4.1.1 The economic environment of low-income households ... 23
4.1.2 Defining vulnerability ... 23
4.1.3 Risks poor people face in Indonesia ... 25
4.1.4 Risk management strategies ... 27
4.1.5 Risk management arrangements ... 28
4.1.6 The impact chain of risk events ... 30
4.2 Individual risk mitigation strategies ... 31
4.2.1 Diversify income sources ... 31
4.2.1.1 Effectiveness and secondary impacts of diversification ... 33
4.2.2 Saving up assets and cash ... 35
4.2.2.1 The usefulness of different assets and cash ... 38
4.2.2.2 Effectiveness and secondary impacts of saving up ... 40
4.3 Group-based risk mitigation strategies ... 44
4.3.1 Reciprocal transfers ... 44
4.3.1.1 Effectiveness of reciprocal transfers ... 45
4.3.2 Rotating savings and credit associations (ROSCAs) ... 48
4.3.3 Accumulating savings and credit associations (ASCAs) ... 50
4.3.3.1 Effectiveness and secondary impacts of ROSCAs and ASCAs ... 53

5. The Microinsurance sector in Indonesia ... 59

5.1 Demand for microinsurance in Indonesia ... 59
5.2 The demand-supply gap – the market for microinsurance products in Indonesia ... 60
5.3 Overview of Indonesian microinsurance providers ... 61
5.4 Microinsurance products in Indonesia ... 62
5.4.1 Credit life insurance ... 62
5.4.2 Sharia-compliant accident life insurance ... 63
5.4.3 Education endowment insurance ... 65
5.4.4 In-patient hospitalization plan ... 67
5.4.5 Effectiveness and secondary impacts of microinsurance ... 69

6. Individual and group-based risk mitigation strategies in comparison to microinsurance ... 73

6.1 Coverage ... 73
6.2 Accessibility ... 76
6.3 Timeliness ... 77
6.4 Secondary impacts ... 78

7. Conclusion ... 80

Appendix 1: Degree of institutional risk in providing insurance ... 84
Appendix 2: Shocks and their impact ... 85
Appendix 3: The insurance density and penetration in selected Asian countries ... 86
Appendix 4: The Indonesian insurance industry ... 87

References ... 88

1. Introduction

Around 52.4%¹ of Indonesia’s 242 Mio. inhabitants² have to live and struggle with an income - respectively a purchasing power parity - of less than two dollar per day. All people who live on less below this international benchmark – set by the World Bank – are considered as poor.³ The poor who dispose of only one dollar a day are considered the extreme or very poor whereas those who have a daily income between one and two dollars are considered as the moderate poor. Both groups are referred to in this work as the poor or low-income households.

Figure 1 (only avaliable in download-version)

These low-income households in Indonesia face disadvantages as they are highly vulnerable to risk events such as health or property risks. The concept of vulnerability describes the poor people’s inability to deal with losses which result from the occurrence of an adverse event, e.g. illness or disability⁴ and is based on two perceptions. Poor people are most exposed to hazards as they often live and work in a perilous environment. In addition, the poor are the group in society least capable of dealing with losses after the occurrence of risk events. In Indonesia at least “two fifth of the population near the poverty line are …highly vulnerable to even modest shocks to the economy”.⁵ Thus, the economic situation of low-income households is intricate in two ways:

„Poor households throughout the world face twin disadvantages. The first is difficulty in generating income, while the second is vulnerability to economic, political and physical downturns. Harder still, the two disadvantages reinforce each other; poverty is a source of vulnerability and repeated exposure to downturns reinforces poverty.”⁶

Besides vulnerability the economic situation of low-income households in Indonesia forms a barrier for the use of financial services in general. As low-income households face difficulties in generating regular incomes they only dispose of small funds that can be used as savings, credit collateral or insurance premium. The poor seem to be too poor to afford the premiums for commercial insurance products because these products are designed for the middle and upper-class market segments. As the poor are not able to purchase commercial insurance products they have to have to use alternative measures for dealing with their risks.

Poor people in Indonesia therefore take on - mostly informal - strategies to deal with risk events. They usually apply three different strategies which can be subsumed as risk management strategies. Through risk prevention strategies they try to put a stop to the occurrence of a risk upfront. Through risk mitigation strategies they try to build up reserves (upfront a risk event) for dealing with the impacts that a risk event induces. Risk coping strategies however, attempt to relieve the impact of a risk event that has already taken place.

Usually poor people try to mitigate their risks through saving up cash or assets, lending money to friends and family with the expectation of repayment. Furthermore, they regularly join saving clubs. The funds they save or lend serve as a protection against the impact of risk events such as high hospital bills or for funeral costs. The above mentioned measures are most often conducted informally in contrast to a formal risk mitigation strategy – microinsurance. Microinsurance is a risk mitigation strategy as it is applied upfront a risk event and tries to lower the risk impact through pooling the risks of many policyholders.

2. Scope, methodology and structure of the study

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1 See United Nations Development Programme, UNDP Human Development Report, 2005, p. 228
2 See Central Intelligence Agency (Internet), http://www.cia.gov/cia/publications/factbook/geos/id.html, 15.11.2005
3 See World Bank (Internet) http://web.worldbank.org/WBSITE/EXTERNAL/TOPICS/EXTPOVERTY/EXTPA/0,,content MDK:20153855~menuPK:435040~pagePK:148956~piPK:216618~theSitePK:430367,00.html, 15.11.2005
Other indexes do exist as well such as the national poverty line – a threshold defined by the national authorities or Sen’s poverty index. I concentrate on the World Bank definition of poverty in order to highlight the approximate number of poor people in Indonesia according to the most widely used index.
4 See Brown/Churchill, Providing Insurance to Low-Income Households, 1999, p. 1
5 Jansen/Hamp/Hannig, Microfinance in the Rural Financial System and the Development of the Local Economy, 2004, p. 1
6 Matin/Hulme/Rutherford, Financial Services For The Poor And Poorest: Deepening Understanding to Improve Provision, 1999, p. 9