Characteristics and Challenges of Microinsurance Operations in Developing Countries

Table of Content

ABBREVIATIONS

LIST OF ILLUSTRATIONS AND TABLES

1 Introduction

2 Microinsurance Framework
2.1 Definition of Microinsurance
2.2 Origins and Current Development of the Microinsurance Market
2.3 Microinsurance as part of Microfinance

3 Demand
3.1 Vulnerability and Risk Management of the Low-Income Population
3.2 The Bottom of Pyramid Concept in Microinsurance
3.3 Need versus Demand for Microinsurance

4 Microinsurance Products
4.1 Insurable Risks
4.2 Product Design
4.2.1 Terms of Cover
4.2.2 Premium Amount
4.2.3 Frequency and Mode of Premium Payment
4.2.4 Coverage
4.3 Microinsurance Products

5 Supply
5.1 Participants in the Microinsurance Market
5.2 Risk Carrier
5.2.1 Commercial Insurers
5.2.2 Non-Commercial Insurers
5.3 Enabler
5.3.1 Capacity Builders
5.3.2 Operational Specialists
5.3.3 Funders
5.4 Distribution Channel

6 Adapting Business Operations For Microinsurance
6.1 Marketing and Consumer Education
6.2 Customer Service and Benefits
6.3 Technology and Communication
6.4 Risk Management, Control and Claim Processing

7 Conclusion and Future Outlook

APPENDICES

REFERENCES

ABBREVIATIONS

illustration not visible in this excerpt

LIST OF ILLUSTRATIONS AND TABLES

Illustration 1: People Covered by Microinsurance (in millions)

Illustration 2: Insurance Premiums in Emerging Markets in 2010 and their Growth Rates

Illustration 3: Impact of Shocks on Household Income and Assets

Illustration 4: Risk Management Choices

Illustration 5: The Concept of BOP for Microinsurance

Illustration 6: Mismatch of Demand and Supply of Coverage

Illustration 7: The Microinsurance Supply Chain

Illustration 8: Explaining the Basics of Insurance: Example of NHIF insurance

1 Introduction

Ever since Muhammad Yunus was been awarded the Nobel Peace Prize in 2006 for his idea to lend to the poor, the topic of microfinance has gained immense popularity. Microinsurance entered the scene much later than microcredit and microsavings products and just recently attracted greater attention by a wider public.

Ten years ago hardly any commercial insurance company recognized a profitable market in the so-called bottom of the pyramid; the low-income segments of developing countries. In 2004, the Indian Ocean tsunami caused about 230,000 deaths and devastated large parts of Indonesia, Thailand and India.^[1] Still, it did not have a significant impact on commercial insurers.^[2] Comparing the last centuries´ most significant natural disasters worldwide with the most costly insurance losses, we find that practically none of them had a large influence on commercial insurers.^{[3] [4]} The reason is rather simple: almost all large-scale disasters happened in developing countries where the majority of population has no insurance coverage. Realizing this disparity lead to a turning point and was the origin of Allianz entering the microinsurance market, explains Michael Anthony, leader of the Allianz SE microinsurance program.^[5]

Today, many large insurers, such as AIG, Zurich and Munich Re have recognized the potential of emerging markets and became active in the microinsurance segment. Though, expansion is largely driven by governmental organizations and key players of development aid who enforce and support community-based organizations.

The attraction of this new instrument of microfinance is based primarily on two factors. Firstly, poor households in developing countries are not only exposed to many risks, they also have almost no strategies to overcome them. In general, they do not have access to social security systems, and private insurance markets are poorly developed and addressed to a wealthy minority. In this context, it is hoped that microinsurance provides low-income households with a possibility of reliable formal protection. Secondly, it drew attention from major insurers who spot an emerging multibillion market with huge potential for further development and the possibility of having a first-mover advantage.

The aim of this thesis is to show how the microinsurance sector is currently developing, under what circumstances insurers can realize growth opportunities and what actions must be taken to provide a valuable financial service.

The paper begins with a definition of microinsurance schemes, an overview on the roots and current development, followed by a distinction towards other microfinancial products. The second section will be dealing with the demand side and their particular living conditions, briefly illustrating traditional ways of hedging against risks. Then it will be outlined what risks can be insured and explain how microinsurance can be designed and exemplify the main products. Chapter five will be dealing with the different providers of insurance, describe other market participants and explain the specific distribution channels. Some key operations, such as marketing and the use of technology in microfinance will then be highlighted. Finally, the conclusion will summarize the particularities to consider in the microinsurance market and give an outlook to possible future developments.

2 Microinsurance Framework

2.1 Definition of Microinsurance

Insurance is per se defined as a risk management instrument referring to a temporary contract, in which the insurer agrees to reimburse the insured in case of an accidental event that results in losses.^[6] This protection is based on a risk-pooling mechanism where many people pay a small amount (premium) which will be accumulated to compensate those who sustain a loss. This risk-pooling mechanism makes it possible to cover losses exceeding the individual´s premium payments. Thereby insurance helps reducing vulnerability as households replace the uncertain prospects of losses with the certainty of having those covered by making small, regular premium payments.^[7]

Most commonly microinsurance is defined as „protection for low-income people against specific perils in exchange for regular premium payments proportionate to the likelihood and cost of the risk involved”.^[8] This definition implies that the basic functionalities are the same as for regular insurances. The International Association of Insurance Supervisors uses this definition, noting that it is not about governmental social welfare as premiums are in relation to risks.^[9] Although in its origins strongly connected to a development intention, it is increasingly about offering an affordable product with a reasonable cost-value ratio. The target group of low-income is not clearly specified whether being poor, working poor or emerging middle class. Churchill refers to “persons, ignored by mainstream (…) insurance schemes” while Roth uses the UN Development Index to define poverty, and many commercial insurers identify the bottom of the pyramid as their customers.^{[10] [11] [12]} Generally it can be said that microinsurance targets not the poorest of the poor, as evidently there has to be an insurable value and the possibility of paying the small premiums on a regular basis.^[13] Therefore descriptions coming from commercial insurers tend to primarily define the financial transactions, premiums and claim value as “micro” and refer to underserved or emerging markets.

In any case, “micro” does not refer to (I) the size of the risk carrier (insurance providers can be multinational companies as well as small, informal groups), (II) to the distribution channel (a variety of delivering systems exists: from community-based schemes and microfinance institutions to large commercial insurers), (III) the scope of the risk (as categorically insured risks are not perceived as micro by the households) nor the (IV) scale of this business.^{[14] [15]}

Moreover, microinsurance products can not be seen as standardized and determined through absolute numbers such as premium or amount of cover, although some regulation offices attempt to so, like the Indian Insurance Regulatory and Development Authority.^[16] As a result of growing markets the range of different products covering multiple risks at variable prices is increasing. The key difference in contrast to regular insurance lies in the specific needs of the target group and the associated lower premiums and payments in the event of damage as well as the set of operations used to provide customers with this financial service.

2.2 Origins and Current Development of the Microinsurance Market

Although the concept of microinsurance seems to be an innovation, it is practically a rediscovery of the roots of insurance companies in the industrial age. The mass popularization of insurance in industrialized countries commenced with cheap insurance policies which would be called microinsurance using today´s terminology.^[17] Those were either offered by commercial insurance companies or by mutual benefit societies and targeted low-asset factory workers.^[18] Since then, insurance has come a long way from collecting premiums at the factory gates to efficiently bundled products provided through employers and other specialized channels.

The first microinsurance trials in developing countries started as a rather charitable initiative in the 1990, when the ILO began to experiment with very cheap insurance policies, joined by local insurance companies and NGOs developing pilot projects. With the cooperation between commercial insurer AIG and the microfinance institution FINCA in Uganda the first partnership without any donor involvement was initiated in 1995.^[19] Still, many commercial insurers were deterred to enter this segment because of low premium volumes, high transaction costs and the lack of infrastructure in many developing countries.

After the millennium the interest in microinsurance has been continuously raising parallel to increasing popularity of microfinancial programs focusing on credits and savings.^[20] Within a decade the perception of the low-income segment changed vitally from donor receivers to potential consumer markets.^[21] Today, emerging markets have strongly moved into the focus of insurance companies and big players like AIG, Allianz and Zurich have become engaged in microinsurance. The significance of the new sector is also seen in the organizational level: Zurich for instance established its own microinsurance unit at headquarters level in 2007.^[22] Not only insurers, but also private investment funds like LeapFrog Investments or philanthropic foundations like the Bill & Melinda Gates Foundation are dedicated to microinsurance.^{[23] [24]}

Inspired by the success of microcredit and confronted with the issue of financial inclusion, it has become a central field of activity for development organizations like GIZ or Opportunity International to use market-based approaches as a tool for poverty reduction.

Huge investments and encouragement from commercial as well as charitable organizations have led to a dramatic increase in the number of insured clients from the first comprehensive landscape study in 2007 identifying 78 million people covered, to more than 135 million insured in 2009.^{[25] [26]} Latest research estimates the number of insured people^[27] worldwide to reach 500 million by 2012.^[28] The global distribution in percentage remains stable with 85 % in Asia, 15 % in South America, and only 5 % of insurants in Africa. With 60 % of all people covered by microinsurance worldwide, India spearheads the development, followed by strong growth in other Asian countries such as China, Bangladesh, Pakistan and the Philippines.

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This is due to dense populations attracting interest from public and private insurers, motivated partners in distribution and not least the active role of governments. For instance the Indian government not only strongly supports the development, but also introduced a regulatory framework that requires insurance companies to extend their business to rural areas with lower income.^[29] In South America the main markets are Brazil, Mexico, Colombia and Peru with growth being largely driven by the private sector targeting the upper poor class.^[30] More than half of the insured Africans live in South Africa, where the prevalent demand is for funeral insurance. The fast-paced development of microinsurance is also based on the fact that existing markets are saturated and market share can be increased only by crowding out competitors. Allianz predicts smaller NGOs and development aid to be displaced by multinational corporations and reinsurers within a few years time.^[31]

Insurers motivated to expand in the market face two main challenges: one being the need to create sustainable and profitable business operations and the other of providing a valuable but affordable product to the poor.^[32] For commercial insurers this means to tackle the issue of reaching the scale needed to balance risks, and at the same time improve efficiency to be able to answer the customers´ needs.^[33]

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Although insurers are reluctant to disclose data on economic performance and figures on profitability are barely available, there is clearly a growth in turnover. Between 2001 and 2010 the insurance industry was able to achieve a real increase in premiums of 11 % in emerging markets, compared to only 1.3 % in industrialized countries.^[34] However, figures include also the wealthier population and differences between markets and business practice inhibit the assessment of overall profitability.

2.3 Microinsurance as part of Microfinance

Microfinance is described as provision of small-scale financial services to low-asset people, in particular those who do not have access to financial services through established channels like conventional banking or insurance.^[35]

The very roots of microfinance were credits, over time supplemented by savings, pensions and insurance, as well as small transactions connected to microbanking. Insurance is particularly related to loans through credit life products, which are intended to prevent losing the gains achieved through the loan as soon as an unexpected loss occurs.^[36] Providers of microfinance services themselves have a growing interest in microinsurance. Naturally MFIs want to secure the loan against default and therefore attempt to limit the risks to life and health of the breadwinner. Otherwise there is a high probability that illnesses and death, accidents and other unforeseen events suddenly throw entire families back into poverty. Secondly, MFIs are using insurance schemes to diversify services in order to achieve market growth and to balance their risk portfolio.^[37]

Still, a crucial distinction is to be made between microinsurance on the one hand and microcredit and -savings on the other hand. The operations and basic mathematics of insurance are far more complex and poor people often lack basic knowledge on the functionality and the principles of insurance.^[38] Additionally households are reluctant to spend parts of their small incomes for an intangible product which does not show immediate results and has no guaranteed payout.^[39] A crucial factor is the reversed risk relation: to receive a microcredit the borrower must prove his trustworthiness, in the case of insurance it is the company that has to be trusted by the customer to be a reliable partner in the long-term future and to pay out claims when needed.^[40] This paradigm shift distinguishes microinsurance clearly from other microfinance products and is a critical issue when entering new markets.

3 Demand

3.1 Vulnerability and Risk Management of the Low-Income Population

In order to understand whether there is a demand for insurance products from the low-incomes in developing countries and what those products should include, it is necessary to first specify the risk situation.

Risk can be defined as the result of the combination of probability of potential danger or harm (hazard) and the ability to cope with the effects of those negative events (vulnerability).^[41] While hazard is very much depending on the sum of external events and individual living conditions, high vulnerability is a comprehensive background for the necessity of insurance.

Generally, developing countries have significant issues in providing comprehensive social protection to their population. It is estimated that less than 20 % of the population in developing countries is included in public health care or other social security systems.^[42] Existing mechanisms are often poorly developed or do not exist at all as governments lack sufficient funds or interest to invest in social protection.^[43]

A further challenge is posed by the high percentage of 80 % of the people working in the informal sector.^[44] The informal sector is typically characterized by irregular income that is subject to strong fluctuations and is often to be found less integrated into public insurance systems. Due to precarious employment situation and unstable living and working conditions people are exposed to a higher degree of hazard then wealthier or formal workers. For example the probability of suffering from serious diseases due to malnutrition or poor water quality is higher for the poor. Consequently, as people become ill more often, the expenses for health care are higher in absolute terms and in relation to household income.^[45] In case the breadwinner is affected, the only option many households have, is to use savings or borrowings to pay medical expenses. This leads to whole families falling into a downward spiral of poverty. Their vulnerability, meaning the lack of possibilities to cope with risks, is therefore much higher.^[46] Generally the loss of the breadwinner through illness or death is considered as the major risk by low-income families. This is followed by general illnesses or disability of family members and losses in assets including crop and livestock.^{[47] [48]}

[...]

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^[1] NewScientist (2005)

^[2] Statista (2012a)

^[3] Statista (2012b)

^[4] Statista (2012a)

^[5] Allianz SE (2010a)

^[6] Encyclopedia Britannica (2012)

^[7] Churchill (2006) p.14

^[8] Churchill (2006) p.12

^[9] IAIS(2007) p.10

^[10] Churchill (2006) p.13

^[11] Roth (et al.) (2007)

^[12] Kalra (2010) p.4

^[13] Hergert (2009)

^[14] Churchill (2006) p.13

^[15] Angove (et al.) (2012) p.8

^[16] IRDA India (2005) p.13

^[17] Microinsurance Network (2012)

^[18] McCord (2006) p.357

^[19] Creagh (2009)

^[20] Churchill (2002) p.381-387

^[21] Steiner/Giesbert (2010) p.2

^[22] Insurance Journal (2007)

^[23] Microfinance Focus (2010)

^[24] Meloche/Greenwood (2007)

^[25] Lloyd´s (2009) p.3

^[26] Roth (et al.) (2007) p.3

^[27] This refers not only to policyholders, but the number of people covered by one policy, such as spouse and /or children

^[28] ILO (2012) p.3-4

^[29] Giesbert/Voss (2009) p.4

^[30] ILO (2012) p.4

^[31] Allianz SE (2010b) p.33

^[32] Harrison/ Philips (2010) p.2

^[33] Kalra (2010) p.30

^[34] Kalra/ Futterknecht (2011) p.2

^[35] CGAP (2012a)

^[36] Otis (2011)

^[37] Mahalanobis (2010)

^[38] The European Business Review (2012)

^[39] Churchill (2006) p.42

^[40] The European Business Review (2012)

^[41] Kotze/Holloway (1999) p.47

^[42] The European Business Review (2012)

^[43] Loewe (2004) p.108

^[44] Loewe (2002) p.93

^[45] Cohen/Sebstad (2006) p.27

^[46] Ibid. p.25

^[47] Swiss Re (2010) p.4

^[48] Cohen/Sebstad (2006) p.27