Frequently Asked Questions

What is microinsurance?

Microinsurance is defined as the protection of low-income people against specific perils in exchange for regular premium payments proportionate to the likelihood and cost of the risk involved. This definition is essentially the same as one might use for regular insurance except for the clearly prescribed target market: low- income people. How low-income people have to be for their insurance protection to be considered micro? Generally microinsurance is for persons ignored by mainstream commercial and social insurance schemes, persons who have not had access to appropriate products. Since it is easier to offer insurance to persons with a predictable income, even if it is a small sum, than to cover informal economy workers with irregular cash flows, the latter represent the microinsurance frontier.

Microinsurance does not refer to the size of the risk carrier, although some providers are small and even informal. There are however examples of very large companies that offer microinsurance, such AIG Uganda, Delta Life in Bangladesh and many insurance companies in India, that have a product line that is appropriate for low- income persons.

Microinsurance also does not refer to the scope of the risk as perceived by the clients. The risks themselves are by no means “micro” to the households that experience them. Microinsurance could cover a variety of different risks, including illness, death and property loss – basically any risk that is insurable. However, illness and death risks are the primary concern of most low- income households.*

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Why do we need microinsurance?

Workers in the informal economy and their families live and work in risky environments, vulnerable to numerous perils, including illness, accidental death and disability, loss of property due to theft or fire, agricultural losses, and disasters of both the natural and man-made varieties. The low-income people are more vulnerable to many of these risks than the rest of the population, and yet they are the least able to cope when a crisis does occur.

Poverty and vulnerability reinforce each other in an escalating downward spiral. Not only does exposure to these risks result in substantial financial losses, but vulnerable households also suffer from the ongoing uncertainty about whether and when a loss might occur. Because of this perpetual apprehension, the poor are less likely to take advantage of income-generating opportunities that might reduce poverty.

One way for the poor to protect themselves is through insurance. By helping low-income households manage risk, microinsurance can assist them to maintain a sense of financial confidence even in the face of significant vulnerability.

Among low-income populations, risk pooling and informal insurance are not entirely new. Informal risk-sharing schemes have been around for generations; however these schemes are usually limited in their outreach and benefits. A key aspect of the interest in microinsurance is to explore ways of significantly increasing the number of poor households that have access to insurance while enhancing the benefits.*

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Who is offering microinsurance?

Around the world, insurance is offered by formal insurers, microfinance institutions (MFIs), health institutions, agricultural and health cooperatives, traditional societies (e.g funeral societies), and many other types of institutions.

Microfinance institutions are perhaps in a unique position to provide microinsurance as they have extensive networks and are already offering financial services to poor clients. In some cases, MFIs link with formal insurance companies and act as agents for the formal insurer, although the insurer retains all of the risk. MFIs can also form joint ventures with formal insurers and share both risk and management. Some MFIs feel that while they have the networks among the poor, they are not technically proficient to provide insurance services. So, they team up with professional insurance providers who have the technical expertise in the area.

At present, it exits a variety of organisations providing microinsurance directly or indirectly. These service providers are for example, MFIs providing insurance and microinsurance companies, but also insurance and reinsurance companies, and organisations providing technical assistance to the sector.

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What are typical business models for microinsurance?

Microinsurance can be delivered through a variety of institutional arrangements. All models have significant potential as well as significant limitations. One way of possibly leveraging their potential while minimizing their short comings is by creating hybrid models that combine different approaches.

In the PARTNER/AGENT MODEL, insurers and MFIs team up to exploit each other's comparative advantages. Insurers utilize MFIs' efficient delivery mechanism, that provides the sales and basic services to the clients. MFIs benefit from being able to provide insurance to their clients with no risk and limited administrative burden. Karuna Trust Karnataka, India has entered such a partnership with National Insurance Corporation (NIC) to provide its clients insurance.

In the COMMUNITY BASED INSURANCE MODEL, the policyholders are themselves the owners and managers of the insurance program. This model is used mainly in health insurance. The members themselves design, develop, service and sell the product, and they negotiate with external health care providers. ALMAO, Sri Lanka is an example of this.

The FULL-SERVICE INSURANCE MODEL is similar to the model followed by formal sector insurers, when the provider is singly responsible for all aspects of product manufacturing, sales, servicing, and claims assessment. The insurers are wholly responsible for all insurance-related costs and losses, but they also retain all profits. SEWA, India is an example of a full-service provider.

Which are the basic insurance principles?

Basic principles that should be observed by microinsurance providers are universal to insurance and risk management. They include:

i. SIMILAR UNITS EXPOSED TO RISK. Insurers require that risks in a particular class or group of policies be similar. For example, a life insurer would require that holders of a certain life insurance policy all have similar exposure to the same types of death risk. Insurers also require that the group insured (or the "risk pool"), includes a large number of these similar risks, relative to the total population. Large numbers of policyholders reduce the potential for adverse selection (a situation where claims are higher than expected because only high-risk households purchase the insurance) and increase the likelihood that the variance of actual claims will be closer to the expected mean used in calculating premiums.

ii. LIMITED POLICY HOLDER CONTROL OVER THE INSURED EVENT. Insurance protection cannot be offered if policyholders can control whether an insured event will occur. If a policyholder has sufficient control over whether a risk can occur, they can take advantage of the insurance provider. Selling an insured truck and claiming it as stolen; setting fire to an old, insured home to build a new one with the insurance settlement; and failing to properly care for an insured goat thereby increasing the chance it will die of disease; all of these actions take advantage of the insurer by increasing their claims experience above expectations. These behaviors are called moral hazards.

iii. EXISTENCE OF INSURABLE INTEREST. Insurance cannot be provided to policyholders who have a vested interest in a loss occurring. A property insurance policy, for example, on a home cannot be sold to anyone other than the residents of the home.

iv. LOSSES ARE DETERMINABLE AND MEASURABLE. Insurance providers must have a mechanism for verifying the occurrence of a loss and identifying its cause and value.

v. LOSSES SHOULD NOT BE CATASTROPHIC. The risk-pooling mechanism of insurance breaks down against risks that cause large losses for a substantial portion of the risk-pool at the same time.

vi. CHANCE OF LOSS IS CALCULABLE. Setting insurance premiums requires estimating the size of expected losses and the chance of loss.

vii. PREMIUMS ARE ECONOMICALLY AFFORDABLE. In general, for an insurance policy to be an attractive purchase, the cost of premiums must be substantially less than the benefit offered by the policy.***

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How does microinsurance operate?

The design, delivery and management of microinsurance products have some unique complications. Particular challenges are the small premiums and benefits driven by the market’s limited resources and extreme cash flow constraints, which restrict the scope of underwriting, claims management and product complexity. These challenges require scale, innovation, efficiency, simplicity and intelligent risk management.

Moreover, some microinsurers have a more complex mandate than insurance companies. The financial and economic drivers of sound insurance business may be supplemented by a development agenda, for example to expand access as widely as possible or to ensure inclusion of certain risks that might be commercially excluded. Not all microinsurers are subject to these influences, but where they are, it is critical that sound risk-management principles are not sacrificed. Where “non-commercial” risk is taken, it must be understood and managed.

In general, product design must strike a balance between broad inclusion, appropriate benefits, low premium rates and sustainability (or targeted profitability). Products have to be customized to clients’ needs and references. Microinsurance is relatively easy if the target market is a well-organized group; significant challenges are faced when trying to serve unorganized individuals.

For microinsurance to succeed, the premium payment mechanism needs to find a balance between being efficient and being sensitive to the needs and capacities of clients. Simply collecting a large number of small premium payments may make the products more accessible to the poor, but can also result in higher transaction costs that drive up premium rates. Similarly, streamlined claims adjustment procedures have to identify false claims without burdening legitimate ones. Many microinsurers realize that claims are also their best marketing opportunity and they carefully structure their approaches to minimize the chances of rejecting claims.

Sound management and governance is one of the most important requirements for long-term success in the insurance business. It is an especially complex task because the bulk of an insurer’s assets are used to back future benefits that are payable contingent on the occurrence of insured events. Many microinsurers – particularly those with roots in the development community – fall short of having an adequate level of financial and risk-management skills.

Strategies to enhance the management of microinsurance schemes include: outsourcing key aspects to experts, including pricing to actuaries; performance benchmarking to better understand how well the organization is doing relative to other, similar schemes; education and awareness campaigns to prevent claims; and strategies to achieve high participation and persistency rates help to reduce administrative expenses.*

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Which are the different microinsurance products?

In theory, microinsurance products could cover any risk that is insurable. In practice, most of the experiences to date have focused on death and health risks.

Successful products from the provider’s perspective generally do not meet the real risk management needs of low-income households. Where providers are able to link insurance coverage to another financial transaction, such as savings or a loan, it is much easier for insurance for the poor to be viable. However, this linkage is more common with short-term life covers than with health insurance. Similarly, greater success has been achieved when products are short-term in nature, although consumers often prefer longer-term protection, perhaps even one that would allow them to build assets.

Health cover, which is in most demand in many contexts, is much more difficult to design and deliver than life insurance. While for other product lines a consensus seems to exist that high cost, low frequency events are worth covering, this does not necessarily hold for health. The poor are aware of the burden of low cost, high frequency events; however these are difficult to cover for a health insurer. For a viable health insurance scheme, it is therefore recommended to involve the policyholders and the community in the business process and thus to mobilize their social capital. The better the interest of the insured and insurer correspond, the more viable the arrangement.

Owing to a number of factors, women, men and children are exposed to different types of risk. Furthermore, the same risks can affect them differently. Their behaviour towards risk management and their access to risk-management strategies may also differ. Greater attention to gender-specific needs is required. Shortcomings are exposed when the “household” or the “family” is considered as a (homogeneous) unit for risk- management strategies. Rather, emphasis needs to focus on gender-specific risk-management instruments. Even if products are jointly developed with female clients, their needs are not necessarily addressed; for example, insurers often exclude benefits such as gynaecological diseases and treatment related to pregnancy.*

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Who are the stakeholders?

The development of microinsurance is not occurring in a vacuum. Many key stakeholders are or should be involved in the process of assisting low-income persons to access insurance coverage.

Microinsurance is growing in popularity among donors. The objectives of microinsurance – helping low-income people manage risks and stopping the vicious cycle of poverty and vulnerability – responds to many donor priorities. Whether from a social protection entry point or a private sector/financial approach (or a combination of both), donors are interested in the contributions of insurance to the Millennium Development Goals. Donor enthusiasm is cause for both caution and optimism. They are well-placed to step in and address both the public and private sector market failures. However, donors need to have a better understanding of microinsurance to intervene effectively.

A similar conclusion can be drawn from the involvement of regulators and policymakers who are tasked with the difficult challenge of create an enabling environment to enhance outreach to low-income persons while guaranteeing the sustainability of a growing microinsurance market. From the policyholder’s perspective, supervisors need to guarantee that the increasing number of semi- or informal microinsurance schemes uphold their obligations to their members. The protection of poor people’s scarce funds is a critical concern.

It is quite difficult to provide this consumer protection while at the same time encouraging innovative solutions to respond to the insurance needs of low-income households. Adjustments to regulatory frameworks are often perceived as being in conflict with prudential principles and run the risk of distorting the market place. Therefore, supervisors have to find a balance that promotes inclusion – which means extending insurance to the huge low-income market while protecting their investments and confidence – without putting an undue burden on supervisors. This is not an easy task.

One possible solution is through a greater involvement of reinsurance, whereby market mechanisms increase the likelihood of sustainability. Reinsurers can make a concrete contribution to implementing business processes that reduce the long-term cost of underwriting risk for low-income persons. Partnerships inspired by this motive can be of interest for both sides, as the commercial partners are best placed to adapt tried-and-tested methods of reinsurance and other modes of risk transfer, and microinsurers can expand the financial capacity of their schemes and underwrite more and larger risks.*

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What are the practices in microinsurance?

In many developing countries, neither governments nor insurance companies have been particularly effective in extending coverage to persons in the informal economy. Where governments have social protection schemes, they are often delivered through formal sector employers, typically with the employers contributing on a cost-sharing basis. Naturally, such approaches do not reach unorganized workers, both employed and self-employed, in the informal economy.

Although some insurers are beginning to notice the vast underserved market of low-income households, numerous obstacles need to be overcome if they are to offer microinsurance. Like social protection schemes, the distribution systems of most insurers are not designed to serve the low-income market. The system of brokers, agents and direct sales traditionally used by insurers does not reach the poor. In addition, the products generally available from insurers are not designed to meet the specific characteristics of the low-income market.

Profitable microinsurance requires large volumes of very small policies. The transaction costs associated with managing these small policies can be extremely high, especially when seen in proportion to the sum assured. For microinsurance to have any value to the policyholder, significant innovations are required to minimize the transaction costs, for insurer and policyholder alike.

A major challenge in extending insurance to the poor is educating the market and overcoming its bias against insurance. Many are sceptical about paying premiums for an intangible product with future benefits that may never be claimed – and they are often not too trusting of insurance companies. Creating awareness about the value of insurance is time-consuming and costly.

To be fair, the bias goes in both directions. The people who work for insurance companies are usually unfamiliar with the needs and concerns of the poor. Similarly, the culture and incentives in insurance companies reward and encourage salespersons to focus on larger policies, more profitable clients and discourage staff from selling insurance to the low-income households.

Whether the scheme covers its costs with the assistance of donors and governments, or from premium revenues and investment income, sustainability ensures permanent access to services. The sustainability dilemma boils down to a trade-off between three competing objectives. Microinsurers have find a balance between 1) coverage, meeting the needs of large volumes of low-income people, 2) costs, operating costs and transaction costs for the insurer, and 3) affordability, representing the price and transaction costs for clients.*

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What are the obstacles to designing a microinsurance product?

Several obstacles make it challenging to design a sound microinsurance scheme. Insurance is a complex matter requiring a certain degree of technical expertise that most MFIs simply do not possess. This is why many MFIs form partnerships with formal insurance companies who have the technical expertise. But even in this case challenges to serving the poor remain. In poor areas demand is often thin due to the regular premiums members must pay. It is often by trial and error that institutions can figure out the right combination of prices and services, and this takes time, effort, and skill. Insurers also find it very hard to operate in areas with frequent natural disasters of very large magnitude.

Two other factors, those of moral hazard and adverse selection, make it difficult to provide insurance. Moral hazard arises because individuals take advantage of the insurance to deliberately overvalue their assets and make claims for loss that they help incur. Adverse selection occurs because only individuals who are prone to a particular risk would purchase insurance against it. These raise the costs of insurance provision.

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Where can I find microinsurance definitions?

For questions about insurance terms, specific glossaries are available here.

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*Source: Executive Summary Protecting the Poor: A Microinsurance Compendium, edited by Churchill, C., April 2007

**Source: Adapted from Health care microinsurance - Case studies from Uganda, Tanzania, India and Cambodia by McCord, M., Dec. 2000

***Source: Insurance provision in low-income communities: Part 2: Initial lessons from micro-insurance experiments for the poor by Brown, W. and Churchill, C., May 2000