DONOR INFORMATION RESOURCE CENTRE Helping to Improve Donor Effectiveness in Microfinance Microinsurance: A Risk Management Strategy

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Overview  What risks do poor people face and how do they protect themselves?  What is microinsurance?  What are the difficulties in providing insurance to poor people?  What are some microinsurance delivery models?  What are some dos and don’ts for donors?

What Risks Do Poor People Face? Key Risks  Death  Illness or injury  Loss of property (theft, fire)  Natural disaster (earthquake, drought) “Life is one long risk” Microfinance client in the Philippines

How Do Poor People Protect Themselves from Risk? Preparation Coping Prevention and Avoidance Careful sanitation Identifying business opportunities Saving Accumulating assets (i.e., livestock) Buying insurance Educating children Taking emergency loans Depleting savings Selling productive assets Defaulting on loans Reducing spending

Alternative Coping Strategies Social Conditions Education, Biases, Risk Tolerance Cash Flow Planning Propensity Understanding the Demand for Risk-Managing Financial Services The demand for Liquid savings Emergency loans Microinsurance depends on Poverty Level Type of Risk

Very Large Small Certain Highly Uncertain Degree of Uncertainty Relative Loss / Cost Life Cycle Events Death Disability Health Property Mass, Co- variant Different Financial Services for Different Risks Source: Warren Brown and Craig F. Churchill, Insurance Provision in Low-Income Communities, Part I. Flexible Savings and Credit Insurance Flexible Savings Partial protection

What Is Microinsurance? Protection of low-income people against specific perils in exchange for regular monetary payments (premiums) proportionate to the likelihood and cost of the risk involved. To serve poor people, microinsurance must be: Responsive to their priority needs for risk protection Easy to understand Affordable ONESTRATEGYONESTRATEGY

Basic Insurance Principles Large number of similar units are exposed to the risk (risk pooling) Policyholder control over the insured event is limited (minimize moral hazard and adverse selection) Insurable interest exists Losses are determinable and measurable Losses should not be covariant (catastrophic) Chance of loss is calculable Premiums are economically affordable

What Are Some of the Difficulties in Providing Insurance to Poor People? Technical Specialization Requires specialized actuarial capacity, which is complicated by the lack of reliable data characteristic of low-income, informal markets Most poor people do not understand insurance or may be biased against it Requires a distribution system that can handle small financial transactions efficiently in convenient locations, and engender trust Marketing and Sales Distribution Channels

Relative Complexity of Insurance Products  Crop insurance  Health and disability insurance  Annuities and endowment (retirement provision)  Property insurance  Term life insurance (payment to beneficiaries on death) HIGHLY COMPLEX SIMPLER

Degree of Risk in Providing Insurance Moral Hazard Fraud Adverse Selection Overusage Limited Risk Moderate Risk Substantial Risk Health Insurance Property Insurance Life Insurance

The Dismal History of Crop Insurance Unspecific Coverage By guaranteeing a minimum crop yield, programs insured against all possible causes of poor crop yield, an endless list of risks Covariant Losses Many programs were bankrupted when a natural calamity affected most insured members at once Moral Hazard Farmers were less likely to follow sound husbandry practices because all severe yield losses were protected, leading to increase in claims Balance of Risks Coverage was focused in specific regions and provided only for poor farmers, covering only the highest risks Trying to provide insurance in uninsurable conditions:

Activities Involved in Offering Insurance Product Sales Marketing, education, signature of policies Product Manufacturing Design issues such as pricing, claims procedures, level of coverage Product Servicing Premium collection, payment of claims Policy Holders

Some Microfinance Delivery Models  Partnerships between MFIs (or other intermediaries) and insurers  Full service provision where regulated insurers provide specific products to the low-income market  Health care service providers offer a health care financing package and absorb the insurance risk  MFI-based insurance where MFIs take on the risk offering insurance to their clients  Community-based programs where communities pool funds and manage a relationship with a health care provider

Examples of Microinsurance Delivery Partner-Agent Model Insurers utilize MFIs’ delivery mechanism to provide sales and basic services to clients There is no risk and limited administrative burden for MFIs Example: FINCA Uganda partners with American International Group Community-Based Model The policyholders own and manage the insurance program, and negotiate with external health care providers Example: UMASIDA in Tanzania Provider Model The service provider and the insurer are the same, i.e., hospitals or doctors offer policies to individuals or groups Example: Gonoshatsasthya Kendra in Bangladesh Full-Service Model The provider is responsible for all aspects of product manufacturing, sales, servicing, and claims assessment The insurers are responsible for all insurance-related costs and losses and they retain all profits Example: SEWA in India

Example: AIG and FINCA Uganda Product Sales Policy Holders Product Manufacturing Product Servicing PartnerAgent FINCA Uganda AIG

Potential Market Are clients interested in insurance protection? Is this the most effective risk management solution? Linkage identified? Pre-requisites for Donor Intervention in Microinsurance Consider alternative risk- managing financial services Broker partnership, monitor performance YES NO Donor Skills and Knowledge Does donor have experience develop- ing markets for low income people? Does donor have basic insurance technical expertise? Does donor have access to local market knowledge? NO YES YES

Preliminary Guidance for Donors Consider client demand Invest in technical expertise Monitor performance Move cautiously and facilitate linkages Work with strong institutions 5

1. Consider Client Demand DO  Consider client demand to understand what risk-managing financial service is most appropriate  Invest in educating poor people on the benefits of insurance DO NOT Push institutions to offer microinsurance The demand for risk protection should come from clients, not donors

2. Move Cautiously and Facilitate Linkages DO Encourage commercial insurers to serve the poor by brokering relationships with MFIs DO NOT Try to influence government policies before there is more experience with microinsurance Coordinate microinsurance efforts with other donors, insurers, governments

3. Work with Strong Institutions DO Take a patient approach, but define a clear, time-bound exit strategy DO NOT Fund new microinsurance providers without sufficient technical capacity Work with strong institutions and conduct a careful analysis of their capacity to manage microinsurance products

4. Invest in Technical Expertise DO Provide access to technical assistance for specific technical problems DO NOT Provide grant funding to cover claims costs Be careful about supporting unregulated insurance schemes that lack expertise, access to reinsurance, or consumer protection oversight

For MFIs  Volumes of policyholders (% of women)  Premium and claim values  Loss ratios  Renewal rates  Average time for claim settlement, premium rate charged to clients  Administrative costs ratio For Insurers  Annual reviews of premiums written  Loss and expense ratios  Claims reserves ratio  Other reserves  Investment returns  Premium rate charged to the MFI  Net income, capital, and surplus Key Microinsurance Performance Indicators 5. Monitor Performance of Microinsurance Partners

Summary  Microinsurance is one of many financial services that helps manage risk  To serve poor people, microinsurance must respond to their priority needs for risk protection, be easy to understand, and be affordable  Insurance is a complex matter requiring technical expertise that most MFIs and donors do not possess  At present, the ability of donors to facilitate linkages and share knowledge on microinsurance is more important than providing funds for specific programs

Where to Get More Information Contact: Nataša Goronja 1818 H Street, NW Washington, DC Tel: Fax: Web: CGAP Working Group on Microinsurance, “Donor Guidelines for Funding Microinsurance,” (paper prepared for CGAP, Washington, DC, October 2003). Microinsurance: Improving Risk Management for the Poor, Nos. 1 and 2 (Luxembourg: ADA, August and November 2003). W. Brown, C. Green, and G. Lindquist, A Cautionary Note for Microfinance Institutions and Donors Considering Developing Microinsurance Products (Bethesda, Md., USA: DAI, 2000). C. Churchill, D. Liber, M.J. McCord, and J. Roth, Making Microinsurance Work for Microfinance Institutions: A Technical Guide to Developing and Delivering Microinsurance (Geneva: ILO, 2003). W. Brown and C. Churchill, Insurance Provision to Low-Income Households: Part I (Toronto:Calmeadow, 1999), and Part 2 (Bethesda, Md., USA: DAI, 2000).