4.2 Key Characteristics

Next, we will look closely at Churchill’s definition to identify the key characteristics of microinsurance, which are summarized in Table 6.

The target group of microinsurance are low-income individuals and households. The typical microinsurance client is a woman who lives in a densely populated urban area or in a remote village of a country with little or no social safety net. She is self-employed or working in the informal sector. With limited or no education, she is either a working poor or faces a high risk of slipping back into poverty. She is severely credit-constrained – with limited or no access to financial products, such as savings account, consumer credit, and traditional insurance. She most likely cannot produce the documents required by the insurer for underwriting or claim payment, such as national identity card, birth, or death certificate. However, she is not destitute – she has some purchasing power that enables her to purchase insurance for at least some of the perils she faces. Those who are destitute and cannot afford to purchase microinsurance are in the purview of the government. This leads us to the second major characteristic of microinsurance: microinsurance is priced based on market principles.

We know from Module 4 that the price of insurance reflects the insurer’s expected loss. We also know from empirical studies that the microinsurance price tends to be higher compared to traditional insurance, other things equal. Putting together our knowledge from Module 4 with our knowledge of the client base for microinsurance, we can reason that the higher price for microinsurance reflects the higher riskiness of the typical microinsurance buyer. However, microinsurance is rarely sold at an actuarially fair premium. The policies carry a premium load, which reflects not only the higher riskiness of the insureds and the limited information the insurance company has on the risk they pose, but also the higher administrative and operating costs such as office building costs, salaries of employees, advertising costs, and commissions to insurance agents and brokers who market the policies to potential clients. Insuring difficult to reach clients, administering small-premium insurance contracts, and making small claim payments is costly for the insurer, which translates into higher premium loads.

Who are the providers of microinsurance products? Both formal and informal insurers offer microinsurance products. Formal insurers such as commercial insurers, cooperatives and mutual funds are regulated and licensed under the laws of the land. They tend to have a dominant market share, but it is informal insurers that dominate the market in number. In Africa, for example, it was commercial insurers who insured about 80% of all lives and properties covered by microinsurance products in 2011.^[1] Informal insurers such as community-based organizations and non-governmental organizations (NGOs) are entirely unregulated and unsupervised. While, as we are going to discuss below, these informal insurers serve an important role in the microinsurance market, they tend to have higher insolvency risk than large, regulated insurers, which factors into the premium loading; furthermore, their clients have no consumer protection.

Often, the buyers of microinsurance are unfamiliar with the purpose of insurance and lack the education and financial literacy needed to comprehend its role in risk management as well as the legal jargon and fine print exclusion restrictions in a standard insurance contract. To cater to this specific market niche, microinsurance products should be purposefully designed to be simple; however, this is rarely the case. Microinsurance policies tend to include complex legal language and require premium payments on a regular basis while potential clients do not receive a steady stream of income. Academicians and practitioners find that health insurance and agricultural insurance are the most highly valued covers by low-income individuals for risk management. In contrast, life and credit life insurance have dominated the market. As we noted before, we can trace the origin of what is known today as microinsurance to the practice of microfinance institutions of offering credit-life insurance to their clients. However, credit-life insurance serves predominantly the needs of lenders rather than the underwriting needs of low-income individuals.

Why is there a disconnect between what people want and the products microinsurers offer? Perhaps the key reason is the inability of insurers to estimate the riskiness of low-income people. Underwriting and business decisions are based on the ability of the insurer to estimate the riskiness of an individual and compute the likelihood that a certain event will occur. Insurers rely on historical data to produce mortality, longevity, and morbidity tables. However, such historical data are rarely, if ever, available for the low-income market in developing countries and existing tables must be adapted to reflect the possibly higher riskiness of the potential buyers for microinsurers

While in relative terms, the perils covered by a microinsurance product could be major or even catastrophic from the perspective of the insured, in absolute terms they are minuscule from the perspective of commercial insurers. Nevertheless, microinsurance should not be thought of as just a scaled-down version of conventional insurance; the products offered by microinsurers should be specifically designed to meet the needs of low-income individuals. In theory, microinsurance can cover any insurable risk covered by traditional insurance such as life, credit life, accident, property, health, and agriculture insurance. Furthermore, environmental risks are growing in prominence with climate change and low-income individuals are disproportionately affected by natural disasters while lacking effective risk management solutions to cope. In practice, however, life and credit life insurance dominate the market.

Conventional insurance products are sold by licensed agents and brokers. Because of imperfections on both the demand and supply side of the market, microinsurance products are sold by both licensed and unlicensed intermediaries. On the supply side, licensed insurance agents do not have an incentive to serve the low-income market. Agents work on a commission commensurate with the insurance premium and it is more lucrative to serve the more affluent segment of the market. On the demand side, the widespread lack of trust in institutions in developing countries hampers the development of the microinsurance market. Governments and large corporations are viewed with distrust by those shunned by the formal financial sector. To sell their products, microinsurers often rely on organizations with grassroots knowledge and access to the buyers such as community-based organizations, informal savings and credit groups, and small business associations. Microinsurers have been particularly innovative in identifying non-traditional delivery channels, such as selling insurance through cell phone providers, professional associations, and retailers.

While the term “microinsurance” has been coined only recently, the practice of microinsurance has deep historical roots in developing countries. For example, burial societies have long served as a risk-management mechanism in South-West Africa. Burial societies are a type of co-operative with voluntary membership intended to help cover funeral expenses upon the death of a member or a member’s dependant. Originating in ancient Rome, burial societies have existed throughout history in many parts of the world. A burial society is a mechanism for risk transfer from an individual to the pool of members, which aims at mitigating the financial burdens of death and its associated funeral costs. They are the precursor of funeral insurance, which is widely offered by for-profit insurers nowadays.