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Social security

Protecting the poor

by Markus Bär
AllLife even offers life insurance to people infected with HIV in South Africa

AllLife even offers life insurance to people infected with HIV in South Africa

Microinsurance is a fledgling sub-sector of microfinance. Private sector schemes could prevent many more people from sinking into poverty. The challenges are daunting, however. Microinsurance is more complex than microcredit. By Markus Bär

For just a few dollars a month, microinsurance can protect poor people in developing countries from elementary risks. In principle, microinsurance does not differ from conventional insurance. It is based on
– insurance companies that cover risks,
– policyholders who pay premiums and thus protect themselves from damage, and
– brokers who act as intermediaries between insurers and policyholders and serve as trustworthy consultants.

The brokers help policyholders to understand the products and apply for claims. Typically, they will be local organisations like village communities and church congregations or commercial providers like tele­communications firms, wholesalers or even retailers.

Personal cases of misfortune tend to hit the poor much harder than the wealthy. Frequently, a family’s income depends on a single person or a single source, such as farming or fishing. An accident, an illness or a failed harvest can throw entire families into misery even if they were not needy before. These people hardly have any savings, so a calamity may force them to sell their land or other assets on which their livelihood depends.

Poor people therefore are generally less willing to take risks than the well-to-do. As a result, they often fail to tap new sources of income and escape poverty. Rather than risking something new, for instance, many small farmers keep using inefficient methods or cultivating plant varieties that have small yields.

Traditional farming, however, cannot feed the growing populations in many world regions. Compounding problems, urban migration is unravelling the traditional social fabric that gave individuals at least a sense of security. Today, people need other safety nets.

Microinsurance can protect policyholders from the consequences of unexpected disasters, thus allowing them to take more risks in order to tap new sources of income. A lot of poor people set aside what little money they have for healthcare. Insurance would be less expensive and offer better protection.

Underdeveloped market

Despite the obvious benefits of microinsurance, this market is largely underdeveloped. In 2007, less than five per cent of the people in world’s poorest 100 countries enjoyed basic insurance coverage. To boost growth in this important, but challenging sector, Germany’s KfW Entwicklungsbank has joined forces with other public and private sector partners to found LeapFrog Investments, an investment fund (see box).
There are a number of reasons why the micro­insurance market has not developed. The most important one is that microinsurance is more complicated than small savings or microcredit programmes. Insurance companies have to be able to assess risks precisely and verify claims beyond doubt.

But in rural areas, in particular, there often is no reliable data. And even in cities, a lot of poor people are not officially registered. They may not have an ID and often don’t even have an address – not to mention bank accounts. At the same time, poor people’s life expectancies are lower than those of wealthier people. They also get sick more often.

Accordingly, the sales and administrative costs of micorinsurance are generally quite high, whereas the premiums are low. As a result, the business model for microinsurance has to be very efficient. Grassroots organisations are often indispensable as brokers between insurance firms and their customers.

In the insurance sector, size is more important than in the banking sector. The bigger an insurance company is, the greater the base becomes for it to spread risks. If, for instance, a crop insurance firm only does business in a single region, a single storm can easily overwhelm it because suddenly all of its customers claim damages at the same time. Microinsurance typically depends on cooperation between local brokers, who know their customers and understand their living conditions, and large insurance firms that spread risks on many shoulders.

So far, however, most insurance firms in developing countries and emerging markets are focusing on the profitable conventional business with the growing urban middle classes. They shy away from the risks of the fledgling microinsurance sector.

Scepticism among potential customers

On the demand side, there are serious obstacles to microinsurance growth too. Potential customers often know little about insurance and have no trust. The very idea of insurance is foreign to many cultures.

Microcredit is easier to sell than microinsurance. Customers get money right at the start. In the case of microinsurance, they pay first. And they will only do so if they have faith in the insurance company – a giant step, especially for poor people.

Unlike loans, microinsurance does not always provide economic benefits. If there is no damage, the insurance company never pays the client any money. Many customers find that unappealing. Microinsurance providers have to do a lot to make future customers understand the benefits they offer and develop trust.

Microinsurance is not a panacea in the fight against poverty, but it does allow people to live safer, more independent and more dignified lives. Capital is not the only thing needed to make microinsurance succeed; investors have to commit long term. At the same time, this budding industry certainly needs a lot of expertise and technical support. Cooperation bet­ween partners from the public and private sectors as practiced by LeapFrog makes a lot of sense.