Microinsurance 101: How do people deal with risk?

Kiva and Financial Access Institute (FAI), a consortium of leading development economists focused on substantially expanding access to quality financial services for low-income individuals, are partnering to bring you a three week educational series on the difference facets of microfinance! The full versions of these articles and the series are available on the FAI website. This week's blog is a basic introduction to the subject of microinsurance. Check out the past 101 blogs on microcredit and microsavings.

Microinsurance is a financial tool that helps low-income households mitigate risk and plan for the future. It enables them to cope with unpredictable and irregular incomes, while also preparing them for financial emergencies that threaten their livelihood. One of the major problems faced by many households is that due to low and unpredictable incomes, they lack a financial cushion. Living so close to the margin means that it doesn’t take much to push a family into destitution. For many people an unexpected trip to the doctor or a bad harvest can quickly become a catastrophe. Microinsurance offers a way for households to manage risk and deal with the ups and downs of life.

Take the story of Feizal, an aluminum trader in India whose ten-member family lived primarily on his income of $36 a month. When Feizal fractured his thighbone and couldn’t work, he also couldn’t go to the doctor because he had no insurance and didn’t know how he would pay the medical bills. When his leg did not heal, he finally sought treatment, and his family exhausted nearly all of their bank savings to pay for it. Feizal was able to work eight months after the accident. If Feizal could have relied on an insurance product he would have had the incentive to seek early, high-quality care at a much lower cost.

So why doesn’t everyone use microinsurance?

Despite the benefits of microinsurance, microfinance institutions (MFIs) have encountered significant challenges in the design and implementation of insurance products. Consequently, there are few sustainable and profitable microinsurance products available for vulnerable populations.

One classic problem microinsurers face is an information asymmetry – that is, they have limited information about potential clients to help them distinguish between those who want an insurance policy because they are prudent and those who want a policy because they are now likely to take more risks. A further complication is that the insured events of most policies (e.g. harvest yield or livestock health) are heavily dependent on the unseen efforts of insured individuals.

Other challenges to the success of microinsurance are specific to the population being insured. For example, there are generally lower literacy levels among low-income households and less familiarity with how insurance works. So insurance providers need to do more to educate clients about the mechanisms and benefits of insurance.

Insurance vs. Savings

Savings are often built up in small installments that are accumulated over time, but when emergencies arise they often require large lump sum payments (like an expensive medical bill after trip to the hospital). Insurance payments are available immediately and can help households access a large amount of cash when they need it most. The flip side, though, is that insurance usually only covers a specific event, whereas savings can be used for anything. In theory, this shouldn’t bother households: if the risk is real and the coverage represents good value, they should buy it. In practice, however, households may reason that given their limited resources, they are better off using general-purpose tools because the insured risk may never occur. For these reasons, insurance coverage attached to savings and loan products, as in the case of credit-life insurance and life-endowment savings, may appeal to low-income households more than a generous portfolio of policies insuring against each and every risk.