Using insurance to drive trade
The poor are more vulnerable to risks and economic shocks than the rest of the population. They are also the least able to cope when a crisis occurs. Development efforts tend to focus on strategies to boost incomes, build assets and create jobs, but it is important to recognize that gains can be quickly lost when households at risk experience difficulties. Poor households can easily lose any gains they may have made in improving their lot in life if they experience illness, a death in the family or other crises, and they may be worse off than they were before. In this context, microinsurance, the provision of insurance to low-income people, is one development tool that can aid poor entrepreneurs in the informal economy to manage risks, reduce vulnerability and sustain productivity. However, there are challenges both on the demand and supply sides that must be tackled by innovative insurers and their delivery partners if they are to serve the market effectively.
Protecting income-generating assets
When asked what kinds of insurance they would like to be more widely available, small entrepreneurs in the developing world commonly mention the need to protect their productive assets, such as tools, sewing machines and livestock. They also see theft, fire and natural disasters as serious threats to their business and, de facto, to their capacity to provide for their families as owners of small- and medium-sized enterprises (SMEs) are often critical to households in covering food, school fees, medical expenses, rent and electricity costs.
Some microinsurance products are specifically designed to protect the assets of SMEs, such as property or livestock, and to contribute to investments in productive activities. For example, property insurance can insure a small manufacturer’s inventory and productive assets, such as machines and a shop. Weather index insurance enables farmers to access credit for agricultural inputs because without protection banks are more cautious about lending. Disaster insurance is an emerging product for SMEs vulnerable to floods, droughts or other catastrophic events. As well as paying for an outstanding loan and helping entrepreneurs with their immediate needs, disaster cover can help entrepreneurs resume work quickly through a new loan.
Fonkoze is Haiti’s largest microfinance institution, with branches across the country serving 55,000 borrowers and 251,000 savers. It developed Kore W, an insurance product that protects small entrepreneurs against hurricanes, earthquakes, floods or destructive winds. The product is mandatory for all borrowers, who pay a premium of 3% of a loan’s principal. If a natural disaster occurs, clients are eligible for a US$ 125 indemnity payout to meet emergency needs such as food, water and temporary shelter, cancellation of their loan with Fonkoze and a new loan as soon as they are ready. Kore W operates through MiCRO, a microinsurance consortium based in Barbados. MiCRO is uniquely structured to provide parametric coverage through Swiss Re that is triggered when there are large-scale catastrophes.
Health issues can result in considerable out-of-pocket expenses for entrepreneurs for hospitalization and medical treatment, as well as losses due to physical incapacity to manage their businesses. SMEs tend to rely on informal protection mechanisms when entrepreneurs cannot work. For example, in their absence they may rely on a family member to manage the business and minimize productivity loss, but this may not be sufficient to maintain income at its usual level.
To mitigate productivity loss, MicroFund for Women in Jordan offers interesting cover: Caregiver is an affordable health insurance product that covers some of the critical costs borne by the clients of MicroFund for Women, mostly women entrepreneurs, in accessing public health care. Although every citizen has access to public facilities for primary health care in Jordan, background research by MicroFund for Women showed dissatisfaction with public health care, citing problems such as overcrowded environments, the absence of important medicines and a lack of professionalism among medical staff. The Caregiver product provides ‘hospital cash’ to help offset the cost of accessing private health care facilities in emergencies or cases of serious illnesses of the entrepreneur or her family members. Because women tend to be family caregivers and take time off work if a child, parent or spouse is ill, the product covers the loss incurred when a female entrepreneur cannot focus on her business.
One of the major factors constraining productivity in the SME sector is a culture of risk aversion among low-income entrepreneurs. Not only does exposure to risks result in substantial financial losses, but vulnerable entrepreneurs also suffer from ongoing uncertainty about if and when a loss might occur. This perpetual apprehension means low-income entrepreneurs are less likely to take advantage of income-generating opportunities that may reduce poverty. They tend to stay away from adding riskier investments to their activities and often lose out on higher rates of return and possibilities to grow. Microinsurance provides an alternative approach that can help poor entrepreneurs manage risk and contribute to long-term business sustainability.
Reducing family vulnerability
While all insurance is protective, life insurance can contribute peace of mind to low-income entrepreneurs and indirectly support business. The most common product SME owners can access is credit life insurance that covers an enterprise loan in the event of an entrepreneur’s death. Credit life primarily benefits the lending institution, which no longer has to worry about non-repayment in the case of death. To a lesser extent, it benefits the deceased borrower's family as it does not have to cover the entrepreneur’s debt.
Credit life is often mandatory and the premium is paid through the loan as SMEs rarely opt in for insurance. Some policies only cover the share of an outstanding balance that is not in arrears. Credit life becomes more appealing when it provides extended benefits such as payment for funeral expenses, payment of utility and grocery bills following the death of the breadwinner, or covers additional risks such as disability or personal accidents for the borrower or fire coverage for business premises.
For example, Opportunity Uganda Limited (OUL) provides short-term loans to a large number of vendors located in fire-prone market areas to purchase stock. OUL's credit life insurance offers protection not only in the event of the death of the borrower, but also in the event of fire. If fire destroys a vendor’s shop, the insurer pays off the outstanding loan. Having observed the devastating economic impact of a market fire on a number of its clients, OUL is exploring the possibility of extending fire cover to protect the entire inventory of the borrower, not just that which can be covered by the amount of the outstanding loan. Such cover could be easily added to the existing credit life product to protect a vendor’s accumulated assets.
More sophisticated life insurance policies that include a savings element may be well suited to poor entrepreneurs because they build up value over time and policyholders do not feel they have wasted their money if an insured event does not occur.
Just as it supports a business investment mindset, insurance helps to protect microentrepreneurs and their families from falling into poverty. It can help them plan for the future of their loved ones. For example, insured entrepreneurs will be less likely to have to choose which child to send to school and more likely to seek preventive medical care and accumulate assets to pay for education, for daughters as well as sons.
Improving supply, consolidating demand
Insurance has great productive and preventive potential for SMEs, but supply and demand issues tend to constrain its effective use in the sector. On one hand there is generally weak demand for insurance among SMEs. Entrepreneurs tend to rely on informal risk protection mechanisms such as subscribing to a neighbourhood security service or taking equipment home every evening in order to secure assets. Insufficient use of insurance certainly does not reflect a lack of risk and most entrepreneurs are keenly aware of the risks they face, but they assume insurance is unaffordable, risk carriers are not trustworthy and are generally not fully aware of where to purchase a policy. Even if adequate insurance products were available at a reasonable cost, it is not clear that many SMEs would voluntarily sign up for them without a large investment by insurers in marketing and financial education.
Another strategy to stimulate demand is to design products that offer more than just risk cover. As in the example of life insurance that accumulates savings, low-income clients need to get some value from a product even if they do not make claims. If value-added benefit can reduce claims, such as weather information to insured farmers or health education to reduce the incidence of preventable diseases, everyone benefits.
On the other hand low demand is connected to the lack of products that provide good value propositions to cover enterprise risks. The risks of low-income entrepreneurs are very specific and each type of SME may have different needs. This implies a potentially significant actuarial burden for a risk carrier seeking to provide insurance to the SME market and difficulty in finding a large enough pool of clients to distribute the risks. The latter challenge could be addressed with a group policy delivered through the sector’s aggregators such as trade associations or chambers of commerce.
Fraud is another major concern for risk carriers. For example, it can be difficult to determine the remaining stock in case of a fire or robbery, or identify a dead animal as one that was insured. Insurers have to find a balance between controlling fraud and maintaining efficiency and low costs if they are to provide quality insurance services.
For example, livestock insurance is critical to mitigating losses incurred by livestock deaths, but insurance claims are often high because of the prevalence of moral hazard and fraud, reducing the availability of affordable coverage. IFFCO-Tokio, a cooperative insurer in India, tested a model to reduce fraud by injecting an identification device based on radio frequency identification technology behind the ear of insured animals. Although the project is still at the pilot stage, the claims ratio is more than five times less than before, which suggests the technology is working. Reducing fraudulent claims has also led to improved value propositions for smallholders with faster claims settlement and lower premiums.
Microinsurance and other financial tools can certainly support the growth of low-income business activities in developing countries, but quality products are needed to cater to the specific needs of the sector. Innovative approaches using alternative delivery channels and technology may be able to convert insurance into a profitable business for insurers and a valuable proposition for low-income entrepreneurs.