Insurability in Microinsurance Markets: An Analysis of Problems and Potential Solutions

Abstract

This paper provides a comprehensive analysis of the insurability of risks in microinsurance markets. Our aim is to enhance the understanding of impediments to and facilitators of microinsurance from an economic perspective and outline potential solutions. The motivation for conducting this analysis arises from two important aspects. (1) Despite strong growth of microinsurance markets in recent years, more than 90 per cent of the poor population in developing countries have limited or no access to insurance.(2) Industry practitioners frequently highlight problems in the insurability of risks that hinder the development of microinsurance. We review 131 papers and find that the most severe problems stem from insufficient resources for risk evaluation, small size of insurance groups, information asymmetries and the size of the insurance premium. On the basis of the analysis, we discuss a number of potential solutions such as, for example, a cooperative microinsurance architecture. The Geneva Papers (2012) 37, 77-107. doi:10.1057/gpp.2011.29 Keywords: microinsurance; insurability; moral hazard; adverse selection IntroductionThe aim of this paper is to conduct a systematic analysis of the insurability of risks in microinsurance markets, point out critical aspects that hinder their development and outline potential solutions to problems in these markets. Microinsurance is commonly defined as a financial arrangement intended to protect low-income people against specific perils in exchange for regular premium payments proportionate to the likelihood and cost of the risk involved. 1 The microinsurance industry has seen strong growth in recent years, with average annual growth rates of approximately 10 per cent. 2 Industry practitioners, however, estimate that only 5 per cent of the potential market is covered, and that there is a high degree of variability in terms of risk and geographical coverage, leaving large segments of the world's poor population with limited or no access to insurance. 3 1 See Churchill (2007). There exist two widespread definitions of microinsurance. Churchill (2007) refers to microinsurance as insurance for low-income people. Dror and Jacquier (1999) define microinsurance as financially autonomous schemes operating at the local level. Throughout this paper, we refer to the definition by Churchill (2007), but also integrate the aspect that microinsurance is typically operated in small locally focused insurance schemes. 2 See Lloyd's and Microinsurance Centre (2009). 3 See Roth et al. (2007). The Geneva Papers, 2012, 37, (77-107) Providing insurance in developing countries is subject to a large array of problems, many of which are frequently addressed in practitioner studies. 4 These studies reveal numerous problems with insurability, including moral hazard, adverse selection, correlated risks, high transaction costs and lack of data, making microinsurance challenging from an economic perspective. Whereas insurability is relevant in all insurance markets, the crucial question in the case of...

Pricing in Microinsurance Markets

“…Despite the growing interest in microinsurance, very few studies offer guidance on pricing in these markets given their specific challenges. 1 Current research confirms significant problems in pricing risk in microinsurance markets (see, e.g., Biener & Eling, 2012;Dlugolecki, 2008), whereas data availability is a prevalent challenge. Meaningful premium estimates, however, cannot be derived without a minimum of reliable data.…”

“…Microinsurance is designed to offer insurance coverage to the low-income population with limited willingness to pay and high price sensitivity (see, e.g., Biener & Eling, 2012;Cole et al, 2010). Due to data constraints, microinsurers are required to add high risk-loadings for uncertainty in the estimation of expected losses.…”

“…Especially the prevalence of contagious diseases such as malaria, tuberculosis, or AIDS/HIV is problematic for morbidity-related microinsurance (see, e.g., Biener & Eling, 2012). For a more detailed understanding of morbidity-related risk factors, more interdisciplinary work on the framing of morbidity patterns in developing countries is needed.…”

“…With each year of operation, the additional information can be used to update premiums according to the experience in the preceding year. 9 Since high operational costs to adjust individual premiums and asymmetric information often are problems in microinsurance markets (see, e.g., Biener & Eling, 2012), it may also be feasible to apply experience rating schemes at the level of group insurance common in microinsurance markets or even at the level of the total insurance risk pool. Sloan (1990) presents an approach to experience rating on the group-level for medical malpractice insurance that may also be feasible with microinsurance.…”

“…Group insurance circumvents the problem of differentiating among categories of risk by creating groups of insured that are not limited to high-risk individuals. The use of group policies can mitigate the potential for moral hazard since mutual monitoring is inherent in such schemes (see, e.g., Biener & Eling, 2012;Dercon, de Weerdt, Bold, & Pankhurst, 2006).…”