Insuring the Poor

Poor households in developing countries face a number of risks. As access to formal insurance and credit markets is limited, they need to rely on informal strategies to reduce these risks ex ante and cope with shocks once they have materialised. One empirically relevant risk reduction strategy is income diversification. Rural households, for example, diversify within their agricultural activities by choosing a variety of crops or by combining livestock and crop farming. In addition, they diversify between sectors by simultaneously working in agricultural and off-farm activities. While income diversification reduces the risk of total income loss, it implies an efficiency loss as households cannot realise the gains from specialisation. In addition to diversifying income, poor households generally choose low-risk, low-return activities. In particular, households tend to be reluctant to adopt new technologies, which prevents them from exploiting their full productive potential.

If adverse shocks occur despite these risk reduction efforts, poor households often have to rely on support from relatives and friends or to sell their financial and non-financial assets. These strategies might be effective in case of idiosyncratic shocks like illness or job loss. But they fail in case of aggregate shocks like drought or hurricanes, which affect the whole environment. Furthermore, the sale of productive assets reduces future production capacity. Overall, these strategies help households to smooth their income and consumption temporarily. But in the longer run, they tend to hamper development. Therefore, measures that more efficiently protect households from risks are an important tool in promoting development and alleviating poverty. One promising approach is the introduction of micro-insurance. Micro-insurance is the provision of insurance services to the low-income population. In exchange for a premium payment, micro-insurance provides protection from unforeseen events. Like classical insurance, micro-insurance is based on the principle of risk pooling. The distinctive feature of micro-insurance is its adaptation to the specific needs of the target population.

While microfinance, in particular micro-credits, has been broadly discussed during the last decade, insurance for the poor has entered the discussion only recently. More and more actors are becoming interested in micro-insurance. On the one hand, the rise in interest stems from the fact that micro-insurance could help poor households to protect themselves from major risks and financial shocks and is thereby seen as a potential tool for promoting development and innovation in developing countries. On the other hand, commercial insurers are starting to acknowledge the potential gains in this huge, untapped market. A recent study by SwissRe estimates, for example, that the market could amount to 4 billion people, being worth up to USD 40 billion. Nonetheless, market penetration remains low and is roughly at 2-3%. Typical problems faced are poor infrastructure, little understanding of insurance products and low take-up rates. It seems necessary to investigate how micro-insurance can reach more people and help achieving development goals and how the global society can contribute to accelerating this process.

How can micro-insurance reach the objective of efficiently insuring the poor to retain the financial gains achieved during the development process? What is the impact of micro-insurance on economic development? How can the supply of micro-insurance be improved? Given the close linkages between micro-credits, micro-savings and micro-insurance, how can the lessons learned in microfinance be transferred to micro-insurance? What is the best way of targeting farmers in remote rural areas and the poorest of the poor? How is it possible to convince poorly educated people that insurance is beneficial?