Insurance companies are looking for feasible ways to provide coverage to rural populations living below the poverty line.

Background

Microinsurance is an insurance scheme specially created for vulnerable sections of society – the disadvantaged, those living in rural areas and those living below the poverty line (BPL). Microinsurance can encompass many types of coverage, including property, health and life insurance, and is often delivered to these vulnerable segments of society through intermediaries such as self-help groups (SHGs), cooperatives and microfinance institutions. The microinsurance industry is still developing, and only time will tell whether it will benefit both the insurer and the insured, or whether it will become a well-intentioned but ineffective publicity tool for the government and other insurance providers.

The insurance industry in India has witnessed phenomenal growth in the last 5 years. The percentage of the market held by the state-owned Life Insurance Corporation of India has decreased with the emergence of new, smaller insurance companies. The market has responded well, as the new players in the insurance industry are able to offer a customer-focused approach, customizing their products to client needs and offering flexibility and efficient delivery of returns.These new players see an opportunity in a segment traditionally ignored by insurance companies. This “micro-segment” – the disadvantaged rural poor targeted by microinsurance — is more vulnerable to market fluctuation because they do not have a constant source of income, which makes them risky to insure. However, with innovative and intelligent product design the insurance companies could reap dividends from this underserved population.

Why is it so risky to insure the rural poor?

The role of an insurance company is to cover the risk or probability of loss of a particular asset, whether that asset is one’s home, business, health, or even one’s life. The insurance company promises to provide compensation if the asset is lost, and in exchange the client pays a fixed price or premium to the insurance company over a period of time. 

Insuring the disadvantaged and rural poor is riskier than insuring urban and middle-class clients for several distinct reasons:

1. The risk of loss of income – uncertainty of the cash flows

2. Variability of the cash flow – high range of dispersion in income

3. Vulnerability of income to natural disasters, disease and market fluctuations

4. Seasonality of employment

All of the above factors pose a risk to the lives, incomes, and properties of the rural poor. Because of the increased risk, offering life and property insurance to this segment of the population requires in-depth understanding and a reimagining of the traditional approach to insurance.

Urban citizens offer insurance companies a reliable profit because their incomes and assets tend to remain stable. With the rural poor, this is not the case. With poorer segments of the population,  insurance companies are faced with a dilemma called “adverse selection”. Adverse selection occurs when insurance is available to a wide variety of people at the same price. People who face the greatest amount of risk are far more likely to purchase insurance than those with lower than average risk. This is detrimental to insurers, who profit when people purchase policies that they do not end up needing.  In such cases, the insurance companies have no flexibility to leverage their own risks.

One way to avoid adverse selection is to raise premiums. However, higher premiums would make insurance too expensive for the rural poor – the very demographic the insurers wish to attract – to purchase. As a rule of thumb if the probability of loss exceeds 40% then the cost of the policy will exceed the amount of cover guaranteed. Therefore the cost of the premium cannot be directly related to risk, because the resultant high premiums would make insurance prohibitively expensive. 

This quintessential question of insurability of the segment under microinsurance surfaces now , making the grounding of program extremely difficult one.

Another way that insurance companies attempt to overcome adverse selection is by expanding the number of people that they insure. To put it mathematically, the revenue stream for an insurer is positively correlated with the size of the population it covers. By increasing the size of their client base insurance companies minimize the probability that they will lose money . Statistically predicting the average loss in any segment becomes easier as the sample size increases, so with a larger population insurance companies are better able to adjust premiums to account for the amount they expect to pay out in returns. But the large numbers also increase the possibility of absolute loss .

Now let’s take a look at the target segment: disadvantaged rural populations. This segment has a very high threat of loss and unpredictable levels of income, and this combination makes their economic status particularly volatile. Moreover, those who occupy this low-income segment of society are often seasonally employed, meaning that their income levels can fluctuate significantly over the course of a year. This variability in income often causes them to lapse on their insurance payments within the first few years. This represents a significant risk for insurance companies, since 10-15% of the premium in the first year goes towards covering administrative and selling expenses, and therefore does not represent a profit for the company.

If insurance companies expand their client base to include micro-enterprises and the rural poor, they expose themselves to greater risk. Consequently, when designing insurance policies for these segments of the population they must fix a premium that is high enough to cover their own risk, yet low enough to remain attractive to low-income clients. They must figure out how to acquire and maintain new customers without stretching their own risk.

Fixing Premiums

So, how will the insurance companies calculate premiums for these population segments? Insurers have attempted several different strategies, including: 

1. In the case of life insurance companies attempt to calculate the monetary value of a human life by estimating an individual’s future income using an average discount rate. This somewhat crude method of fixing premiums is ineffective in the microinsurance industry because of the target population’s variable and uncertain cash flow.

2. Another method involves calculating the cumulative needs of a family or individual, comparing their savings and current income to the money needed to meet their needs, and then using an insurance policy to cover the gap between the two. However, this approach also proves ineffective because those in the microinsurance segment have volatile incomes and little in the way of savings.

Companies are thinking of new ways to get around the challenges of fixing premiums for the microinsurance segment. These policy offerings include:

1.            Term-renewable policies – Companies may offer the microinsurance segment term-renewable policies, policies that change based upon their fluctuating income stream and assets.

2.            Flexi-premium – Instead of the usual fixed premium insurance companies may offer flexible premiums. Flexible premiums allow beneficiaries to pay more when their cash flow is high and pay less when their income drops. This would take care of the reinvestment requirements of the insurance companies in high compounding return investments.

Other measures that could be adapted for better utilization of resources in the microinsurance sector:

1.            The group approach – This approach would focus on self-help groups by linking individual members of a rural community together in a group insurance policy. This would bring down the rate of premium considerably. The group members could themselves enroll newer members and thereby expand the size of the group.

2.            Bancassurance – The safest way of providing insurance to the microsegment is through banks. Insurance companies can collaborate with prominent banks by selling their insurance products in local bank locations through local bank employees. Selling insurance through banks would ensure a stable client base for insurance providers because beneficiaries with bank accounts are more likely to be financially stable than beneficiaries without bank accounts. Bancassurance would be beneficial to both banks and insurance companies. Coordination with banks would allow insurance companies to expand their client base while reducing their sales staff and bringing down operating costs in the long run, and banks would receive a portion of the profits from the insurance sales.  Using bancassurance, insurance companies are better able to enhance their client base, sell more insurance and customize their insurance products to client needs.

Finally, insurance should not be looked at as only a tool for risk management. Built into this is also a component of minimum assured savings built into insurance . It is time to reiterate this savings aspect also to attract newer clientele. .True, insurers would have to reorganize their fund management to offer better returns on investment in insurance policies to the insured. That’s the underlying consideration in any investment decision by an individual. An insurance decision is an investment decision – whatever the payback.

The views expressed in this article are the author's own and do not necessarily reflect Fair Observer’s editorial policy.