Innovations in Microinsurance – Can index-based microinsurance be a sustainable instrument to reduce poverty?

In the field of microfinance, microinsurance aims to provide protection for low-income people against risk in exchange for a premium payment according and proportional to their respective risk exposure. As in industrialized countries almost everyone owns some type of insurance, in developing countries formal insurance contracts are uncommon and rare. This is due to diverse limitations and barriers for the extreme and rural poor to enter the insurance market.

Microinsurance basically provides insurance for a low fee payment to cover specific perils (e.g. livestock disease, natural disaster, illness etc.). By this mechanism it protects poor people against risks, which might trap them into a state of severe poverty. Hence microinsurance is especially designed to cover risks of the poor in terms of easy access and efficient processes.

According to the Microinsurance network[1] the total microinsurance coverage ratio in Latin America and the Caribbean is about 8.5%, in Asia and Oceania almost 7% and in Africa 5.4%. Although the coverage ratios tremendously increased in the last ten years, they remain low compared to industrialized countries. Reflected by the coverage ratios in the agricultural sector, which remain 2.5% in Latin America and the Caribbean, 0.1% in Africa and even 0.05% in Asia and Oceania.

Food security and weather risk are inextricably linked. In conclusion weather related shocks could push households into a poverty trap and prevent the agricultural sector from reaching its potential output.

In the past it has shown that agricultural microinsurance, e.g. traditional crop insurance, did not succeed in many countries for example in Malawi, due to high costs associated with handling individual claims case-by-case. “In fact one could go so far as to state that traditional crop insurance is a global failure (…)”[2]

In areas like Sub-Saharan Africa, where a large fraction of GDP is contributed by the agricultural sector and approximately two thirds of total formal employment lies within agriculture, a risk management tool is needed to secure these jobs in the long-run[3].

This is the reason why I will focus on agricultural insurance, primarily Weather index-based microinsurance (WII). WII is intended to offer solutions to the adverse effects on development, which traditional agricultural insurance cannot solve. Besides WII, microinsurance includes life insurance, health insurance and property insurance, but including those would go beyond the scope of this article.

WII benefits are calculated on the basis of publicly observed data. The insurance contract is only written against a specific risk measured by physical and economic triggers (e.g. rainfall measured at a local weather station). Payouts are only determined by the index. Though compensation of policyholders with the same contract are equal regardless of their actual loss. The index is basically a proxy for the actual loss and there is no need for individual examination anymore.

The question is whether WII offers a possible solution to the concerns affronting agricultural insurance and to increase welfare, consequently decreasing poverty?

Although the demand for microinsurance is still low and it is commonly said by financial institutions that the market for microinsurance is not saturated. This raises the question, whether the poor are really in need of formal microinsurance as they exist right now. Or the other way round, are we only trying to care for them despite their will?

Formal insurance could namely decrease social trust among a network, when an informal transfer system among friends, family and neighbors is in place. By introducing formal insurance to those networks, it might crowd out the informal solidarity system because the informal insurance supposedly is not necessary for the villagers anymore[4]. This decreases social trust and solidarity in the network. So microinsurance could cause a damage when institutions are not considering negative externalities, which are brought to a country without sophistically implementing it.

Still in case of a covariate shock, it will be challenging for the rural poor to recover only by informal insurance mechanism. Here formal insurance may provide a more efficient solution to absorb a covariate shock.

So the remaining questions are which innovations can decrease world poverty especially WII and what rather harms the poor even more?

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Hess, U.; Syroka, J. (2005), Weather-based insurance in Southern Africa : the case of Malawi (English). Agricultural and Rural Development Discussion Paper ; no. 13. Washington, DC: World Bank.

Adams, A.V.; de Silva, S.J.; Razmara, S. (2013), Improving skills development in the informal sector: Strategies for Sub-Saharan Africa, Directions in development: human development, Washington, DC: World Bank.

Verena Wilhelm (2008), Weather Index-based Microinsurance in Developing Countries – Analysis and Evaluation. VDM Verlag Dr. Mueller

Landmann, A.; Vollan, B.; Froelich, M. (2012), Insurance Versus Savings for the Poor: Why One Should Offer Either Both or None. IZA Discussion Paper No. 6298.

Rahul Bhatia; Tess Riley (2016, April 21), India crippled by extreme weather as 100 million exposed to floods, The Guardian, Retrieved 15.06.2018 from https://www.theguardian.com/global-development-professionals-network/2014/oct/29/agricultural-insurance-smallholder-farmers-risk-financial-inclusion

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[1] See for more details: http://worldmapofmicroinsurance.org/.

[2] Hess; Syroka; (2005), p.15.

[3] Adams; de Silva; Razmara; (2013), p.1.

[4] Landmann; Vollan; Fröhlich; (2012), p.2-3.

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