Microfinance (MF) Microfinance is the provision of small scale financial services, primarily credit and savings, to low income households and enterprises which have traditionally been excluded from the mainstream financial system. (Dileo and FitzHerbert, 2007)
It has been proved that small credit provided by microfinance institutions (MFIs) to poor people can successfully increase their income, build assets, stabilize consumptions and cross the poverty line. These are opportunities that would otherwise have been out of their reach without of microfinance. (Cohen and Young, 2007)
However, it is argued that, accessing loans does not eliminate the economic vulnerability of poor people. Many MFIs clients remain on the financial edge, highly vulnerable to health crises, natural disasters or death of breadwinners. Few have access to the protection that insurance offers. As MFIs expand and diversify their services, they are considering insurance for low-income people (micro-insurance), an exciting new area of business that potentially meets both social and financial objectives [1] .
Despite its importance micro-insurance is a response that most MFIs will find difficult to implement it, because they have to create the specialized skills and institutional structures that commercial insurer have developed over decades, in order to underwrite risks prudently. (Miller and Northrip, 2001)
Abels et al., (2005): defines micro-insurance as the protection of low income people against specific perils in exchange for premium payments proportionate to the likelihood and cost of the risk involved.
Micro-insurance shall refer to the insurance business activity of providing specific insurance products that meet the needs of the disadvantaged for risk protection and relief against distress or misfortune. (Wiedmaier-pfister et al., 2007)
The realization that financial services are not just for income-generating activities like loans, but also for risk management protection needs is important. Both protective side and productive side need to be considered because any gains achieved through productive activities could easily be reduced by a tsunami or even smaller risks at a household or personal level. If it is possible to complement productive activities with financial services that assist the households minimise risks, then financial services will have a more sustainable impact [2]
Over the years, microfinance has been seen as a key instrument for poverty reduction, whereby poor people improve their living conditions through the use of credit and savings. However, microfinance clients are often face more risks which threaten their livelihoods as well as repayments and savings. Therefore, resulting to unsustainable microfinance programmes (Mayoux 2002).
TYPES OF RISKS FACED BY POOR PEOPLE
A risk is the likelihood that a hazard will cause a specified harm to someone or something [3]
Risk may be seen as a cause of persistent poverty, as shocks cause severe losses of both physical and human capital assets. Due to risk, poorer holds tend to be more risk averse, even at the expense of potential returns. For instance, they may choose to grow safe but low returning crops and avoiding committing more resources to productive capital so as to preserve the liquidity of their asset base. (Dercon, 2007)
Microfinance clients are exposed to frequent and wide-range of risks. Even life for the poor is one long risk. There are many sources of risk; structural factors, unexpected emergencies, loss of employment, fires and theft; and the high costs associated with life cycle events. (Cohen and Sebstad, 1999)
According to Brown and Churchill, (1999): the most of risks faced by poor people are:
Life cycle needs
Death risks
Property risks
Health risks
Disability risks
Mass covariant risks
Life cycle needs: Poor people are exposed to needs of every day such as eating, dressing, pay for children's education, housing, save for retirement.These needs arise when flows of income do not coincide with expenditures to be taken into account. While households are generally aware whether and when these events will occur, the high likelihood and frequency of their occurrence create an on-going uncertainty as to whether the household will have income or assets to cover the cost associated with these events. While individually these events have the least severe impact, their frequency makes managing them a pressing need for many poor people.
Death risks: Death risks include the costs that result from the death of a family member. It is unavoidable. The degree of uncertainty regarding death is greater than that caused by life cycle events, but less than that caused by most other risks faced by poor people. This is because it is unavoidable. However they experience uncertainty regarding when it may happen. The problem is how then to replace income that the deceased formerly provided to the family.
Property risks: include events leading to theft, damage, destruction of property, loss of family or business assets that low-income poor people may need to protect. Given the range in value of these assets and the situation specific nature of property risks, the impact of property risks will vary by family and locality. In general, property risks are likely to cause households greater uncertainty than death risks or lifecycle needs because they cannot be sure whether, when, or how often a fire or theft might occur. The relative value of a household's loss due to a property risk will depend on the asset at risk; for this reason property risks are displayed in a long, narrow bubble.
Health risks: include accidents, illnesses, and injuries that require households to pay for medical treatment. The cost to a household of each accident, illness or injury is generally one-time and, like property risks, it can also vary the frequency with which health risks can occur, and the household's limited ability to predict whether or when they will be affected, suggest that health risks generate a greater degree of uncertainty than other risks.
Disability risks: The causes of disability risks are essentially the same as those for health risks (accidents, illnesses, and injuries), however there is a greater relative cost to a household of having a family member disabled than injured or sick. A disabled family member may require ongoing treatment expenses besides the cost of the initial medical attention. Households may also incur additional costs in replacing lost income if the family member is no longer able to work. The disable requires an on-going expense Instead of becoming a future source of income for the family.
Mass, covariant risks: include epidemics, natural disasters, and wars that may cause severe losses to a large portion of a population. All these risks fits the above mentioned categories based on the impact they have on households.
HOW DO POOR PEOPLE PROTECT THEMESELVES AGAINST RISKS
Poor people already deal with risk and try to manage them with their own means: Using multiple informal mechanisms (cash savings, asset ownership, rotating savings and credit associations, moneylenders). Very few households have access to formal insurance to cope with risks.
Prevention and avoidance: We can consider that, often poor people try to reduce risk through non-financial methods. An example of a non-financial service is the provision of good sanitation that reduce the risk of infectious illness.
Preparation: We may consider savings of poor people. They accumulate assets. For example roscas, land, livestock, paying for children's education in other to handle future risks.
Coping: We may also consider the fact that poor people face risks with desperate measures that can render them more vulnerable to risks. In a situation of adverse economic stress, poor people may borrow emergency loans from moneylenders, microfinance institutions, dispose productive assets, minimise spending on food and schooling or take a bolt decision to default on loans. (Latortue et al., 2003).
MICRO-INSURANCE: A RISK MANAGEMENT STRATEGY
IV.1. TYPES OF MICRO-INSURANCE PRODUCTS
Life insurance
Micro-insurance against death risks
Health insurance
Health insurance helps households cover the costs of hospital and surgical expenses, medications, and doctor's fees.
Disability insurance
Disability insurance extends the protection offered by health insurance (coverage of the immediate medical costs of illness or accident) to include protection against reduction or loss of income due to illness or accident.
Property insurance
Property insurance can protect against the cost of damage or loss of any type of asset. (Brown and Churchill, 1999)
Disaster insurance
Threats from natural disasters.
Insurance against bad weather rather than bad crop outcomes
According to Churchill et al., (2003): if an MFI were looking to reduce its clients vulnerability by offering micro-insurance product, given their degree of difficulty, health insurance, disaster insurance and property insurance would not be good plates to start;
They recommend 5 micro-insurance products to MFI:
Credit life insurance
Coverage for the outstanding balance of the loan if the borrower dies.
Credit disability insurance
Coverage for the outstanding balance of the loan in the event of permanent disability of the borrower.
Additional benefit insurance
It is a term life policy for borrowers that correspond with the loan term. If the borrower dies during the loan term, their beneficiaries would receive a fixed payout to cover funeral and other immediate expenses.
Additional lives insurance
Always sold with additional benefit, this term life policy covers a certain number of additional household members. The insurance term corresponds to the loan term.
Continuation insurance
This one month renewable term policy is a continuation of the additional benefit policy. An MFI's clients could purchase this product at the end of their loan term if they wanted to have insurance coverage without borrowing another loan.
How these 5 micro-insurance products work
Credit life
Credit disability
Additional benefit
Additional lives
continuation
Insurable event
Death of the client
Permanent disability to the client
Death of the client
Death of nominated household member
Death of the client
Eligibility
client
Client
Client, this must be sold with a credit life policy
Specified members of the client's house hold. sold with additional benefit
Client with previous additional benefit cover
Screening
Credit screening with tactful scrutiny by a loan officer
Visual screening by the loan officer
Credit screening with tactful scrutiny by a loan officer
Visual screening by the loan officer
Previous credit screening
Waiting period
None
None
One loan cycle or four months, whichever is longer
Two loan cycle or six months, whichever is longer
None as the client has already gone
Exclusion
suicide
Self mutilation and specified pre existing conditions
Suicide
Suicide possible age exclusion
Suicide
Policy holder fraud
Disqualification from future services
Disqualification from future services
Disqualification from future services
Disqualification from future services
Disqualification from future services
Benefit
Various options related to the outstanding loan
Various options related to the outstanding loan
Adjust premium and benefit according to demand and affordability
Adjust premium and benefit according to demand and affordability
Adjust premium and benefit according to demand and affordability
Term
Same as loan term
Same as loan term
Same as loan term
Same as loan term
Single month renewable term
voluntary / Compulsory
compulsory
compulsory
voluntary
Probably voluntary
voluntary
Premium collection method
In advance deducted from the loan disbursement
In advance deducted from the loan disbursement
In advance deducted from the loan disbursement
In advance deducted from the loan disbursement
Monthly cash payments or savings deductions
Lapses
None possible
None possible
None possible
None possible
Any non-renewal should result in disqualification
Source: Churchill et al.; 2003
MICROFINANCE INSTITUTIONS AND MICRO-INSURANCE SERVICES
MFIs have demonstrated interest in entering the micro-insurance industry for several reasons. In some cases, it is a response to clients' expressed need for micro-insurance. MFIs have come to realise that micro-insurance, in addition to reducing household risks and protecting the client, is also efficient in protecting the institution. As micro-insurance increases clients' ability to repay their loans, it has a positive impact on default rates. Providing micro-insurance as an additional product might not only enhance client satisfaction, but also allow MFIs an additional source of income, potentially improving their profitability and financial sustainability [4] .
According to Mc Cord and Roth, (2007) MFI managers noted that when clients were having difficulty repaying their loans, it was often because of idiosyncratic financial risks such as a death or illness in the family. For MFIs that use group lending methodologies, a personal crisis affecting one member could also undermine the cohesion of the group and contaminate the quality of several loans.
Many MFI managers have recognized that micro-insurance might reduce the impact of these problems. Some MFIs want to protect their portfolio through micro-insurance; others also want to aid their clients and their families in difficult times.
The primary motivation of MFIs for offering micro-insurance is to protect the poor, to ensure that workers in the informal economy and their family members have access to an appropriate menu of affordable social protection, risk prevention and coping mechanisms. Other MFIs primarily want to protect themselves. They want to offer insurance to reduce credit risks stemming from the death or illness of borrowers. (Roth et al., 2005)
Overall, MFIs appear to have three distinct motives in offering micro-insurance products to their clients. First, some MFIs regard micro-insurance as a valuable financial service not less than lending, and thus wish to enhance the extent to which their clients have access to it. Second, offering micro-insurance to clients is a way of creating an additional income stream for the MFI, for example by keeping some share of the premium as a commission. And third, as particularly with the credit life insurance described above, the introduction of micro-insurance can serve as a means of creating more financial stability for the MFI, e.g. in view of the risk of premature death of borrowers. (Aliber, 2000)
There are two main ways for MFI to offer micro-insurance to their clients: self insurance or partnering with a licensed insurer.
V.1. MICRO-INSURANCE IN HOUSE
There are more advantages when MFIs provide direct micro-insurance services to their clients. As the MFIs understand better their clients, they can design insurance products that best suits their client needs. MFIs with long standing relationships with their clients can instil confidence to their clientele and be able to deal promptly to clients claims. Group Clients may provide low cost and effective delivery channels to MFIs and clients as well by increasing coverage due to economies of scale and minimising false claims from clients (Mayoux, 2002).
Example: ASA's micro-insurance history (Roth et al., 2005)
MFIs generally have not attempted to take up the role of the insurer, because of the onerous demands of complying with the legislation and regulation governing registered insurance companies. (Aliber, 2000)
Nor does client vulnerability address the question of whether MFIs are suitably equipped to provide micro-insurance. Most are not: the vast majority of MFIs lack the expertise required to price the products effectively, do not have the resources (both human and financial) to support an insurance product, and are too small to achieve sufficient pooling of risk.
MFIs may experience challenges in designing coverage that is both affordable for clients and financially viable for the institution.
For most MFIs and most types of insurance, there is strong logic for MFIs to partner with a licensed insurer in order to deliver insurance benefits to their clients. (Warren et al., 2000)
V.2 MICROFINANCE AND PARTERNERS IN PROVIDING MICRO-INSURANCE
Linkages with insurance companies make sense for many MFIs since their core activities are savings and credit; and most do not have the expertise to offer insurance on their own. The MFI acts as a distribution channel making it possible for the insurer to reach a market that it could not cost-effectively serve on its own. From the clients' perspective, they have access to insurance coverage that is priced and managed by professionals. (Roth et al., 2005)
Example: FINCA microfinance in Uganda in partnership with AIG
As shown below, the experiences of many MFIs suggest that partnering can be beneficial not only for MFIs but also for their partners and clients. (Miller and Northrip, 2001)
V.2.1. BENEFITS OF PARTNERING FOR THE MFI
Limited Initial Capital Investment and Low Variable Costs
By partnering, the MFI does not need to spend time or money developing the actuarial, underwriting, and claims management expertise of its staff. This reduces both the up-front and the ongoing costs for the MFI. Some investment will be required to provide staff training on marketing and sales.
Rapid Product Launch and Scale-up: Product launch and scale-up can take place quickly because both sides already have in place most of the resources and staff needed to develop and offer the product.
Compliance with Legal and Regulatory Requirements: Although regulatory
requirements for licensed insurers differ around the world, an MFI acting as an agent is generally not subject to regulatory requirements such as reserve or capital requirements, investment restrictions, and other policy provisions.
Potential for Stable Revenue Stream: In most partner-agent relationships, the agent receives a commission for distributing the product. This revenue stream is more stable and often larger than the profits from a new insurance business in its early years.
Learning the Business: Partnering is a technique often used by developed insurers when they are considering expanding into a new line of business. Rather than take the risk of developing their own organization from scratch without any previous experience, these insurers partner with an insurer that has experience in the area and, over time, learn enough about the business to decide whether they want to take it on themselves.
Similarly, MFIs partnering with an insurer will benefit from organizational learning, as well as enhanced skill sets among key MFI staff.
V.2.2. BENEFITS OF PARTNERING FOR THE INSURANCE COMPANY
Access to New Markets: The insurance provider gains access to a new market and new customers that had previously been overlooked or avoided because of the high cost of reaching these customers. Over time, this new market may become receptive to other, more sophisticated insurance products.
Access to Clientele with Strong Financial Records: Insurers working with MFIs benefit from access to a stable client base that has an existing financial relationship and credit history with the MFI. Entering the market on their own, most insurers would not have this ability to identify high-potential new customers.
Lower Transaction Costs for Serving a New Market: Because the insurer relies on the MFI to identify and serve new clients, transaction costs are lower than if the insurer had sought to enter this market alone. The insurance provider benefits from the existing relationship between the MFI and its borrowers/savers.
Corporate Citizenship: Licensed insurers may benefit from the perception that they are contributing to the well-being of low-income groups and to the development of the financial sector as a whole. This benefit may be of particular value to foreign insurers seeking to establish a reputable advantage in the minds of host-market customers and regulators.
Regulatory Compliance: Some licensed insurers may face legal requirements to invest a certain amount of capital in a host-country financial institution. It is possible that insurers could fulfil this requirement by partnering with an MFI.
V.2.3. BENEFITS OF PARTNERING FOR LOW-INCOME CLIENTS
Better Products at a Lower Cost: Because insurance providers have expertise in investment management, actuarial analysis, and claims management, they are more likely to be efficient and require less of a safety margin in their premium calculations than would a new MFI-insurer. Although some MFIs may have the capability to develop their own insurance products, the evidence suggests that greater benefits and lower premiums can be offered on policies provided in partnership with an insurer.
Greater Financial Security: Clients benefit from the financial strength of a regulated local or international insurer, which is likely to be greater than that of their MFI.
CONCLUSION
Micro-insurance as a product of MFIs can have positive effects for MFIs clients.
As MFIs expand and diversify their services, they are considering micro-insurance, because MFIs' clients are vulnerable to a range of risks. These not only threaten the livelihoods and wellbeing of clients but also affect loan repayment, savings and hence the sustainability of micro-finance programmes.
Financial services are not just for income-generating loans or micro-enterprises, but also people needs risk management protection. Thus it is important to consider the protective side and not only the productive side
MFIs have realised that, in addition to reduce household risks and protecting the client, micro-insurance is efficient in protecting the institutions. Moreover, micro-insurance increases clients' ability to repay their loans and on the other hand it has a positive impact on default rates. Providing micro-insurance as an additional product not only enhance client satisfaction, but also is an additional source of income for MFIs which potentially improving their profitability and financial sustainability.
REFERENCIES
Paul DiLeo and David FitzHerbert (2007).The Investment Opportunity in Microfinance
Monique Cohen and Pamela Young (2007) Using Micro-insurance and Financial Education to Protect and Accumulate Assets
Herman Abels, Blue Rhino consult Too Bullens, MIAN (2005). Micro-insurance
Martina Wiedmaier-Pfister, Matthew Jowett, Dante O. Portula, and Gilberto M. Llanto, (2007). Micro-insurance Innovations Project (MIP) in the Philippines
James Roth, Craig Churchill, Gabriele Ramm and Namerta (2005): Micro-insurance and microfinance institutions Evidence from India
Monique Cohen and Jennefer Sebstad, (1999) Microfinance and Risk Management: A Client Perspective
Stefan Delcon (2007) Designing insurance for the poor
Beatriz Armendrariz de Aghion and Jonathan Morduch (2005).The economics of microfinance
Warren Brown and Craig Churchill November (1999) providing insurance to low income households part I.
Warren Brown, Colleen Green and Gordon Lindquist (2000) A cautionary note for microfinance institutions and donors considering developing micro-insurance products
CGAP Micro-insurance: A risk management strategy by Alexia Latortue, with inputs from Monique Cohen, Michael J. McCord, Craig Churchill, and CGAP staff, December 2003
Craig F. Churchill, Dominic liber, Michael j. Mc Cord and James Roth (2003) Making insurance work for microfinance institutions : A technical guide to developing delivering micro-insurance.
Michael J. Mc Cord and Jim Roth (2007) Partnerships: Microfinance institutions and commercial insurers.
Michael Aliber (2000) Social Finance Programme & InFocus Programme on Boosting Employment through Small Enterprise Development South African Micro-insurance Case-Study
Linda Mayoux (2002) Gender dimensions of micro-insurance: Questioning the new bootstraps
Mary Miller and Zan Northrip of Development Alternatives, Inc. (2001) Insurance as a microfinance product
