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Microinsurance – A risk managing mechanism for poor people

18.06.2012Claudia Huber

Faisal lives in the rural areas of Northern Mozambique where he earns his living from growing cassava. With the money he makes from selling cassava, he can provide a meager living for his wife and their three children. Besides growing cassava, Faisal and his wife also grow vegetables, such as potatoes and tomatoes for their own consumption. When the weather is favorable and the crop turns out well, they sell their produce on the local market.  

And this is precisely what makes a difference for Faisal’s family: the weather. If the rains come in at the expected time and leave again at the expected time, things go well. However, if the rains don’t come or if the rains don’t leave again, things turn bad for Faisal and his family.  

One of the major risks Faisal and his family have to deal with is crop failure. If they cannot harvest their cassava because a drought or a flood destroyed their crop, they have nothing to sell and nothing to eat.  

Microinsurance is a mechanism to provide cover for this and other types of risk events. Poor people are extremely vulnerable to risks, such as crop failure, the sudden death of a family member, an illness or loss of income or property. Since low-income populations often do not have social or financial protection from own savings or social welfare to help them overcome shocks, they are often very close to dropping into poverty as soon as an unexpected risk event occurs. Insurance is a tool that can help them mitigate shocks that otherwise would have worsened their financial situation. Consequently, access to insurance plays an important role in helping to reduce poverty.  

Whereas microfinance products and services, such as micro enterprise loans and savings have been around for some time now, microinsurance is rather new.  

The International Association of Insurance Supervisors (IAIS) defines microinsurance as “insurance that is accessed by the low-income population, provided by a variety of different entities, but run in accordance with generally accepted insurance practices (the IAIS Insurance Core Principles). Importantly, this means that the risk insured under a microinsurance policy is managed based on insurance principles and funded by premiums”.  

Microinsurance - sometimes called insurance for the grassroots or insurance for all - includes a broad range of insurance products, such as, life insurance, funeral cover, health, invalidity, livestock, crop and asset insurance and can be provided by a variety of organizations, such as microfinance institutions, mainstream insurance companies, NGOs, cooperatives or mutuals.  

The development of microinsurance products that are viable and sustainable for the supplier and at the same time provide value to the poor client faces several challenges. Potential clients often do not know and/or understand the concept of insurance and have generally limited knowledge of financial concepts. Similar to high income markets, poor people often do not trust insurers or insurance companies. The needs as well as the means to pay for an insurance policy of low-income people are different from the high-income population.  

To be viable, it is not enough to shrink traditional insurance products’ premiums and coverage by a factor of 5, 10 or 50 to fit smaller pockets. On the contrary, products need to be simpler in design, have less exclusions and straight-forward claims processes. Finding the most adequate distribution channel for a market which is often geographically dispersed is typically a challenge for an insurer entering the micro segment.  

Besides challenges in product development and distribution, the regulation of the insurance sector can be a bottleneck in many countries. If regulatory requirements are too demanding (e.g. the capital requirements too high or regulation for distribution channels too narrow) it can be difficult for a provider to sustainably offer microinsurance products. On the other side, the regulator has an important role in protecting consumers from inadequate sales or fraud and in enforcing claims settlement.  

After last year’s drought, Faisal and his family had to face a few hard months where they could not spare the money to send their children to school. Faisal has recently heard about an organization that offers insurance for his cassava crop against the payment of a small premium. His neighbor, the sole breadwinner for a family of six, also told him he has taken up a life insurance policy to protect his family in case of his own sudden death. Faisal is interested in learning more about these services and already talked to several people in his community.  

The partnership Making Finance Work for Africa via its German contribution (Promoting Financial Sector Dialogue in Africa: "Making Finance Work for Africa") is supporting financial inclusion in insurance markets for the low-income population. We work closely with the Access to Insurance Initiative (A2ii), a partnership to strengthen the capacity of policymakers, regulators, and supervisors seeking to advance insurance market access, particularly for low-income clients, by promoting sound, effective and proportionate regulation and supervision of insurance markets.  

Currently, we are involved in carrying out A2ii Microinsurance Diagnostics in Mozambique and Nigeria and are supporting together with the Munich Re Foundation and several other partners the update of a Microinsurance Landscaping Study for Africa which will be presented at the 8th International Microinsurance Conference in Tanzania taking place on November 6-8, 2012.      

Claudia Huber is advisor in Financial Systems Development at the Gesellschaft für Internationale Zusammenarbeit (GIZ), where she is responsible for the microinsurance component within the team managing the German contribution to the partnership Making Finance Work for Africa (MFW4A). Claudia is a member of the Advisory Committee of the Access to Insurance Initiative (A2ii) and a member of the Joint Working Group on Regulation, Supervision and Policy of the IAIS and the Microinsurance Network.  
Before joining GIZ, she worked for three years as an advisor to the management teams and in operational positions on the credit as well as retail and banking services sides in various ProCredit Banks in Africa and Latin America. From 2006 to 2008, Claudia worked as an associate microfinance analyst at CGAP, a microfinance resource center housed at The World Bank.  

Making macroprudential supervision work for Africa

04.06.2012Miquel Dijkman

Although the concept of macroprudential supervision dates back to the seventies, it has staged a remarkable comeback since the global financial crisis. There is now by and large consensus that pre-crisis approaches to regulation and supervision lacked a proper “macro” dimension, focusing exclusively on risk within individual financial institutions and insufficiently on assessing and controlling systemic risk. Macroprudential supervision is meant to fill this gap. It requires a holistic perspective on the financial sector, that pays due consideration to the interconnections between financial institutions, markets and infrastructure and the real economy. Operationalizing macroprudential supervision requires progress on several fronts: monitoring risk build-up and detecting when risks have materialized (i.e. macroprudential surveillance), and applying tools to curb the accumulation of risks (i.e. macroprudential policymaking).  

Macroprudential surveillance should thus contribute to more informed choices with regard to macroprudential policymaking. Macroprudential supervision should be comprehensive, capturing the time-series and the cross-sectional dimension of systemic risk. The former refers to the tendency for financial firms, nonfinancial corporates and households, to overexpose themselves to risk in the upswing of a credit cycle, and to become overly risk-averse in a downswing, while the latter refers to the linkages within the financial system that can function as contagion channels in times of distress, potentially creating self-amplifying spirals and severe contagion effects.  

Policymakers worldwide have enthusiastically embraced the rationale for macroprudential supervision. African policymakers are no exemption to the rule, as illustrated at a recent seminar in Douala on the topic where central bankers across the continent exchanged experiences. They strongly endorsed the rationale for macroprudential supervision, but also highlighted the difficulties in putting macroprudential supervision to actual practice. To some extent, this is a challenge that policymakers worldwide are struggling with. A satisfactory operational framework for macroprudential supervision is still lacking and the measurement of systemic risk is still “fuzzy”. In the case of Africa, these measurement issues are often exacerbated by concerns over data availability, reliability and comparability, and capacity constraints. 

Participants of the seminar echoed these concerns, reiterating that the need for additional guidance for the practitioner. This includes a clarification of the scope of macroprudential supervision, its relation to existing microprudential supervisory frameworks, and the nexus between macroprudential surveillance and macroprudential policymakers. Policymakers in emerging market economies would also benefit from a systematic appraisal of the suitability of the various instruments (such as forward-looking provisioning requirements and countercyclical capital buffers) in light of the overall stage of economic and financial development: financial regulation is not without costs and there are concerns that measures to smooth the credit cycle can delay financial development.

Another important set of questions relates to the relevance of macroprudential supervision for African policymakers. Its relevance depends on many factors, especially the stage of economic and financial development. As a general rule, macroprudential supervision gains in importance as financial systems mature and deepen. The process of financial deepening is often accompanied by a changing composition of the financial system, with an increasing share of new financial instruments, greater leverage and the emergence of financial intermediation outside the realm of the deposit-taking banking system. Also, increasing cross-industry and cross-border integration contribute to greater interconnectedness of financial systems, both nationally and internationally while financial innovation leads to a more complex financial system, in terms of the intricacy of financial instruments, activities, and risks, as some countries in the region have already experienced.

An increasing body of academic research indicates that financial development can propel economic growth, but it also raises the economic costs of disruptions in the financial system, usually in the form of an erosion of economic activity and significant budgetary outlays to support troubled financial institutions. As financial systems mature, it thus becomes increasingly important that policymakers adopt a more holistic perspective on the financial sector and take timely measures aimed at curbing emerging risks to financial stability through macroprudential supervision.

The capacity of the authorities to credibly deliver on a macroprudential also matters. The lead agency responsible for macroprudential supervision, typically the central bank and the supervisory agency, need to be adequately resourced for the new task. Many central banks have established financial stability units responsible for periodic financial stability reports. To be effective, they need a critical mass of qualified staff, and access to information - including key prudential indicators from the supervisory agency. Ideally, the central bank should also be provided with an explicit mandate for financial stability. Since macroprudential supervision is essentially an add-on to microprudential supervision, a robust basic microprudential framework should be in place before branching out into this new territory. Lastly, the authorities responsible for macroprudential policies need to have sufficient gravitas and independence to overcome industry and political pressures, so that the outcomes of macroprudential analysis can be credibly translated into macroprudential policymaking. Scaling up macroprudential supervision can thus be a worthy objective, provided that these preconditions are met.

Miquel Dijkman is a senior financial sector specialist at the Financial and Private Sector Development Vice Presidency of the World Bank.

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