«Protecting the poor A microinsurance compendium Edited by Craig Churchill Protecting the poor A microinsurance compendium Protecting the poor A ...»
The optimal combination of instruments will vary from one country to another, and within one country as it moves through different stages of development towards universal coverage.
5.4 The role of insurers and reinsurers in supporting insurance for the poor
The authors gratefully acknowledge the useful review comments formulated by the following persons who acted as reviewers: George Allen (Munich Re of Africa), Toon Bullens (Interpolis), Denis Garand (consulting actuary) and Till Heydel (Munich Re).
In his address to the Microinsurance Conference sponsored by the Munich Re Foundation in October 2005, Hans-Jürgen Schinzler1 offered his perspective on why commercial insurers and reinsurers were infrequent players in the low-income market: “Premium income is low, administrative costs are relatively high, and infrastructure for insurance is lacking; that’s why commercial insurers have not taken more interest in this market.” This candid statement suggests that if premium income were high and administrative costs were relatively low, and the infrastructure for insurance were improved, commercial insurers and reinsurers would take more interest in this market. This raises two issues: first, what is the value proposition of commercial insurers and reinsurers for microinsurance schemes and the market of low-income clients? Secondly, as improvements on all three counts are more likely to evolve over time than to occur through a “big bang”, what part(s) of this value proposition can insurers and reinsurers deliver during this evolutionary process? This chapter proposes a few answers to these questions.
The answers might differ according to the business model. This chapter focuses mainly on the role of insurers and reinsurers in supporting community-based insurance schemes that operate the mutual model, namely communities of individuals that bear the insurance risk and operate the scheme.
The provision of much-needed reinsurance, training and technical support to these microinsurers is a key challenge for the development of microinsurance. This chapter refrains from dealing with microinsurance arrangements in which NGOs distribute insurance products but do not underwrite the risk (the partner-agent model), because these grassroots organizations are already associated with a specific commercial insurer. That insurer may or may not cede risks to reinsurance depending on ceding decisions that are not specific 1 Hans-Jürgen Schinzler is the Chairman of the Supervisory Board of Munich Re and Chairman of the Board of Trustees of the Munich Re Foundation.
The role of insurers and reinsurers 525 to the agent. This chapter is inspired by the attitude that commercial insurers and reinsurers can capture viable business opportunities from a wider penetration of insurance in low-income settings, and that these opportunities justify the investment in microinsurance schemes because of their potential to serve as change agents in low-income communities.
1 The value proposition of reinsurance The value proposition of reinsurance is its enhancement of primary insurers’
ability to conduct their business by reducing the long-term cost of the underwritten risk. Reinsurance deals routinely with four main financial exposures:
1) capacity, 2) surplus relief, 3) catastrophes and 4) stabilization. Additionally, reinsurers provide ancillary services that complement the knowledge base of insurers. All of these services are relevant for microinsurers.
Every insurer (and microinsurers are no exception) can achieve the aim of reducing the cost of underwritten risks better when the number of clients increases. Taking on more insureds increases the predictability of business results, but it also means that for the overall quantum of claims and for catastrophic events the insurer becomes more exposed to the possibility – if only temporarily – that insurance losses could exceed premium income. Hence, insurers wishing to sell more insurance contracts than their own financial limits allow need to extend their financial capacity. Increasing capacity expands insurers’ ability to underwrite a single large loss exposure (large line capacity) or many contracts in one line of business (premium capacity). Incidentally, the additional capacity needed is not proportional, but is less as the insurer grows.
Premium capacity enhancement is probably more relevant in the context of microinsurers (see Box 102). This can be achieved either through proportional reinsurance methods (e.g. “quota share” or “surplus”) or through nonproportional reinsurance (e.g. applying a method called “risk of excess loss”).
Since reinsurance is an expense, the microinsurer will wish to compare the alternatives for capital; those that can access cheaper capital will prefer to do so rather than opt for reinsurance, but in the absence of alternatives, reinsurance is useful.
Insurers collect premiums in advance, but know what portion of the premium they retain as earnings only retrospectively. Hence, at certain times, insurers hold premium income that they have not yet earned. Insurance regulations oblige insurers to keep surpluses reflecting premiums collected but not yet earned, which should equal the present value of future claims. However, microinsurers have to reserve all unearned premiums and at the same time bear all costs in the current year. This has a negative effect on the 526 The role of other stakeholders
What do microinsurers get out of reinsurance?Box 102
Reinsurance gives microinsurers a discretionary budget and protection against insolvency.
Protection against insolvency is the fundamental advantage. The reinsurance contract guarantees that the reinsurer pays all costs above the reinsurance threshold, and thus the microinsurer’s risk of failure is limited to below-threshold costs. The cost of the reinsurance premium must compare favourably with the safety margin that the microinsurer must maintain. The safety margin is proportional to the variance of the microinsurer’s benefits.
Studies have shown that reinsurance presents a clear advantage for microinsurers, particularly as their specific benefit package evolves in terms of diverse products and higher maxima (Dror et al., 2005a).2 Reinsurance can also relieve microinsurers of the need to maintain contingency reserves to cover higher-than-expected costs in bad years. These reserves are normally accumulated in good years. Obviously, reinsurance does not affect the probability of good years, but when it relieves microinsurers of the need to keep reserves, they can use surpluses accumulated in good years as discretionary budgets without taking any additional risk of insolvency.
The practical implications are that microinsurers measure the benefit they obtain according to two yardsticks: first, the larger the premium they need to pay to avoid failure and secure full solvency, the smaller the benefit; second, the larger the amount of discretionary budget they can obtain, the larger the benefit.
2 In Chapter 3.6, the opinion is presented that ceding risks to reinsurance is as much a management decision as the result of a set of calculations of the primary insurer’s exposure. The authors of that chapter hold the view that, in certain circumstances, the choice may be subject to the exercise of judgment by management. This is particularly valid when the underlying terms of insurance are less than optimal due to extreme limitations on benefits. For example, when the expected incidence of an event is high, its predictability will also be high, and consequently its variance will be low. Variance also decreases when the benefit package includes few uniform benefit types and low maximum benefit amounts, because claims then become more predictable. There is less need for reinsurance in such cases, because the incidence of claims and amounts for claims submitted is reduced to a degree that renders fluctuations low and the financial protection of insurance less relevant.
Experience with microinsurance suggests that for many life products, claim amounts are constant due to the uniform coverage; therefore, the random variable “aggregate claim variance” would tend toward zero. For credit life, there is some variance in the outstanding loan amounts, so there is a contribution to aggregate claims variance. For health, if there is a low benefit maximum (as is frequent at present in health microinsurance schemes), contribution to aggregate claims variance would be small;
in fact, the higher the number of clients reaching the maximum, the lower the contribution to variance.
Finally, it should be borne in mind that the reinsurance programme comes at a cost; thus, over-insurance can be as detrimental to the overall cost-benefit situation of the organization as underinsurance. Catastrophe reinsurance is one form of reinsurance that should not cost much and would be useful in most situations. The other functions of reinsurance are usually not used by microinsurance schemes.
The role of insurers and reinsurers 527 microinsurer’s results and may cause liquidity problems. Buying quota-share reinsurance would enable the microinsurer to reduce the unearned premium reserve; additionally, the microinsurer would receive a commission from the reinsurer, which would contribute to covering the costs and improving results. This is amplified when microinsurers experience rapid growth.
Fledgling insurers may also have difficulty managing the surplus account, particularly early in financial periods, and when the client-base increases rapidly. Some insurers find it easier to meet this surplus requirement by buying surplus relief, also known as financing, from a reinsurer.
Insurers accept the risks of their insureds on the basis of statistical assumptions about the probability and variance of risk occurrence. However, every insurer also knows that there is a small possibility that the company’s survival might be endangered if worst-case scenarios occur. Catastrophe protection is the preventive measure taken by insurers to spread exposure to fundamental risks that can endanger the company’s survival. The prevalent reinsurance methods that offer catastrophe protection are catastrophe per occurrence excess-of-loss and aggregate (stop) excess-of-loss, both nonproportional methods of reinsurance. There seems to be broad consensus that catastrophe reinsurance is indispensable for microinsurers. Low volumes should not be a limiting factor for the provision of this reinsurance. In fact, in a historical perspective, one of the main tasks of professional reinsurers has always been to help small insurance companies to remove their existential risk first. Microinsurance companies should be able to access the same service.
Finally, insurers wishing to operate within a predictable and stable environment may wish to keep loss ratios within defined tolerance levels and/or ensure steady profits. This stabilization (or stable loss experience) can be achieved through reinsurance (but, of course, reinsurance is not a subsidy, and microinsurers will have to pay in good years for what they receive as compensation in bad ones). Most reinsurance methods can be used for this purpose.
In addition to the four main financial functions described above, reinsurers often sell expertise in insurance mathematics and statistical information on the market. Reinsurers can offer underwriting expertise because their client-base includes more than one insurer in the same or similar markets.
This superior access to information gives reinsurers a relative advantage in preparing statistical estimates of risks and costs. In addition, reinsurers specialize in the expertise that is required for the insurer to decide which risks to cede to reinsurance and which risks to retain. The caveat to this general description is that, at present, reinsurers do not offer much expertise to microinsurers.
528 The role of other stakeholders Reinsurers are also instrumental in cases where the regulations require insurers to reinsure certain risks. Reinsurance that is prescribed by regulations rather than by autonomous cession decisions of the insurer is essential for insurers to meet regulatory requirements. This is why it is often called compliance assistance.