«Protecting the poor A microinsurance compendium Edited by Craig Churchill Protecting the poor A microinsurance compendium Protecting the poor A ...»
Although these small schemes would have similar advantages if they could access reinsurance, the empirical experience suggests that they are usually unable to buy the full range of reinsurance services. The obstacles seem to be on the supply and regulatory side, rather than on the demand side.
At the Munich Re Foundation microinsurance conference, a proposal was tabled for reinsurers to create a “Joint Reinsurance Underwriting Association” or a syndicate to provide reinsurance to microinsurance schemes to reduce risk exposure while spreading the cost of developing the market. The objective is to enable microinsurers to buy reinsurance, while limiting the effort of each participating commercial reinsurer. This syndicate would have to overcome some definition problems, including a decision about which kinds of risks to accept, whether to operate worldwide or only within the boundaries of single countries, and so on. It would also have to deal with a microinsurance industry that is not always well managed. Most critically, such a syndicate would have to overcome a mental barrier that seems to impede cooperation between large reinsurers, who usually prefer to operate individually and have sufficient financial and technical capacity to do so.
However, a syndicated facility by several reinsurers who see the merit of institutionalizing the access of microinsurers to reinsurance would fill part of the “missing industrial infrastructure”.
Another concept for the supply of reinsurance for micro schemes is the “social reinsurance” model, which emphasizes the need to reduce the exposure of microinsurance to claims fluctuations (see Box 103). The conceptual
analysis reported in the Social Re book (Dror and Preker, 2002) shows a way to remedy inherent vulnerabilities of microinsurance schemes operating on their own by establishing a generalized ceding limit (or threshold) identical to the long-term average cost of claims and passing on to the social reinsurer the risk of outlier claims. This enables microinsurers to remain financially viable and to calculate their premiums more accurately, while reducing their need to maintain capital for contingencies.
A short summary of the social reinsurance modelBox 103
The “social reinsurance” model offers a way to quantify microinsurers’ vulnerability and to examine the effectiveness of reinsurance as a remedy. The model deals only with considerations that can be predicted by the application of statistical laws. The focus is on the effect of fluctuations in microinsurers’ and reinsurer’s total benefit expenditure. Variance in total cost can stem from a small claim load or from a large variation in unit cost. A small claim load is likely to occur either when the group is very small or when the insured event is very rare.
The Social Re model is suited to deal with these circumstances. It can be applied when the standard deviation (SD) of each microinsurer’s total benefit cost is known. The reinsurer’s success is highly sensitive to the accuracy of this SD; a 20 per cent error in SD value can signify the difference between the reinsurer’s long-term solvency and bankruptcy.
The SD can be calculated only when the risk probability is known. In reality, the estimate of risk is often unreliable. Even when risk probability is known, the reinsurer is still affected by the size of the pool (or the number of reinsured microinsurers) and the heterogeneity of risk profiles. The larger the pool, the better the reinsurer can spread risk and reduce the variations in its business outcome and premiums. When the pool is small, the adverse effect of heterogeneous risk profiles requires a higher premium for stabilization.
When the reinsurance contract reduces the resources needed to secure at least the same level of solvency for a defined level of expenditure, it becomes an interesting option. This value proposition calls for a comparison between two quantities: the cost of a safety margin over and above the mean cost of benefits7 and the reinsurance premium. Reinsurance is advantageous when the reinsurance premium is cheaper than the safety margin (assuming that the reinsurance threshold is equal to the mean benefits).
The comparison between the two values is complicated because the microinsurer’s expenses fluctuate, and thus the maximum capitalization needed is unknown. Since expenditure fluctuates, the microinsurer will need less than the maximum in some years and is challenged to operate with as little up-front capital retention as possible, without increasing the insolvency rate. When reinsurance is considered, the cost of the reinsurance premium plus the microinsurer’s maximum liability (defined as the reinsurance threshold) ceases to be an estimate as it is defined in the reinsurance treaty. Hence, reinsurance also reduces the uncertainty for the microinsurer.
The reinsurance premium has to cover the reinsurer’s solvency. The solvency rate of the reinsurer is assumed to be 95 per cent. The number of microinsurers in the pool and each pooled microinsurer’s risk profile determine the reinsurer’s solvency. A simplified example shows that each microinsurer needs 10 monetary units at the beginning of each period to ensure its solvency without reinsurance, but only half that amount of capital with reinsurance, when 30 identical microinsurers sign identical reinsurance contracts for one year.
Source: Adapted from Dror and Preker, 2002.
The social reinsurance model distinguishes itself from commercial models by the specific focus on the needs of microinsurers, including the option that microinsurance units can enjoy discretionary budgets for development of new benefits in years when claims are below the estimated long-term average. This feature is designed to motivate communities to reduce moral hazard and free-riding, as these phenomena counteract the interests of the insured.
Additionally, the link between social reinsurance and microinsurers includes a systematic access to technical assistance, including benefit-package design, claims processing, IT systems, etc. Since the success of social reinsurance depends on effective pooling of multiple micro schemes, it is necessary to develop and implement a standardized data-collection system and a datatransfer protocol.
Implementation of the social reinsurance concept can occur through multiple options of incorporation. It is essential that a way is developed for unincorporated microinsurance schemes to enter into reinsurance relationships so that they can offer viable protection to the low-income market. The mission of the social reinsurer is to serve as the conduit between microinsurers and the commercial (re)insurers.
540 The role of other stakeholders
4.1 Partnership-favouring considerations Partnerships usually succeed when both sides consider the relationship to be beneficial. Many insurers and reinsurers in developed countries operate increasingly in stagnating markets, with much competition and shrinking profits. At the same time, new markets in emerging countries (e.g. China, India and South Africa) provide large untapped business opportunities. Some of these opportunities extend to high-net-worth individuals and companies, but the vast majority of the untapped client base is the low-income segment.
The experience of microcredit and mobile phones has demonstrated that financial services for low-income groups can operate profitably. The same applies to insurance; there are no inherent reasons why insurance for lowincome persons should be unattractive commercially. However, success of insurance at “the bottom of the pyramid” requires the industry to adapt to the clientele, rather than expecting clients to adapt to the vendor. Adaptation in this context would refer mainly to front-office and back-office administrative practices, rather than to core business considerations such as diversification of risks over large risk pools and over long periods of time. The lower cost of computers, software and means of communication and better educational facilities make it feasible today to operate in low-income and rural population segments.
Insurers and reinsurers may find in microinsurers capable partners that simplify the process of entering the low-income market, and thus change the business paradigm of insurance. Businesses that depend on access to large numbers of clients for their success can no longer adopt a strategy of ignoring the majority of the world’s population.
Table 49 summarizes both internal factors (those arising from internal and organizational constraints) and external factors (demanded by external stakeholders and regulations) that favour partnerships for insurers and reinsurers.
At the other end of the partnership continuum, microinsurance schemes are also subject to internal and external pressures that favour partnerships with insurers and reinsurers. These factors do not apply uniformly everywhere, but they are given here (Table 50) to facilitate the understanding that partnerships are win-win business propositions in the long term.
The role of insurers and reinsurers 541 Partnership factors for an insurance or reinsurance company Table 49
4.2 Establishing the partnership Partnerships between microinsurance schemes and commercial insurers or reinsurers will occur when both sides agree to adjust and adapt to each other.
The insurance products must be of interest to and affordable for the lowincome market, and at the same time commercially viable. The viability of products is determined by an adequate fit between premiums and benefits, independently of business volumes. At the same time, also independently of business volumes, insurers and reinsurers must adapt their products to the needs and business model of microinsurers. At the present “embryonic stage”, business development entails on the one hand looking for solutions which enable microinsurers to operate profitably, and on the other hand recognizing that profitability may be compromised by start-up costs.
Reinsurance companies can help design products. Insurers can help commercialize products. However, neither insurers nor reinsurers are best placed to organize training activities, even though they can support this crucial activity financially and by allocating experts to training. It is tempting to suggest that the most promising approach to partnerships is to involve microinsurer, insurer and reinsurer from the beginning. However, the case studies do not offer much evidence to support that this suggestion has been followed very frequently. Instead, the more consistent conclusion from the experiences reported elsewhere in this book is that commercial insurers and reinsurers must acknowledge that microinsurers are not simply scaled-down verThe role of other stakeholders sions of insurance agents. The different economic and social situation of lowincome groups requires a critical review and adaptation of the processes applied and the products offered in the traditional insurance market. Secondly, microinsurers must do more than just expect others to adapt to their unique situation; they must take the lead in developing innovative approaches to tap what their clients want in product design, insurance practices and loading levels for administrative and capital costs. The evidence provided by the case studies suggests that the prevalent practices of commercial insurers or reinsurance providers are not in line with the needs of most microinsurers that underwrite risks.
The partnerships which enable microinsurers to obtain adequate domain knowledge and the necessary access to information, capital, hardware and software will, for the foreseeable future, constitute as much a means of collaboration to create the “industrial infrastructure” as pure commercial transactions involving the transfer of risk. It will take more than merely “win-win potential” to see the partnerships take hold on the ground.