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April 14, 2014

Coping with Financial Shocks, Insurance is one Tool of Many

By Emily Zimmerman

This blog post is co-written with Barbara Magnoni and Laura Budzyna.

Do clients get value from microinsurance? This was a straightforward question asked of the MILK Project over three years ago. And as the Project comes to an end, we have come up with a perhaps uninspiring answer: Sometimes.  But keep reading- the inspiration is in the nuance.

Insurance is one of many coping strategies that low-income people might use when faced with a financial shock. It is rarely sufficient, and as such, even when people have insurance, they turn to one or more other strategies to cover their financing needs. Which additional tools are used, when and in what amounts, depends on their accessibility (how much if at all can be raised through a tool and how quickly?) and the burden they impose (what direct, opportunity or social costs are associated with using this tool?). Thinking in terms of their relative access and burden helps us understand the role insurance plays and under what conditions it may offer the most financial value.

Through over 1,000 interviews with insured and uninsured people worldwide, we identified the 8 most common tools for financing these shocks, provided below in order of frequency of use by those who also had insurance. We find that the more frequent tools (gifts, household income, spending cuts, informal loans) are the most accessible, and in many cases less burdensome, as people tend to either have limited access to the less frequent ones (formal loans, savings, asset sales), or resist using these because of their relatively higher burden:

  • Gifts (51%) and other contributions from friends, family, and community can play a crucial role in financing the costs of a shock. But this differs widely by shock type and context. 81% of respondents in our life insurance studies received gifts compared to only 17% of respondents in our outpatient health studies.
  • Household income (50%) was used especially for smaller shocks as it is hard to amass in large amounts. Those who used income to cover their shocks had a higher average household monthly income of $301 compared to the overall average $218.
  • Spending cuts (31%) As with income, it is hard to make spending cuts add up to large amounts, and those who did tighten their belts often had higher incomes.
  • Informal loans (31%) The expectation of an eventual insurance payment seemed in some cases to help “crowd in” low-cost informal loans from friends and family.
  • Savings (17%) People preferred to avoid using savings to finance a shock. Of those who had a formal savings account, only 20% used it. Savings were usually insufficient to cover the shock. For those who used savings, it comprised only 21% of their financing.
  • Formal loan use (14%) was surprisingly low. Access to formal loans varied, though it was higher in the insured groups, many of whom were microfinance borrowers.  But even microfinance borrowers had difficulty borrowing for “consumption” purposes in the aftermath of a shock. Where formal loans are available, they are typically quick and relatively large. They can help bridge the gap, meeting immediate needs before slower forms of financing are available. However, their cost (in the form of interest payments) can add up quickly.
  • Asset sales (11%) were most common among respondents suffering flood damage in Haiti (37% of insured and 58% of uninsured respondents) some of the poorest and most vulnerable people we spoke with. Selling a productive asset is seen as a last resort, as it can have a long-term effect on income.  The illiquidity of many assets held by the poor also led some to sell these at a discount, or to sell more valuable assets that were worth more than their immediate financing needs.

Insurance is not always the quickest, the easiest, or the most accessible tool. But it can be an important complement to the other strategies outlined above.  While on average we do not observe people with insurance using fewer financing strategies, we do see them using smaller amounts of the most burdensome ones. As such, microinsurance makes sense as part of a broader risk management strategy for the poor, but only when it is specifically designed to reduce the need to turn to other strategies. 

Our research points to several recommendations about the design of better insurance as the industry seeks to broaden access for the poor. First, providers should design products for people who lack viable financing alternatives and offer enough coverage to actually take the “bite” out of the financial shock.  Second, they should schedule payouts for the times people need them most, and pay them on time to avoid over financing or “churning” of multiple strategies. At times, insurance can be useful as a cashless service, if this replaces spending that would otherwise take place at a lower cost or with greater convenience.  Other times, particularly when a shock reduces the income generating ability of a household, insurance should aim to get the household economy up and running. Finally, it’s crucial that customers are aware of the coverage they have and know how to put it to use if needed.      

Barbara Magnoni is the president of EA Consultants, a development consulting firm dedicated to supporting initiatives that facilitate access to finance, markets and social protection. Emily Zimmerman is a Research Associate with EA Consultants and the MicroInsurance Centre, and Laura Budzyna contributes statistical analysis and study implementation support to the MILK Project's Client Math studies.

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