When does insurance make sense?

In his useful assessment of microinsurance schemes, Paul Mosley proposes the idea of “quasi-insurance” – the provision of risk-protection through non-insurance routes such as loans and savings in markets where microinsurance is lacking or insufficient. Mosley purports that “in every case where a choice has to be made concerning choice of risk management strategies it is desirable to assess whether such non-insurance options may offer a lower-cost or more effective method of protective the poor than microinsurance.”  

His suggestion is consistent with what authors of Portfolios of the Poor found when they reviewed the financial lives of low-income households in India, Bangladesh and South Africa. Diary households preferred general-purpose financial tools such as emergency loans and savings to insurance, because the general-purpose tools offered protection against a broad range of crises.  In contrast, single-purpose insurance tools, which are intentionally specific to protect against misuse and fraud, offered restricted protection.  

The problem is that these broad protection measures are often insufficient when facing a major crisis. FAI recently conducted a survey on household’s health seeking behavior and financing options when facing a health event. We asked households who had undergone a surgical treatment about how they financed the treatment. 

Almost all households used a general-purpose tool first – they dipped into their savings.  Unfortunately, these savings were never sufficient to meet all the costs of the treatment. Households had to supplement limited savings with advances from work, interest-free loans from friends or family, expensive interest-bearing loans from money lenders, or proceeds from pawning jewelry.  

We might not consider an appendectomy to be a catastrophic event, but for poor households it can be.  Providing greater protection against such an emergency, at a time when households are most vulnerable, is the main advantage that insurance offers over “quasi-insurance” approaches.