Chapter One – The importance of insurance

1.1 The plight of the poor
Countless explanations have been put forward for the despairing situation of the many millions of poor people in developing countries. An understanding of these reasons and the characteristics of the poor are important when discussing the potential role of insurance mechanisms (Appendix One).

The livelihoods of citizens in countries with low human development
compared to high human development

HDI
rank
(from 174)
1998 Country
HDI value
1998 GDP per capita
(PPP US$)
1998 Life expecta-ncy
at birth
(years)
1998 Adult literacy
(% age 15 and above)
1998 GDI•
value
1998 Population below income poverty line
(%)
Under-five mortality rate
(per 1000 live births)
1998 Doctors per 100,000
People
1992-95
1 Canada 0.935 23,582 79.1 99.0 0.932 5.9º 6 221
2 Norway 0.934 26,342 78.3 99.0 0.932 2.6º 4 -
3 United States 0.929 29,605 76.8 99.0 0.927 14.1º 8 245
172 Burkina Faso 0.303 870 44.7 22.2 0.290 61.2* 165 -
173 Niger 0.293 739 48.9 14.7 0.280 61.4* 280 3
174 Sierra Leone 0.252 458 37.9 31.0 - 57.0* 316 -

HDI (Human development index) – composite index based on life expectancy, educational attainment and standard of living. A HDI value equal to or more than 0.800 has high human development, 0.500-0.799 HDI has medium human development and a HDI below 0.500 reflects low human development and well being.

•GDI (Gender-related development index) – composite index using same variables as HDI but adjusted in accordance with the disparity in achievement between women and men. A GDI of less than 0.500 show that women in these countries suffer the double deprivation of low overall achievement in human development than men.

º Income poverty line is $14.40 a day (1985 PPP US$) 1989-95 –as used in HPI – 2 calculation
* Income poverty line is $1 a day (1993 PPP US$) 1989-1998–as used in HPI – 1 calculation

Source: UNDP (2000).

1.1.1. - Location
About 70% of the world’s poor live in rural areas. Employment is informal, family or self-orientated and mainly in agriculture, providing only seasonal and fluctuating cash flows. Inadequate roads and lack of transport and communication isolate the poor from economic opportunities and limit access to social services including health, food , sanitation and education, in particular for women and minorities (Appendix One). Manipulation from intermediaries, depressed food prices, monopolistic marketing boards, and protectionism by developed countries makes it difficult for producers to access export markets and obtain market prices for their goods (Carney 1999, Creese & Bennett 1997). The disparity between rural and urban sectors is evident by the greater progress in human development and less deprivation for people in urban areas (UNDP 2000) .

1.1.2. - Lack of access to the formal sector
In most developing countries the informal sector accounts for between 50 to 60 percent of the workforce, whilst in some it can be over 90 percent. The informal sector is characterised by very small entities that are family orientated, providing for small local markets, requiring minimal capital investment and low-level labour intensive skills. Workers in the informal sector do not have formal employment contracts, they are unaware of their rights and do not have any effective lobbying force (Dassanayake 1999). Additionally, the lack of formal financial services enables rogue moneylenders to exploit the poor through informal saving schemes (Rutherford 1999b, Ford Foundation 2000).

1.1.3. - Health
Almost half of the world’s population does not have access to basic healthcare (STEP 1999) . Where public-financed facilities are available they are too far and are not usually of adequate quality or quantity (Dror & Jacquier 1999). In Africa the economic crisis of 1970s and 1980s resulted in cuts in state subsidies and the introduction of user fees which further limited access for the poor (Atim 1998).

The poor need health-care, their living environment is dirty and polluted causing a high risks of infections and diseases. HIV/AIDS are predominant in the poorer regions where income opportunities are low and information on sexual practice is non-existent. Vaccinations against measles, meningitis, tuberculosis, yellow fever and hepatitis are either unavailable or too expensive . Polluted water and air mean diarrhoea and respiratory infections are the most common causes of death amongst young children . Injuries and chronic illnesses resulting in long-term disability affect an estimated 5-10 percent of people in developing countries. Disability is related to poor education, nutrition and unemployment and caused by injuries or by communicable, maternal diseases (World Bank 2000, Brown & Churchill 1999).

1.1.4. - Education
Education is a route for upward mobility and a form of social security for parents in their old age (Wright 1999). However, very few poor children obtain an education as many have to work to provide household income. Without education the poor are unable to access wage employment in the formal sector or obtain important information on health and birth control (McKay 1997).

1.1.5. - Corruption
Democratic and participatory political processes are key to stable growth and poverty reduction. (World Bank 2000). “Democratic” central governments in developing countries are unable and unwilling to finance and manage social services to the poor (Creese & Bennett 1997). The policy environment determines the effect of economic growth on inequality (Goudie & Ladd 1999). Corrupt officials increase inequality and prevent the dissemination of economic growth to the poor in order to maintain their stronghold on power (Appendix One). They are influenced by the needs of powerful elite groups and multinationals that pay bribes in return for favourable policies. The poor have no voice in the political area, most public resources are spent on debt servicing, maintaining the wealthy, subsidising inefficient state enterprises and undertaking military purchases (Hulme & Mosley 1996). There is a lack of public accountability, credible information, transparency, regulation and sound financial supervision. . Money and power undermine the independence of the judicial system . The lack of regulatory enforcement and low paid government officials provide a breeding ground for corruptive practices. Poor people and in particular minority ethnic groups have little knowledge of their rights and have limited understanding of the written law (World Bank 2000).

1.1.6. - Natural disasters and civil war
Over the past ten years the incidence of natural disasters has increased, adverse weather situations such as drought, flood and storms are becoming more frequent and more severe. The settlements of the poor are commonly found in hazardous or coastal areas where nobody else has the use of the land. These slums are highly inflammable, structurally very weak and prone to collapse (Pollner 2001). Between 1990 and 1998, 94 percent of the world’s 568 major natural disasters and more than 97 percent of all natural disaster related deaths were in developing countries. People in low-income countries are four times as likely to die from catastrophes than those in high-income countries (World Bank 2000). The majority of civil conflicts are also in poor countries, the poor are easily manipulated to uprise due to their frustrating situation . Many of these conflicts lead to widespread devastation and the mass slaughter of women and children.

1.1.7. - Women in poverty
Women are disproportionately represented among the poor and the challenges they face are greater than that of men (Appendix One). It is women who bear the burden of poverty, taking care of the sick, working extra hours and giving up their food and education in times of crisis (Ford Foundation 2000). They are culturally regarded as inferior and are usually assigned to part-time, temporary or occasional work, which is the most vulnerable to economic pressures (Dassanayake 1999, Hulme & Mosley 1996). Women bear the brunt of arranged marriages, migration and child fostering and usually lose out more then men during downturns (Morduch 1999). Very poor women face geographical and social exclusion, they lack self-confidence, and have restricted access to training and information on health and nutritional problems. This leads to a large number of unhealthy babies and an increased strain on the resources of the household. (Dunford 2001). Literacy rates are also low for women as they stay at home helping with the housework and agriculture, this reduces their employability, understanding of legal rights and their ability to make informed health decisions. They are regarded as belonging to the husband’s family and therefore a wasteful investment (Dassanayake 1999).

A woman is the head of the family in more than one-fourth of all households due to increasing divorces, migration by husbands and death in civil war, however limited access to adequate education and training prevents the growth of women’s micro-enterprises. Majority of women entrepreneurs in the informal sector work long hours in poor conditions for low and irregular income. They lack capital, have little bargaining power and have to rely on manipulative moneylenders. They are not protected from sickness, death or accidents, which continuously hinders their capital formation (Women’s World Banking et al 2000, Women and Micro-enterprise Initiative 1999, Dassanayake 1999). The empowerment of women will contribute to the well being of the whole family and the community, enhancing the entire development process. Women with better education and autonomy are more able to protect their children and increase their development. With equal opportunities and new productive economic roles women can become successful entrepreneurs and provide for better economic growth (Dassanayake 1999, Dunford 2001, Hulme & Mosley 1996).

1.2. - The impact of risks on the poor
As discussed above, poor households face difficulty in generating regular and substantial income and are extremely vulnerable to economic, political and physical downturns (Matin et al 1999, Brown & McCord 2000). Additionally, the inequality, lack of diversification and social injustice faced by the poor mean that unexpected losses can only be met from existing funds, there are limited opportunities to find other sources of income or assistance. For the poor and for those just above the poverty line, a drop in income or increase in expenses can further reduce their already low standard of living. The risk is that some peril such as death, sickness, accident or old age may interrupt income, forcing the disposal of productive assets or household consumables to recover from the loss, which in turn decreases future income and current livelihood (Ali 2000). The frequency of losses are also greater on the poor, life expectancy is lower, and illness, disability and crime rates are higher than the average citizen, many are exposed regularly to harsh weather, political instability and economic mismanagement (Hauck 1997, World Bank 2000, Brown & Churchill 1999). Without investment in health the productivity of the household’s labour force is diminished, as the informal sector is predominantly labour intensive (Wright 1999). The high risks of death and disability mean the loss of the income earner (usually the man) without able substitutes is quite common, this is due to lack of access to training, education and opportunities for women (Brown & Churchill 1999). Crimes such as theft and violence occur regularly in a poor neighbourhood, where there are no adequate means of safeguarding assets. Cheaply constructed houses in slum areas are more likely to be destroyed by fire and natural disasters, spiralling many households into poverty following the depletion or damage to productive assets (Morduch 1999).

To cope with a loss the poor have to resort to emergency measures such as child labour, malnutrition and reducing children’s education and family healthcare (World Bank 2000, Wright 1999). Also the fear of losses can mean sacrificing new technologies and profitable business opportunities, impeding any possibility to move out of poverty (Morduch 1999). The poor are already limited to low-risk and low-return strategies due to the lack of working capital, opportunities, inputs and skills. Subsequent exposure to risks and the accompanying uncertainty leads to even less growth focused opportunities taken (Brown & Churchill 1999). It is therefore important that the poor are protected from these risks if not to directly alleviate poverty but at least to enable the benefits of other measures such as education, gender equality, sanitation, employment opportunities, population control, healthcare and nutrition to be realised.

1.3. - Risk-coping mechanisms
In addition to coping with the effects of risks, the poor also need resources to deal with lifecycle events such as marriage, birth, death, education, and old age. They need to be able to take advantage of income-generating opportunities or acquire life-enhancing consumer durables such as TVs and refrigerators. The poor therefore occasionally need access to large sums of money to deal comprehensively with these requirements without affecting their current or future livelihood (Rutherford 1999a). Unfortunately, the poor have little means for money management, as there is little access to banks and insurance companies (Rutherford 1999b). There are no unemployment benefit or pension plans available and no easy access to credit markets in times of volatile flows of income. To provide protection against risks the poor have in the past developed informal insurance mechanisms such as selling assets, exchanging gifts, cash transfers and diversifying crops, unfortunately these have proved inadequate and have instead retarded economic growth and social mobility (Morduch 1999). Since the 1970s there have been many pro-poor banking institutes established in the semi-formal sector including micro-finance institutions (MFIs) and non-governmental organisations (NGOs) to satisfy this need (Rutherford 1999b). It has now become recognised that poor people can save and want to save, and their need to access lump sums in return for smaller affordable payments can be satisfied in the following ways:

a) Savings deposit – lump sum in the future from small savings now.
b) Loans - lump sum now for saving (repayments) in the future.
c) Insurance – lump sum at an unspecified time for series of savings (premiums) now and in the future.

Many elderly people live in poverty due to limited access to pension plans and saving facilities and the low income of other family members. Consequently they have a large number of children to provide informal social security for their later years. Convenient and reliable savings schemes allow households to reduce the number of children they have without undermining their ability to cope with a lower income in old age (Morduch 1999). In particular, women, as well as an important source of labour are also an important savers group. They are better savers then men, they spend their money more wisely and take care of food and health needs, take care of the sick and elderly and provide for the education of their children. They have invaluable knowledge and understanding of the problems and constraints facing the poor, and reinvest more in their family and community (Dassanayake 1999). Without easy saving opportunities the poor tend to spend or lend to friends and families foregoing any long-term capital accumulation. Savings can ensure that basic needs are covered in times of household shocks such as old age, death and disability (Rutherford 1999, Morduch 1999)

Loans help the poor to diversify their risks, invest in productive assets, and enable education, healthcare and lifestyle expenses to be within reach. Access to credit enables the poor to smooth consumption during periods of low income or unexpected losses without having to sell productive assets or spend working capital. It enhances gender equality by giving the woman the opportunity to make a larger contribution to household income and increase her role in the family (Wright 1999, Matin et al 1999).

Whilst both savings and credit facilities are integral in assisting the poor overcome unforeseen losses their benefits are limited to the capacity of the individual to save or make repayments. When bad conditions and their consequences persist for several years such as drought and flooding, then the use of savings as protection are limited. In addition, high risks of illnesses, death and disability of the breadwinner means outstanding loans become difficult to repay (Ford Foundation 2000). Debt bondage is a form of child labour that is a consequence of loan default, the bonded labourer has to work off a loan contracted many years or generations ago at terms that make full repayment impossible (SFU 2000). There is also a high risks of non-payment due to lack of protection against natural hazards which limits the availability of credit to the poor (Hulme & Mosley 1996). In Eastern Africa compulsory savings are locked in to act as security for loans, and ensure good repayment rates. However, as well as restricting access to savings, most loans are only half as large again as the savings and are not sufficient to cover all risks or losses (Rutherford 1999).

Consequently, insurance has been recognised as the most appropriate means for protection against highly unpredictable events, whilst savings can still be used for more predictable risk (Atim 1998). Although in some cases the substantial costs of predictable events, such as death, may mean insurance is a better option.

Differences between Savings and Insurance

Insurance <-----------------------------------------------------------------------------------------------------------------------------------> Savings

Highly unpredictable <----------------------------------------------------------------------------------------------------------> More Predictable


House fire or storm damage
Car damage
Crop
Loss
Theft
Loss
Disability
Emergency
health care
Hospital care
Delivery
Out-patient
care
Life/
funeral
Pension
Purchase of durable goods


Source: Atim (1998)
Funerals as an example, are a major expense for the poor , aggravated by the rise in HIV/AIDS. Selling assets, obtaining credit, drawing on savings, receiving gifts or purchasing insurance are possible methods available to pay for the costs. Selling assets is difficult due to the time lag and lack of available assets, use of credit and savings mean either greater debt or sacrificing a productive use of accumulated wealth and gifts are monetarily insignificant. Therefore funeral insurance is the most appropriate and affordable method to cover the expense (Roth 2001).

1.4. - Micro-insurance
Insurance is the most effective means of reducing the vulnerability of the poor from the impacts of disease, theft, violence, disability, fire and other hazards. Insurance protects against unexpected losses by pooling the resources of the many to compensate for the losses of the few, the more uncertain the event the more insurance becomes the most economical form of protection. Policyholders only pay the average loss suffered by the group rather than the actual costs of an individual event, insurance replaces the uncertain prospect of large losses with the certainty of making small, regular, affordable premium payments (Brown & McCord 2000, Brown & Churchill 1999). The primary function of insurance is to act as a risk transfer mechanism, to provide peace of mind and protect against losses. Risk can be handled by either; assumption, combination, transfer or loss prevention activities. Insurance schemes utilize the combination method by persuading a large number of individuals to pool their risks into a large group to minimize overall risk (Ali 2000). In the developed world insurance is part of society, such that some forms of cover are required by law. In developing countries the need for such a safety net is much greater, particular at the poorest levels where vulnerability to risks is much greater and there are fewer opportunities available to recover from a large loss.

1.4.1. – Types of micro-insurance products
Loan protection insurance ensures that in the event of death all outstanding repayments are written off. Health and disability insurance enables the poor to cover the costs of medicine, hospital stay and treatment as well as protecting the loss of income due to sickness or injury . Funeral insurance covers the costs of burial, and property insurance replaces assets lost due to theft, damage or destruction (Brown & Churchill 1999). Livestock insurance is important in developing countries where animals are not only a source of food but are used for agricultural production and transport (IDB 1977). Life savings insurance, which pays the deceased beneficiary the amount held in the savings account plus a benefit enables funeral expenses to be taken care of and replaces some of the loss of income source (Brown & Churchill 2000) . Insurance can cover the risks of damage, piracy and theft of goods in transit which is much greater in developing countries, particularly for those that are landlocked. Commodities account for about 34 per cent of the export earnings of developing countries, in Africa they represent 79 percent. Producers are vulnerable to a number of geological and environmental risks including floods, earthquakes, droughts, typhoons and hurricanes. Crop insurance schemes can protect the producer from the losses of climatic and natural disasters . The availability of agricultural insurance including crop insurance, machinery, raw materials and even life-insurance gives greater assurance to credit providers to service the poor (Matringe 1997). Insurance is vital to ensure the continued access to credit and greater security for the individual. For the MFI, providing insurance products lowers default rates and reduces the clients need to draw down on savings, which improves the profitability and sustainability of the organisation (Ford Foundation 2000, Brown & Churchill 1999, Hulme & Mosley 1996).

1.4.2. – Micro-insurance and human development
In the past poverty has been measured solely by per capita income, however, it is now widely recognised that poverty also includes deprivation from health, education, food, liberty and opportunity. The Human Development Index (HDI) measures welfare of people using three factors, income (GDP per capita), educational attainment and life expectancy at birth (UNDP 2000). Micro-insurance programs can increase HDI by providing creditors with greater security and incentive to lend to micro-enterprises (World Bank 2000). For the individual, reducing risk through insurance enables credit and savings to be used more productively on income-generating opportunities (Devaux 2000, Matin et al 1999). With greater resources and a safety net the borrower can take on greater risk to achieve higher income and stimulate outside investment. They can also market their products outside of the local market achieving a better price for goods and for raw materials (Ford Foundation 2000). Insurance enables the policyholder to save a portion of his income, without the need to use it on medication, fire, theft and death, it can instead be invested in a child’s education. The requirement for less income also enables parents to send their children to school instead of working in the fields, better education leads to better health and better income earning potential as well as population control (World Bank 2000). Health insurance enables access to better medical services and a better quality and longer life. Access to adequate insurance protection can assist the poor to achieve sustainable growth and provide them with the capability to attain a better standard of living. It can mitigate the impact of personal and national calamities on the build up of assets, providing escape from the viscous circle of poverty that engulfs each new generation. Insurance can also protect those that have risen above the poverty level against unforeseen events that may cause them to fall into poverty again. Insurance provides security where none is available from the state, it facilitates self-sufficiency and empowers people to build for their own future.

Whilst the benefits of insurance for the poor are clear there are still very few micro-insurance schemes which have proved their viability and sustainability. The next chapter will look at why it has been so difficult to provide the same insurance products to the poor which are so widely available in developed countries.