Microfinance and Microinsurance Tools for Poverty Alleviation
Microfinance and Microinsurance
Tools for Poverty Alleviation
Microfinance and microinsurance are becoming more commonplace throughout the world to assist those less fortunate. Find out how actuaries can help the cause.
By Shiraz Jetha
In an announcement from Oslo on Oct. 13, 2006, the Norwegian Nobel Committee awarded the 2006 Nobel Peace Prize jointly to Professor Mohamed Yunus and the Grameen Bank "for their efforts to create economic and social development from below." This event was the ultimate recognition of the role of microfinance in poverty alleviation and the part played by Professor Yunus and the organization he founded in Bangladesh, the Grameen Bank.
Microfinance is generally understood as the provision of basic financial services, including savings, credit, money–transfer and even insurance, to the poor—or in a broader sense, those unable to access such services due to exclusion by the mainstream retail banking sector.
The History of Microfinance
Microfinance began in the 1960s and 1970s as a humanitarian activity directed at the poor. It was initially termed microcredit or unsecured/partially secured loans of small amounts available to individuals for income generation purposes.
Bangladesh is the seventh most populated country in the world with 145 million people and ranks 180th (out of 209 countries listed) in terms of per capita GNI (or 167th in terms of purchasing power parity rankings). In the mid '70s, Bangladesh—then a relatively young country—was in the midst of a severe famine resulting in heartwrenching misery for the impoverished. Feeling helpless by the inability of traditional economic theory to provide solutions to the poverty crisis, Professor Yunus, an economist, made a desperate move. He provided direct personal assistance to the poverty–stricken—at an individual level—one human being to another. To his surprise, he learned that the amount of financial assistance involved was very small.
The first group of 42 individuals only needed a total sum of $27 to help improve their income levels. These people were all involved in viable income generating activities. The problem was that their terms of trade were such that they could never improve their economic condition. To produce their merchandise—for example, bamboo stools—they needed working capital for the raw materials. Having only non–formal loan sources to do business with, the workers were required to sell back their finished products to the lenders at minimal prices, which essentially amounted to economic slavery.
Professor Yunus provided the $27 and found that, contrary to conventional thinking, the loans were all paid back. Encouraged by this, he continued "lending," and each time the results were the same—the micro loans were paid back.
With growing conviction in the ability of micro loans to help the poor, the next step was to increase his efforts. To bring this endeavor to a higher scale, there were many challenges to work through—cultural (loans were mostly to women), religious (loans involved interest which is unlawful in a Muslim country following Sharia law) and there was little support from where it really mattered most (political and banking circles). With unwavering determination, Professor Yunus' efforts continued and the Grameen Bank—which first started as a humanitarian project—came into being in 1983 and well, the rest is history! According to the Microfinance Information Exchange (or MIX; see Mix.org which is a comprehensive site for information on self–listing microfinance institutions), Grameen had nearly seven million borrowers in 2006, up from five million a year ago. In addition, the bank reports a loan portfolio of $481 million for an average loan of about $70.
Microlending practices are now widely accepted in the developing world and have evolved significantly over time with institutional business models ranging from those with entirely social goals to those operating purely on a commercial basis.
This article is intended to provide an introduction to microfinance and microinsurance. While the relevance of these topics may be limited in the West, both receive significant attention and resources in the developing world since both the "micros" are thought to play an important role in poverty alleviation. These areas can also provide a new venue for actuaries to contribute their know–how. For now though, actuarial presence in the area while needed, is very limited.
Microfinance, Microinsurance and Poverty
According to World Bank estimates, around one in five of the world's population lives on less than $1 a day (extreme poverty) and around one in two live on less than $2 a day (moderate poverty). While there have been improvements in extreme poverty levels more recently, both levels remain high and there is now a concerted effort worldwide (e.g., UN's Millennium Development Goals) to significantly improve outcomes in this area. Microfinance is thought to have an important role to play since (a) an encompassing and vibrant financial (banking) sector is essential to increasing the level of economic activity and (b) the traditional banks do not cater to the needs of the poor who make up the vast majority of the population in some areas.
As previously mentioned, microfinance has found widespread acceptance from the early days in the 1970s; currently the MIX Web site lists over 1,000 institutions from over 100 countries that have registered with the Exchange. Many countries have already enacted legislation to formalize the sector through regulation, allowing some banking activities, such as taking deposits and extending deposit protection, in addition to lending. In other countries, MFIs (or microfinance institutions) are restricted to lending activities only or are unregulated. A regulated sector with customer protection is an important element in building capacity in this area.
Microcredit loans involve group responsibility. The process typically starts with membership in a group, for example, a group of five unrelated individuals. An initial period of regular (weekly) savings is required and after a certain number of weeks, the members of the group are eligible to take out loans. Loans are a multiple of amount saved (from two to as high as five times); there is collective responsibility to ensure payment of loans. A delinquent group member affects the ability of every other member to take new loans, and in some cases, may also affect access to their savings. Therefore, peer monitoring plays an important role in reducing defaults. MFIs typically report very low default rates, usually in the area of 2 percent to 3 percent. As business models have evolved, the group–based lending model described is also evolving.
So how does microinsurance (MI) come into play? MI protects people in the low–income range against specific perils in exchange for regular premium payments. The coverage is typically bought in the context of loans made by MFIs and can provide protection in the event of death and/or hospitalization of the borrower. It also can cover certain hazards to which the business may be exposed—fire or burglary, for example. The main challenge associated with MI is to offer needed—and ideally comprehensive—protection at affordable premiums.
In Kenya, for example, MI started appearing on the radar screens of some insurers as a result of the needs of the MFIs. Engaged in microlending as they are—and in a country where HIV/AIDs is a factor—the death of borrowers, for example, can seriously affect the performance of the loan portfolio. It can also have a profound effect on the ability of the institution—which oftentimes is affiliated with a worldwide faith–based aid organization—to pursue its mission to alleviate poverty.
Lately, MFI business models are starting to shift from the purely social, or philanthropic, model where microlending programs accompany other social programs—such as health and education programs—to mixed models, where programs are delivered more with a focus on income enhancement, and ultimately to commercial models, where microlending becomes by far the most dominant and oftentimes the sole program offered. This has occurred because the social model requires ongoing donor funding and the bottom line discipline of the commercial model would, over time, lead to self–sufficiency. In a departure from the historical origins of microcredit—as one of several social programs all directed at poverty alleviation—there is a now a separation of lending programs from other social programs. And with the shift to the more bottom line oriented commercial business model for the lending activity, MI coverage is generating a lot of interest from MFIs.
Hospital Insurance Program—One Solution
Jamii Bora Trust, a microlending institution in Kenya, recognized early on the importance of insurance. Researchers found from a study they performed on its loan defaulters that over 90 percent of the delinquencies had one thing in common. An unexpected large expense was tied to hospitalization of either the borrower or one of the family members. Jamii Bora, which works with the very poor, concluded that a hospitalization insurance program for its borrowers was the solution. The trick, however, was to design a comprehensive yet affordable program. The premiums being contemplated were between 10 percent and 20 percent of the lowest commercial premiums in the market. And of course, all of the local insurers that were approached refused to provide the coverage. So Jamii Bora decided to experiment to see if they could provide this coverage themselves, as they had previously done on the life side for similar reasons, e.g. institutional need but unwilling insurers. By using low–cost, faith–based hospital providers exclusively, they have been able to deliver coverage at targeted premiums. Both programs have now been in existence for several years and have provided much needed relief to those borrowers and their families affected by misfortune of illness and death. Gradually one or two of the insurance carriers started to see a significant opportunity and have made cautious entry into this market of covering MFI borrowers.
Microinsurance programs are becoming more common in India, and are gradually appearing in many other countries. Actuarial presence is quite limited with only a few practitioners. Product needs vary from life and health insurance to property and casualty coverages including newer lines such as crop and livestock insurance. The challenges are quite significant in terms of data quality/availability, sound product design and innovation in creating a product spectrum that meets the needs of the poor and of the institutions serving them.
Beyond the institutional loan based products, there are opportunities to also develop individual products at a premium rate level appropriate for the market; these could be pure risk products like term life or savings and life insurance like simple unit linked or traditional whole life/endowments. One is often reminded of the parallels with the industrial assurance era when small individual permanent life insurance policies were sold and serviced by dedicated career agents who collected premiums in weekly cash installments. This model has been used in rural areas to service the microloans and the accompanying insurance coverage payments. However, with the widespread proliferation of cost–effective communications technology combined with innovation in funds transfer (e.g., using the SMS technology of mobile phones), these older bicycle servicing models are fast being replaced by motorbikes and slick handhelds using wireless technology. This has significant implications for lowering the cost of administration of the business.
Other Areas of Actuarial Involvement in the MFI Sector; the Other Half
Beyond microinsurance, what are other ways that actuaries can make a contribution in this sector? Several aspects come to mind.
- MFIs essentially are financial organizations providing financial products—both savings and borrowing. Many actuaries have experience in these products, which could serve these institutions well, especially those operating a commercially leaning model. At a different level, actuaries would be well qualified to also lead and run these organizations.
- While not strictly actuarial in the traditional sense, institutional studies are another area of possible involvement for actuaries. One example is designing study(ies) that enable an institution to track how its members progressively move out of poverty over time. Along similar lines, another avenue would be assisting organizations in establishing social goals/targets and designing metrics (or surveys) to measure performance against these targets.
The developing world (the "Other Half") itself offers new opportunities for actuarial involvement. For example, many countries with donor support are looking at strengthening their national financial security and health– care programs. While the objectives of these programs may be similar to those in the developed world, their complexion can be different reflecting local attributes. The center stage in many of these situations does not involve actuaries today, and it should! Our training and long history of involvement with these types of programs gives us the ability to make significant contribution in these areas. The trick lies in getting the planners and the decision makers to "find us." Part of the strategy here probably involves outreach efforts by both individual actuaries and our actuarial organizations into the development aid community (inter–governmental organizations, e.g., World Bank, high–profile donor organizations like the Gates' and Clinton foundations and other Non–Governmental Organizations (NGOs)).
Shiraz Jetha works as an actuary at the Office of Insurance Commissioner, Washington. In 2006–2007, he served as consultant to Aga Khan Foundation, USA, and led an organizational study of the Jamii Bora Trust, an MFI in Kenya. He can be reached at shirazj@oic.wa.gov. A copy of the study report is available for interested readers.