International Tsunami Programme - ProVention · PDF fileSWOT Analysis of Index Insurance...

May 26, 20062 southasiadisasters.net

Key Idea

In this issue

1. Recipes for Risk Reduction–the Emergence ofMicroinsurance 2

2. Conceptualising RiskTransfer 3

3. Role Models inMicroinsurance: WhoContributes in theProvision? 4

4. Insurance Models forDeveloping Countries fromDeveloped Countries: ACase for Microinsurance 6

5. Learning from the PositiveExperiences in the Field ofMicrofinance 7

6. A Life and Non-lifeInsurance Product forthe Poor: the Afat VimoScheme 8

7. Product Innovations:The Index Insurance 10

8. Due Diligence Checklistfor Identifying anInsurance Partner 11

9. Commodity RiskManagement forDeveloping Countries 12

10. SWOT Analysis of IndexInsurance Products 16

Editorial Advisors:

Dr. Ian DavisCranfield University, UK

Kala Peiris De CostaSiyath Foundation, Sri Lanka

Khurshid AlamInternational Tsunami ProgrammeActionAid International, Dhaka

Madhavi Malalgoda AriyabanduIntermediate Technology DevelopmentGroup (ITDG) - South Asia, Sri Lanka

Mihir R. BhattAll India Disaster Mitigation Institute, India

Dr. Rita Schneider - SliwaBasel University, Switzerland

Dr. Satchit Balsari, MD, MPHThe University Hospital of Columbia andCornell, New York

Recipes for Risk Reduction– theEmergence of Microinsurance

Following the UN year of Microcredit in 2005, there is growing interestin microfinance solutions to help alleviate poverty in developing countries.

In Asia, in particular, the demand for microfinance has encouraged an ever-increasing number of institutions to provide services, such as microcredit,savings and social funds for low-income households. Microfinance services arealso now beginning to include the provision of microinsurance as financialprotection for low-income households or businesses against specific losses,including death and funeral expenses, health expenses, loss of small-scale assets,damage to property or loss of livestock and crops. The emergence ofmicroinsurance is an important development within the field of microfinanceand challenges the previously wide-held belief of the "non-insurability" of thepoor.

Microinsurance is also emerging as a potential instrument for transferringnatural disaster risks by providing cover, or indemnification, against lossesfrom a disaster event. Like other forms of microinsurance, the intent it toprovide easily accessible insurance cover for small-scale assets at affordablepremiums by keeping transaction and other costs low. By protecting the poorfrom disaster losses and providing incentives for risk reduction, microinsuranceis increasingly recognised as an important part of disaster risk management.

However, questions remain over the affordability for the poor and the viabilityof such products from a commercial point of view. To address these key concernsthere is need for more learning informed by practice and, thus, this latestsouthasiadisasters.net is an important contribution to the debate onmicroinsurance.

This issue of southasiadisasters.net examines the subject of microinsuranceand discusses the opportunities and challenges that have been learned throughrecent experiences in implementing microinsurance schemes in Asia. Theopening articles introduce the concept of risk transfer that underpinsmicroinsurance and discuss its relevance to disaster mitigation. Case studyexamples illustrate different approaches to microinsurance, including a rangeof insurance services and products tailor-made for low-income communities,and highlight salient lessons learned for the evolving microinsuranceagenda.

We sincerely hope that this issue of southasiadisasters.net will contributetowards further learning and practice in microinsurance and help promote theuse of risk transfer as an important tool in the field of disaster risk reduction.Certainly, as disaster losses continue to grow and the poor are hit the hardestthere is an urgent need for more innovative solutions–microinsurance could beone.

David PeppiattHead, ProVention Consortium Secretariat

May 2006

This issue has been prepared by AIDMI as a contribution to the Annual Meetingof the International Task Force on Commodity Risk Management in Pretoria,South Africa.

May 26, 2006 3southasiadisasters.net

The provision of financial serviceslike savings or credit for the poor

is well recognised as an effectiveinstrument to address poverty,especially the economic well being ofthe poor.

However, despite savings and creditservices, the population of India andits neighbour countries face many risksor shocks in the form of naturaldisasters that make the poorvulnerable. Implicitly, attempts bypoorer households to cope with severehazards, often leads them into debt andultimate impoverishment—a challengethat the World Bank refers to as the"poverty trap".

In order to address this issue, thisnewsletter will focus on the conceptof risk transfer for achieving riskreduction. One microfinance toolwhich allows risk transfer is therelatively new instrument ofmicroinsurance. Essentially, manyindividuals or groups are capable ofsharing the cost of a risky event whenapplying microinsurance.

The rationale behind the concept ofrisk transfer lays in the fact that by

forging relationships with othercommunity members, low incomehouseholds can achieve a greaterreduction in vulnerability than throughindividual strategies. Thus, the risk is

How can we Define Microinsurance?

The Consultative Group to Assistthe Poor (CGAP) provides a

helpful definition of this instrumentof microfinance:

"Microinsurance is the protection oflow-income people against specificperils in exchange for regularmonetary payments (premiums)proportionate to the likelihood andcost of the risk involved. As with allinsurance, risk pooling allows manyindividuals or groups to share the costof a risky event. To serve poor people,microinsurance must respond to theirpriority needs for risk protection(depending on the market, they may

seek health, car, or life insurance),be easy to understand, and affordable"(CGAP 2003).

This definition refers to anotherimportant feature: the insurance hasto be understandable. This is an issuewe will devote more attention to interms of the discussion of the Afat Vimo(AIDMI's disaster insurance) schemesince it implies that alongside thesupply of products every interestedinstitution, the training of potential"clients" becomes relevant.

After having provided a definition ofmicroinsurance, it appears interesting

to learn more about the criteria ofinsurability from the perspective of apotential provider. According toBrown and Churchill, the features tobe taken into account are the following(Brown and Churchill 2003):• A large number of similar units

exposed to the risk.• Limited policyholder control

over the insured event.• Insurable interest.• Losses are determinable and

measurable.• Losses should not be catastrophic.• Chance of loss is calculable.• Premiums are economically

affordable.

transferred from the individual levelto the community or inter-communitylevel with groups in differentgeographic locations which are notequally disaster-prone.

As we will learn, microinsuranceproducts have the potential to offermore complete protection againstmany risks and therefore againstsignificant loss. This service isprovided at an affordable cost, the socalled premium.

All

phot

ogra

phs

in th

is is

sue:

AID

MI

"Of the four billion people onearth today who live on lessthan two dollars a day, fewer

than ten million have access toinsurance."

– Munich Re Foundation

Conceptualising Risk Transfer

Disasters destroy assets that have been accumulated by individuals and families.Without these assets, they are increasingly vulnerable to future disasters.


Following Cohen and McCord(2003), we can distinguish four

institutional models for providingmicroinsurance which help us tounderstand how corporate insurers,government bodies as well as otherinstitutions, such as microfinanceinstitutions (MFIs) can play a role.

Organisations considering taking upmicroinsurance initiatives should takethe positive and negative aspect ofeach into account in order to achievethe best fit with their circumstances.

a. Partner - agent model:Commercial or public insurerstogether with MFIs or non-governmental organisations(NGOs) collaboratively developthe product. The insurer absorbsthe risk, and the MFI/NGOmarkets the product through itsestablished distribution network.This lowers the cost of distributionand thus promotes affordability.

This model of collaboration hasbecome the dominant approach tomicroinsurance in India and hasencouraged many microfinanceinstitutions to switch from a full-service model to the partner-agentmodel. Examples of this scheme areAIDMI's Afat Vimo as well as SEWA,a microinsurance pioneer, who offersits life, health and asset coverage inpartnership with various insurers.

b. Community-based model:A group of people or localcommunities, MFIs, NGOs and/or cooperatives develop anddistribute their own product,manage the risk pool and absorbthe risk.

The Swayamkrushi Youth CharitableOrganisation (YCO) in Andhra Pradesh

Role Models in Microinsurance: WhoContributes in the Provision?

is an example of a community-basedmodel. It is primarily a savings andcredit association with added insurancefeatures. The cooperative's 8,100members pay a yearly premium of Rs.100 ($2.22) into a pool managed by thecooperative and receive cover for deathand property loss. The life insurancebenefit is Rs. 15,000 ($333) for anatural death, and Rs. 30,000 in theevent of an accidental death.

c. In the in-house or full-servicemodel, a MFI or NGO runs itsown insurance scheme for itsclients and any profit or loss isabsorbed by the MFI. The systemis not very common anymore butit still exists in some organisationssuch as SPANDANA, located inGuntur, Andhra Pradesh. Thisscheme started in urban areas andthen moved to rural ones and hasexpanded enormously in recentyears.

d. Provider model: Banks and otherproviders of microfinance candirectly offer or require insurancecontracts. These are usuallycoupled with credit, for example,to insure against default risk.

This model is usedwidely in thegeneral insurancemarket but hightransaction costsand low ability topay premiumsinhibit itsextensive use in

the field of disaster insurance for thepoor.

If microfinance tools are consideredappropriate in order to help the poor-then why are microinsuranceproducts relatively new and why domany corporate insurers lackinterest in this market?An answer to this question will includeseveral factors. Economic reasonsrelate to the insurability of the poorin developing countries. Other reasonshave to do with the specific terms ofdisaster insurances.

Concerning the first point, namelythe economic reasons, one can statethat the insurance sector has notshown much interest in the provisionof insurance schemes for the poorsince they are usually not expectedto be able to pay high r iskpremiums. This is understandablegiven the irregular and small incomethese people earn—especially thosein the informal sector. Furthermore,the transact ion cost of theseinsurance products very high relativeto the premiums because properinfrastructure is lacking andpotential insurers would face a highilliteracy rate. This implies thatpolicyholders need training beforesigning an insurance contract. Theseproblems are often addressed to asthe concern of "capability" and the"willingness to pay" of the poor.

"We cannot stop naturalcalamities, but we can and must

better equip individuals andcommunities to withstand them."

– UN Secretary Kofi Annan

Follow the money: Partner-agent financial transactions.


A very central issue that deservesmore explanation is the asymmetricdistribution of information betweeninsurer and insured which might leadto adverse selection as well as moralhazard. Adverse selection implies thatsince the insurer is not able to screenthe beneficiaries of his product interms of their related risks, he mightset the premium which should reflectthe risk of the insured too highwhich leads the "good risks" to dropout of the market- finally leading tomarket failure. Moral Hazard on theother hand, refers to the fact that aninsured person might change hisbehaviour after having signed thecontract (i.e. by investing less effortin the harvest). Moral hazard istherefore commonly known as theproblem of incentives.

There are some other importantfeatures to be kept in mind, namelythe specific difficulties related todisasters.

Contrary to risks such as the death ofa breadwinner or livestock, healthexpenses, funeral expenses andproperty damage from theft/fire whichare mostly independent (i.e. they donot affect whole communities or riskpools at a time), disasters, on the otherhand, are covariant risks which implythat they not only take the lives ofpeople and livestock but cause alsodamages to property and crops. Brownand Churchill (2000) refer to thefollowing characteristics which makedisaster insurance different fromothers:• Disaster risks are difficult to

estimate.• They can affect large portions of

the population or the risk pool atthe same time.

• Informal safety nets (family andfriends) tend to break down.

• They cause multiple lossessimultaneously to health, life andproperty.

The characteristics of poor people,especially in disaster-prone areas,

make it difficult to imagine thatprivate insurers could ever showinterest in these individuals. Recentexperience, however, indicates that itis possible to provide microinsuranceschemes and at the same time workingcost-efficiently. Details on successfulproducts and lessons learnt are foundbelow.

Do people affected not face other,more important problems related totheir very basic needs such as shelteror food and how does the provisionof microinsurance products fit in thestandards of the InternationalCommunity in terms of disastermitigation?Indeed, the above question is a verylegitimate one and one may askwhether insurance products are ofcentral importance or they ratherrepresent secondary needs.

In providing an answer to thisquestion, one has to consider thatdisaster mitigation is a long-termprocess and implicit in sustainablehuman development. The issue of riskreduction in the form of risk transferbecomes central as it helps toaccelerate the recovery and secure thegains of disaster-affected people. Inorder to implement insurances as auseful tool in the field of disaster

mitigation, any institution working inthis specialised field of developmentwork has to be aware of the fact thatcomplementary actions such as disasterawareness, capacity building, andeffective product design are of centralimportance.

Quoting UN Secretary General KofiAnnan in this context sheds light onthe fact that the internationalcommunity shares this perception:"We cannot stop natural calamities,but we can and must better equipindividuals and communities towithstand them". We find furtherevidence in favour of the importanceof Disaster Risk Reduction as one ofthe so called "UN Priorities forAction" (point 5) as a part of the"Hyogo Framework for Action 2005-2015" by the UN ISDR (InternationalStrategy for Disaster Reduction). Thisframework is dedicated to DisasterRisk Reduction and states that disasterpreparedness for effective responseshould be strengthened at all levels.

Microinsurance contributes tobreaking the cycle of poverty andmitigating disasters. This is possiblebecause it helps transfer life as wellas non-life risks and fits the statespriorities of the internationalcommunity.

Glossary of Important Terms Related toInsuranceAdverse Selection: Also called anti selection, the tendency of persons who

present a worse than average risk to apply for, orcontinue, insurance. If not controlled by underwriting,results in higher-than-expected loss levels.

Covariant Risk: A peril that affects a large number of the policyholdersat the same, e.g., an earthquake; or several risks thatconsistently occur together (at the same time or underthe same circumstances).

Moral Hazard: A risk that occurs when insurance protection createsincentives for individuals to cause the insured event;or behaviour that increases the likelihood that the eventwill occur. Examples include bad habit such as smokingin the case of health insurance or life insurance.

Source: ILO


In rich countries, financial serviceson the whole work well. These

services have evolved to fit the needsand circumstances of theseenvironments. The vast majority ofpeople have access to interest bearingsavings accounts, mortgages atreasonable rates; they have a choice ofconsumer credits as well as insurancesfor almost every kind of risk atpremiums that reflect the risk of losses.

A recent study of the World Bank(Hess et al., 2005) has addressed thequestion on whether agriculturalinsurances designed for developedcountries can be applied in the samefashion in the context of developingcountries. The results of this study arerelevant since they hint at someenvironmental characteristics thatmust be taken into considerationwhenever an institution is interestedin providing insurance schemes.

The mentioned study presents theavailable insurance products coveringagricultural risks in Canada, Spain andthe United States of America. Theproducts are covered either by thegovernment (regional or national) aloneor jointly alongside a corporateinsurer and cover around 100 speciesof crops. These insurances work quitewell at first sight and farmers in thementioned developed countries arekeen on signing the insurancecontracts. When undertaking furtheranalysis, however, the authors noticethat the respective governments haveto provide high monetary contributionsto the various insurance schemes. Theauthors find that, considering theseissues, agriculture insurance modelsfor developed countries are notapplicable for developing countries.

Each of the presented countries, thegovernment plays either a minor ormajor role in providing the insuranceproducts. This implies an income

Insurance Models for Developing Countries fromDeveloped Countries: A Case for Microinsurance

transfer in terms of national budget,the very basic fact of the amount ofavailable resources becomes veryrelevant.

Implicitly, developed countries canafford to allocate much higher amountsof money in this form of agriculturalsubsidies with respect to developingones1. A further consequence of thediscrepancy in fiscal resources as wellas the status of countries' developmenthas been depicted in the opportunitycosts of money spent in this particularfield. Considering the scarce resourcesof developing countries, the opportunitycosts of money allocated to agriculturalsubsidies are much higher since moneycould be spent in another manner thatmight result in higher growth rates andin better long-term welfare.

Another relevant point is theimportance of the tertiary sector inthe economies of developed anddeveloping countries respectively isvery different. In India, for instance,two thirds of the workforce has anoccupation in agriculture compared toapproximately 3% in the United States.Consequently, would the expenses ofwide coverage be exuberant in adeveloping country with respect to aricher country that has successfully

transformed its economy into a moreservice oriented one?

Apart from aspects related to theeconomic power of developed anddeveloping countries, the study findsout that in developing countries thefarms are much smaller compared to"industrialised" farms in richcountries which implies relatively highadministrative costs.

Another important aspect is thatdeveloping countries have much lessaccess to global reinsurance markets.Reinsurance contracts usually facetransaction costs as well as duediligence since they must understandevery aspect of the insurance productthey are reinsuring. This impliesunderwriting, contract design,ratemaking, and moral hazard andadverse selection control mechanisms.

Taking these points into consideration,one has to conclude that as far asagricultural insurances are concerned,the schemes working "quite" well indeveloped countries cannot be appliedin the same fashion for developingcountries. As a consequence, we haveto rely on products that take the specialfeatures of clients in developingcountries into account.

1 For instance, agricultural insurances in the US: for every $ of insurance provided,the US taxpayer has to subsidise with US $5 (Yaron et al., 1997)

Source: Munich Re Foundation


Glossary of important terms related to insurance

Adverse selection: Also called anti selection, the tendency of persons who present a worse than average risk toapply for, or continue, insurance. If not controlled by underwriting, results in higher-than-expected loss levels.

Covariant Risk: A peril that affects a large number of the policyholders at the same, e.g., an earthquake; orseveral risks that consistently occur together (at the same time or under the same circumstances).

Moral hazard: A risk that occurs when insurance protection creates incentives for individuals to cause theinsured event; or behaviour that increases the likelihood that the event will occur. Examplesinclude bad habit such as smoking in the case of health insurance or life insurance

Source: ILO

2005 saw the launch of the UnitedNation's Year of the Microcredit

as well as the creation of anInternational Day for DisasterReduction that is celebrated annuallyon October, 12th. This day is designedto raise awareness of the need to putdisaster risk reduction on policyagendas and encourage thedevelopment of innovative methods forreducing disaster vulnerability.

Taking this into account, the All IndiaDisaster Mitigation Institute (AIDMI)seised the opportunity of these twocoinciding events to instigate aninternational discussion on thepotential use of microfinance fortsunami recovery.

The workshop was hosted by AIDMIwith the United Nations InternationalStrategy for Disaster Reduction(UNISDR) and the Indian NationalInstitute of Disaster Management(NIDM) and was held at the IndiaHabitat Centre in New Delhi.

It was well attended by an array ofexperts in microfinance provision anddisaster risk reduction from acrossthe world, as well as representativesof the Government of India includingthe Honourable Home Minister,Shivraj Patil, D.K. Shankaran andM.P. Sajnani from the Ministry ofHome Affairs. Representatives fromtsunami-affected states in South Indiawere also in attendance.

The central outcomes of theworkshops were the following:• Due to the fact that experiences

with microfinance tools havebeen very positive in terms ofpoverty and vulnerabilityreduction, there has been a clearRecommendation for

Learning from the Positive Experiences in theField of Microfinance

developing a strategy forapplying microfinance fordisaster recovery.

• The participants have agreed thatbefore microfinance can besuccessfully and broadly applied,fundamental paradigm shifts inoutlook and approach arerequired. Policy and institutionallevel commitment is necessary inorder to build disaster mitigationin the development process.

As Mr Sajnani, Advisor at theMinistry of Home Affairs put it:“Where previously governmentauthorities concentrated on disasterrelief, a shift in orientation is takingplace, from a relief-centric approach toa holistic multi-disciplinary approach.This new approach encompassesprevention, mitigation, preparedness,response, relief and rehabilitation."

Development of a microfinancerecovery model:• The international experiences

shared in the workshop have

shed light on the fact that thereis not a single model formicrofinance and its application.Credit-based models areconsidered most effective, andshould be combined withcomplementary risk transfer suchas savings and insurance.

• In expanding the use ofmicrofinance for disasterrecovery in all areas, it wasconcluded that more work isrequired to reach the poorestof the poor.

• At the same time as recognisingthe disaster-stricken as clients,it was agreed that indigenouscoping strategies should be builtinto programme design throughcommunity consultationfollowing a community-based,participatory approach. This willhelp increase the community'scapacity to address risk in thefuture.

To learn more about the workshop,please consult: www.unisdr.org

International Workshop on Disaster Risk Mitigation: Potential of Microfinancefor Tsunami Recovery, New Delhi, October 14th and 15th, 2005

The workshop was lead by practitioners and policymakers, including (left to right):D.K. Shankaran, Ministry of Home Affairs; P.G. Dhar Chakrabarti, ExecutiveDirector, NDMA; Shivraj Patil, Honorable Union Home Minister; N.C. Vij, ViceChair, NDMA; Praveen Pardeshi, Senior Advisor, UNISDR; and Mihir R. Bhatt,Honorary Director, All India Disaster Mitigation Institute.


A Life and Non-life Insurance Product for thePoor: the Afat Vimo Scheme

In August 2004, the All India DisasterMitigation Institute (AIDMI)

launched the Regional Risk TransferInitiative (RRTI) in association withthe Provention Consortium. Other keypartners are the Chamber ofCommerce and Industry of SmallBusinesses, the InternationalFederation for Red Cross and RedCrescent Societies, the World Bank,the Asian Development Bank and theDepartment for InternationalDevelopment.

The main objective of the RRTI is inthe convergence of micromitigation,microcredit and microinsurance as aprecondition for effective local, low-cost risk transfer. It therefore strivesto promote more effective riskmanagement for the poor. The RRTIhas been central in terms ofestablishing the Afat Vimo scheme asdisaster insurance for the poor.

Background of Afat VimoFollowing the 1998 Kandla cyclone,AIDMI established the LivelihoodRelief Fund (LRF) with the mainobjective of building livelihoodsecurity and reducing economic risksthrough sustainable long-termrecovery. Following the January 2001earthquake in Gujarat, LRF expandedand played a major role duringrecovery from the February 2002 riots

in Gujarat. In the wake ofthe 2004 tsunami, AIDMIresponded again providingmuch needed livelihoodrelief.

To coincide with the launchof the RRTI in September2003, AIDMI held a focusgroup session onmicroinsurance for the poorwhich brought to life theidea of a "Demand forInsurance Survey". The survey wasconducted in September 2003 within14 earthquake-affected slumcommunities in Bhuj, Gujarat. Thisprovided information on whatpercentage of the population alreadyhad insurance (only 2%) and how manyrespondents were interested in takingout a policy in the future (73%). Thesurvey also revealed that capacitybuilding was required since awarenessand understanding of insurance and risktransfer was low.

Afat VimoSince the survey revealed need bybeneficiaries for mechanisms tosafeguard their newly replaced orcreated assets in the aftermath ofdisaster, the Afat Vimo scheme wasborn.

After negotiations with companiesinterested in supplying low-premium insurance policiesto poor clients, goodpartnerships were forgedwith the Life InsuranceCorporation of India (LIC)and the Oriental InsuranceCompany Ltd. (OIC). LICcommitted to providing alife insurance policy underAfat Vimo and OIC agreedto establish non-lifeinsurance policy coverage

for Afat Vimo beneficiaries. Thescheme was launched in August 2004,with the coverage of 829 LRFbeneficiaries in Bhuj. It has extendedits coverage to 5597 in February 2006.LRF beneficiaries are now covered inseveral districts in Gujarat, as wellas in Tamil Nadu and Pondicherry inSouth India.

Description of the Afat Vimo ProductAfat Vimo provides life and non-lifedisaster insurance to low-incomeclients who are beneficiaries ofAIDMI's livelihood relief through theLRF. It covers policyholders for lossesincurred in the case of 19 eventualities,among them earthquake, cyclone,lightening, and landslide.

Like all AIDMI initiatives, Afat Vimofocuses on the poor among disastervictims. Thus, the typical profile ofAfat Vimo policyholders is as follows:• Disaster affected.• LRF beneficiary.• Low-income household—average

annual income Rs. 12000-Rs. 18000.

• Engaged in microenterprises inthe unorganised sector.

• Average assets worth Rs. 9000.• Average savings Rs. 200–Rs. 400.

The insurance scheme of Afat Vimo isunique since it combines life and non-

Growth of Coverage by LIC under Afat Vimo

8291174

4597

5597

0

1000

2000

3000

4000

5000

6000

Aug 04 Feb 05 Aug 05 Feb 06

Half-Yearly Addition/Renewal

No

.of

Ben

efic

iari

es C

ove

red

Growth of Coverage by OIC under Afat Vimo

938 1173

3000

4597

5597

0

1000

2000

3000

4000

5000

6000

Aug 04 Feb 05 Aug 05 Feb 06

Half-Yearly Addition/Renewal

No

.of

Ben

efic

iari

es C

ove

red


life coverage in one policy. Thecoverage is provided by differentinsurance companies but is broughttogether by AIDMI under Afat Vimo.

The total payable premium in Gujaratfor instance, is Rs. 146 (tax incl.) perhousehold per annum. The lifeinsurance component in this exampleincludes an assured sum of Rs. 20,000at a premium of Rs. 86, whereas thenon-life insurance costs Rs. 60 perannum and covers house and contents(Rs. 40,000), stock-in-trade (Rs. 10,000)and personal accident (Rs. 25,000).

Complementary Services Providedby AIDMIAs stated above, the role of AIDMI inthe Afat Vimo scheme is of bothfacilitator and intermediary. Unlikeother organisations, however, theiractivity is not limited to the initialstages of insurance coverage, butAIDMI's community-based approachensures that they are actively involvedwith the beneficiaries at every stage.They are committed to supportingcommunities in the long-run whenrelief institutions leave to provideassistance elsewhere. AIDMI has noexit strategy because they continueproviding relief, rehabilitation anddevelopment assistance to vulnerablecommunities. This implies also thecapacity building provided byAIDMI's Learning Resources team incooperation with the LRF team in theform of training sessions with thecommunity. These involvecomprehensive explanations of howinsurance works, why it is beneficial,

how to be a good policyholder, thedifferences between microcredit andmicroinsurance, and the importance ofthe Indian Insurance RegulatoryDevelopment Authority. Trainingcourses are essential for the effectiveoperation of Afat Vimo; through these,beneficiaries come to understand whatto do in the event of a disaster in termsof how to make claims as per the legaland procedural requirements of theinsurers and AIDMI.

Apart from providing educationalservices, AIDMI also collects thepremiums and helps the disaster-affected to start the claim process.

Lessons to be LearntAs described above, the number ofhouseholds covered by Afat Vimo hasincreased from an originalmembership of 829 in August 2004 to5597 in February 2006. This has beena very successful development.

Furthermore, the renewal rates forAfat Vimo have been encouraging withan average of 88% which is verypositive for a scheme in its relativeinfancy. However, there are also anumber of reasons why beneficiariesdo not renew their policies.

The LRF team has observed that thefollowing reasons are the mostcommon explanations for non-renewalof policies:• migration,• inability to pay,• no desire to renew because people

do not see the benefit in insurance.

Regarding the scheme as a whole, onecan state that it has proven to bepossible to achieve relatively lowinsurance premiums as well asexpanding the programme by spreadingrisks to other communities since noteveryone will be affected by disaster.Apart from the success of the scheme,however, there are some challengesto cope with such as the limitations inthe expansion of coverage since anaugmentation of membership wouldinvariably mean a substantial increasein operating costs—particularly ifgeographical coverage was toincrease.

To learn more about the Afat Vimoinsurance scheme, viewwww.southasiadisasters.net andwww.proventionconsortium.org

A possible cycle for developing a microinsurance schemes.

A typical Livelihood Relief Fund beneficiary is able to return to work based oncompensation from Afat Vimo scheme.


Recently, the World Bank hasprovided the impetus and

technical assistance for theimplementation of innovative index-based crop insurance schemes indeveloping countries based on theexperience of developed countries. Theindex-based crop insurance contractsare sold in standard units by ruraldevelopment banks, farm cooperativesor microfinance organisations, and the"premium" varies from crop to crop.Payments to policyholders are basedon a weather index that is highlycorrelated to farm yield or revenueoutcomes.

Since payouts are not coupled withindividual loss experience, farmershave an incentive to engage in loss-reduction measures, for example,switching to a more robust cropvariant. A physical trigger also meansthat claims are not always fullycorrelated with actual losses, but this"basis risk" may be offset by thereduction of moral hazard andelimination of long and expensiveclaims settlement. Since the claim isa fixed amount of money per unit ofprotection, transactions are greatlysimplified. The major advantages ofindex-based insurance are thereduction of moral hazard andtransaction costs. Index-basedmechanisms are also more transparentsince they are based on a physicaltrigger, and the payout is fixed inadvance. The major downside ofindex insurance is the basis risk: ifthe trigger is insufficiently correlatedwith the losses experienced then nopayout may occur despite substantiallosses.

In order to provide an analysis of thesenew products, we will apply a SWOTanalysis to the Index Insurance that willtell us more about the "Strengths,Weaknesses, Opportunities andThreats" of the products. In thiscontext, Strengths and Weaknesses

Product Innovations: The Index Insurancerefer to the internal perspectivewhereas Opportunity and Threat setup the external one. Strengths and

Opportunities refer to the positiveperspective while Weaknesses andThreats refer to the negative.

References and where to learn more about Risk transfer andmicroinsurance:Churchill, Craig F.; Liber, Dominic; Mc Cord, Michael J.; Roth, James:"Making Insurance Work for Microfinance Institutions- A technical Guide toDeveloping and Delivering Microinsurance", edited by ILO, Geneva, 2003

Cohen, Monique; Sebstad, Jennefer: "Policy Arena- Reducing vulnerability-The Demand for Microinsurance"; Journal of International Development, J.Int. Dev. 17, 397-474 (2005) available at: www.interscience.wiley.com

Hess, Ulrich; Skees, Jerry; Stoppa, Andrea; Barnett, Barry; Nash, John:"Managing Agricultural Production Risk- Innovation in Developing Countries";The World Bank Report No. 32727-GLB, Washington D.C., June 2005,available at: www.itfcommrisk.org

International Strategy for Disaster Reduction (ISDR): "Invest to preventdisaster"; Geneva, 2005

Mechler, Reinhard; Linnerooth-Bayer, Joanne; Peppiatt, David:"Microinsurance for Natural Disaster Risks in developing countries- Benefits,Limitations and Viability; A ProVention/IIASA study, January 2006

Miamidian, Eileen; Arnold, Margaret; Burritt, Kiendel; Jacquand, Marc:Surviving Disasters and Supporting Recovery: A Guidebook for MicrofinanceInstitutions; The World Bank Hazard Management Unit, Working PaperSeries No. 10, Washington D.C., February 2005

Morduch, Jonathan, "Microinsurance: the next revolution?; in Banrejee,Abhijit, Benabou, Roland, Mookherjee, Dilip; New York, 2004

Outcome of the World Conference on Disaster Reduction, Hyogo, KobeJapan, 18-22 Jan 2005: available at: www.unisdr.org/wcdr

Roth, James; Athreye, Vijay: ""TATA-AIG Life Insurance Company IndiaLtd.", CGAP Working Group on Microinsurance- Good and bad practice",Case Study No.14, September 2005, available at:www.microfinancegateway.org/section/resourcecenters/microinsurance

Roth, James; Churchill, Craig; Ramm, Gabriele and Namerta: "Microinsuranceand Microfinance Institutions-Evidence from India", in: CGAP Working Groupon Microinsurance- Good and bad practices, Case Study No. 15; September2005; available at: www.microfinancegateway.org/section/resourcecenters/microinsurance

For more information:www.ilo.org/stepwww.iiasa.ac.atwww.microfinancegateway.org/section/resourcecenters/microinsurancewww.proventionconsortium.orgwww.southasiadisasters.netwww.unisdr.org/hfawww.worldbank.org


Due Diligence Checklist for Identifying anInsurance Partner

What is the reputation of theinsurance provider?

How is the insurer currentlyfinanced?

What is the claims experienceof the insurer and its history ofclaims payouts?

How interested is the insurerin serving the low-incomemarket?

Will the insurer adjust itsproducts to suit the preferencesof the poor?

Is the insurer willing to makea medium- or long-termcommitment to the MFI?

Is the insurer willing to pay acommission to the MFI forperforming the agent role?

Are there issues related toregulatory compliance by theinsurer?

Will the insurer give the MFIresponsibility for verifyingclaims?

Can the insurer minimisethe number of exclusionswithout jeopardising thesustainability of the plan?

Questions What an MFI Should Look For

It should be a strong institution that pays claims on time. Check with policyholdersto see if they have had a positive experience.

The insurer should be financed from its earnings, and it should have a stable,conservative asset portfolio.

They should pay most claims within a month and be willing to guarantee a fastturnaround (within two weeks guaranteed with an effort to pay within one week) onclaims from MFI clients. The MFI should track this once a relationship is finalised.

They should not only express interest but also have examples of current work withthis market or at least examples of efforts to work with this market.

They will likely need to reduce the coverage, reduce the price proportionately,and even adjust some procedures to facilitate the transactions between the MFIand the insurer.

This type of relationship will take time to mature. If the insurer is not willing tomake a commitment for at least three years, it is not worth the MFI entering thearrangement. Note: the insurer is not tied to the original terms of the insurancefor that period, just to continue to work with the MFI and its clients.

On short-term group life business, insurers typically pay an agent five to twentypercent of the premium. The MFI should get a substantial portion of that amount.

An MFI should review the insurer's annual report and discuss its regulatorycompliance with the insurance commission. Some insurance companies employ anombudsman to interact with the public. If one is available, the MFI should discusswith her issues related to regulatory compliance and common customer complaints.

It is not recommended for the insurer to verify claims. The two partners shouldhave a written understanding regarding what proof the insurer requires. The agreeddocumentation should be accessible to the poor, yet conclusive.

Generally, MFIs have difficulty informing clients about complex products. Insurancewill be the same. Not only will MFIs have to explain the concept of insurance(risk pooling), but they will also have to help clients understand the product. Thesimpler the product, the easier it will be to sell and administer the product.

From a legal point of view, insuranceproducts cannot be offered in Indiaby organisations that are not licensedby the Insurance Regulatory andDevelopment Authority. The laws forregistration as an insurance companyare such that it is highly unlikely thatany MFI could ever comply. Onestrategy for dealing with this isthrough terminology. By referring to

an "insurance scheme" as a "welfaremeasure" in its annual reports, an MFImay fall under the radar of the law. InIndia, as long as the scheme isavailable only to members andcomplies with the legislationregulating NGOs, the state at presentis not concerned with restricting theiractivities.

Source: ILO

Dealing with Restrictive Legal Environments


Introduction

Farmers face a spectrum of risks, andeach of these risks-along with howfarmers manage them-impact farmincome, productivity and access tocredit.

Among the risks farmers in developingcountries have to deal with is theweather risk as well as the risk relatedto the price of commodities. A recentstudy of AIDMI conducted withfarmers in the Indian state of Gujarathas shown that 40% of the intervieweesdo not know about the existence of cropinsurances.

Furthermore, AIDMI gained evidenceamong those who know about theexistence of these schemes, only 34%have signed in a contract. Theconclusion for AIDMI in terms of thementioned survey implies to increasethe awareness of agriculture insuranceis an effective method to reduceseveral risks and reduce theirvulnerability and give them a morestable livelihood.

Whereas our article on index insuranceschemes has provided an analysis ofan appropriate method to mitigateweather risks, this contribution shedslight on the tools that can help farmersmanage risks in the context ofcommodity prices better.

Impact of Price Volatility onFarmersPrice volatility significantly impactsthe incomes of farmers as well as themacroeconomic health of theircountries. According to the WorldBank, from 1983-1998, the price ofmany commodities fluctuated frombelow 50 percent to above 150 percentof their average prices. Attempts bymany countries to guarantee farmers

Commodity Risk Management forDeveloping Countries

minimum prices by separatingdomestic commodity prices frominternational prices have provenfinancially unsustainable. Instead,these countries have started to pursuethe path of liberalisation which exposesfarmers to price fluctuations over thecourse of a season creating uncertaintyabout the price they will receive fortheir product to be sold.

At the farm level, this uncertainty incommodity prices makes it difficultfor producers to allocate resourcesefficiently, limits their access tocredit for productivity enhancing inputsand leads them to adopt low-yield, low-risk production technologies, therebylowering average incomes. At themacro level commodity pricevolatility affects government's fiscalrevenues, trade balance, exchangerate, and creditworthiness.

While market based tools (futures andoptions) that insulate producers fromthe negative effects of short-term pricevolatility are widely used in high-income countries, the vast majority ofagricultural producers in developing

countries are, in general, unable toaccess these markets. In the absenceof markets for price hedginginstruments, farmers try to cope withprice risks by:a. self-insuring by asset accumulationb. income diversificationc. informal insurance arrangements.

Diversification to other activities isdifficult due to the lack of necessaryskills of most farmers, information andcapital to do something else. Manyfarmers adopt low-risk and low-yieldcrop to ensure a minimum income.However, these inefficient productionpatterns inhibit the creation of incomegrowth and the accumulation ofcapital. Finally, informal insurancearrangements at the local communitylevel often break down in the face oflarge systemic risks such as thecollapse in commodity prices.

The use of market oriented price riskmanagement strategies to mitigate thisprice risk would provide farmers withnew alternatives and allow themgreater certainty in planning their on-farm activities.

Farmers discuss possible hazards in a workshop in Delhi.


Why are farmers unable to accessthese financial instruments?Some barriers have preventedsmallholders from assessing thesetools:• the minimum contract size traded

on organised exchanges farexceeds their annual productionquantity

• lack of knowledge of such market-based price insurance instruments

• lack of understanding of how touse the tools available

• sellers of such instruments–generally international banks and

brokerage houses-are oftenunwilling to engage with a newand unfamiliar customer base ofsmall-scale producers,characterised by high transactioncosts, diminished access tocredit, and performance risk.

The World Bank as a facilitatorAs learned above, market based toolsare difficult or almost impossible forpoor people to assess. The WorldBank- with support from several donorgovernments, and in collaboration withinternational organisations and private

sector representatives– has beenworking as a has been working as afacilitator, providing technicalassistance and capacity building toallow producers in developingcountries and local intermediaryinstitutions with links to producers toaccess these instruments. To dateseven transactions have been completedbetween developing country clients (inUganda, Tanzania, and Nicaragua)and international providers (mainlymajor international banks in Europeand the US).

These transactions provided priceprotection for tonnages ranging fromas low as 50 tons to as much as 700tons. Transactions provided priceprotection for sales that were madeas short period as one month in advanceup to seven months in advance. Therange of premiums paid for priceprotection varied from around 3% ofthe value of the commodity to as muchas 8% with most transactions involvingpremium payment of around 4-6%.

How do Price Risk ManagementInstruments Work?A parallel can be drawn betweenhedging instruments for price risk andtypical insurance products. Producers'organisations, local banks, orexporters can purchase derivatives that

An AIDMI team member finds that falling commodity prices represent big risk tofarmers.


BackgroundIn 2001 and 2002 coffee price fell toforty-year lows. Tanzania liberalisedthe coffee sector in 1993 and as aresult both private traders andcooperatives buy it at competitiveprices at the community level. Coffeemakes 20% of Tanzania's exportearnings and the drop in price hasaffected 400,000 people. Indeed,liberalisation and implicitly thevolatility in prices have made itdifficult for farmers to optimiseproduction technology, timing of sales,and use of assets that could eventuallyresult in higher household incomes.Overall, the welfare of coffee farmersin Tanzania has diminished.

The ProductBeing aware of the impossibility ofstopping the long-term trend ofdeclining prices cannot be stoppedwithout significant structural changesin the world coffee market, one ofthe largest coffee cooperatives in thecountry has begun working with theWorld Bank in order to confront thenegative effects of short-term pricevolatility. In doing so, they utiliseprice risk management instrumentsto hedge their price risk. Thiscooperative union has a large numberof smallholder producer memberswhose average production is between20-100 kg per farmer.

Like many other cooperatives inTanzania, the cooperative unionutilises a pricing system that consistsof multiple payments to farmersthroughout the year. Cooperativemembers receive a uniform minimumprice for their coffee when theydeliver it to the union, and then laterin the season, depending on sales andmarket performance overall, farmersmay receive subsequent payments fortheir product. The uniform minimumprice, which is called the 1stpayment, is established months inadvance of the actual selling season

and agreed at the annual generalmeeting of the producers. Theguaranteed 1st payment is viewed asa service to the farmers and providesthem with some form of price stability,but it can have disastrous financialimpacts on the cooperative overall. Ifcooperatives guarantee a low 1stpayment at the beginning of the season,they run the risk that market priceswill rise and farmers will sell totraders instead of to the cooperative(local traders compete with thecooperatives by paying full marketprice for coffee, in cash, at the timeof delivery of the product). Ifcooperatives guarantee a high 1stpayment at the beginning of the season,they run the risk that market priceswill fall, and they will make losses onthe negative margin between purchaseprice to farmers and actual sales priceson the market. Since the 1st paymentprice is established well ahead of theselling season at a time when salesprices are not yet known, thecooperative union is essentially takinga long position on coffee, which is ineffect from the time they set the 1stpayment until the time they concludeall sales of coffee at the end of theseason, a period which can stretch upto ten months.

Complications of the ProgrammeHowever, in order to assure long-termsustainability of the cooperative, it hasbeen necessary to develop a numberof strategies as for instance finding away to protect overall profitabilityfrom the often disastrous affects ofsetting 1st payment price high at thebeginning of the season and having tosell low when prices fell later in theseason.

For the cooperative, althoughconclusive impacts of the riskmanagement strategy are not yetentirely known since the season is justnow ending, there were a number ofpositive affects:

1. The union improved itsrelationship with its local bank,which included a loan forpremiums to cover the cost ofhedging instruments in the totalloan package given at thebeginning of the year.

2. The union improved its overallfinancial state, including itsdebt position, and managementof the union had a clear view ofoverall financial statusthroughout the season, withouthaving to worry about the impactof prices falling below a certainlevel on the global market. Theywere able to communicate resultswith confidence to the local bankand government ministers whowere monitoring progress.

3. Improved financial transparencyhelped the union make better andmore strategic selling decisions.

4. The union was able to pay farmersa 2nd and 3rd payment since therewere periods of relatively highermarket prices during somemonths of the selling season. Inthe past, any positive returnsfrom high priced sales wouldhave been held by the union untilthe end of the season to protectagainst future losses. Withhedging, the price floor createdby the option allowed the unionto disperse revenue at the timeit was earned.

Concluding RemarksEach of the impacts listed abovebodes well for the union's ability tocontinue to strengthen its relationshipwith its lenders and improve its accessto credit. In a very short period oftime, the union has moved from beinga very high-risk enterprise to a muchmore stable operation. Price riskmanagement has contributed to thatgrowing stability and the union'smanagers have indicated that they arevery pleased to have knowledge andaccess to such tools.

Can South Asia Learn from other Developing Countries?The Example of Tanzania


are traded on international exchange(or based off these exchanges); in mostcases a simple put option, on behalf oftheir producers. When combined withphysical sales these financialinstruments, it will guarantee aminimum price level based on aninternational price (not a local price)for a given commodity for a numberof months. In order to purchase thisfinancial product producers must paya market related fee or a premium. Inthe case of put options, when price risesduring the option contract period, theproducer receives no payout from thecontract but can still sell his physicalproduct for the market price in orderto benefit from the rising prices.However, when price falls during thisperiod, the producer receives a payoutequal to the difference between theprice the producer chose to insure withthe price risk management contract andthe international market price on thelast date of the option coverage.

Because of the size of these contractsit is necessary to aggregate producerdemand for these products. A diversityof different types of organisationscould serve this role as an

The World Bank, 2002, "DeliveringPrice Insurance, Lessons LearnedFrom Four Cases Studies",

The World Bank, 2002, "Tanzania:Coffee Price Risk Management",

Commodity Price Risk ManagementGroup, Washington, D.C., February.

Varangis, P., D. Larson and N. Yabuki,1998, "Commodity Risk Managementand Development", The World BankPolicy Research Working Paper No.1963, August.

The ProVention Consortium is aglobal coal i t ion of

governments, internat ionalorganisat ions, academicinstitutions, the private sector, andcivil society organisations. TheConsortium is based on the premisethat we all must take responsibilityfor making the new millennium asafer one and that it is the inter-sectoral links-among the scientificcommunity, policymakers, and theprivate and public sectors-that willfacilitate the promotion of riskassessment, risk reduction, and riskeducation activities in developingcountries. The Consortium'sobjectives are straightforward andattainable:• To promote a culture of safety

through education and training

among leaders and citizens ofdeveloping countries.

• To support public policy that canreduce the risk of natural andtechnological disasters indeveloping countries.

• To support pilot projects and todisseminate information about"best practices" proven tomitigate the scope and frequencyof disasters.

• To develop governments' abilityto minimise disasters and torespond effectively when theyoccur.

• To forge links between public andprivate sectors, between thescientific community andpolicymakers, between donors andvictims, so that all stakeholderswork together to strengthen the

economy, reduce pain andsuffering, and promote thecommon good.

The ProVention Consortium functionsas a network to share knowledge andto connect and leverage resources toreduce disaster risk. It focuses onsynergy and coordination so thatefforts, and benefits, are shared.Partners include the Governments ofJapan and Norway, Organisation ofAmerican States, InternationalFederation of the Red Cross, UNDevelopment-, Environmental-, FoodProgrammes, World MeteorologicalOrganisation, African DevelopmentBank, Asian Development Bank,Wharton School of the University ofPennsylvania or private groups suchas Munich Reinsurance.

intermediary. A domestic bank or otherfinancial institution could integratethese products into its services.

Sources:

Commodity Risk Management Group,Washington, D.C. February.

Commodity Risk Management Group,Washington, D.C. August.

The World Bank, 2001, "DeliveringPrice Insurance, Lessons LearnedFrom Four Cases Studies",

The ProVention Consortium

Mutual learning between farmers and insurance companies about the risks andcommodity prices at a workshop conducted by AIDMI.


PRINTED MATTERBook-Post

Ms./Mr.

Do you wish to receive this publication regularly? Write to Vandana Patel at AIDMI ([email protected]).The publication will be sent to you by E-mail.

You may also send your comments to improve this publication so that it is more effective and informative.

Please contribute comments, features, reports, discussion points, and essays about your work. Today!

ALL INDIA DISASTER MITIGATION INSTITUTE411 Sakar Five, Near Natraj Cinema, Ashram Road, Ahmedabad-380 009 India

Tel: +91-79-2658 6234/2658 3607, Fax: +91-79-2658 2962

E-mail: [email protected]: http://www.southasiadisasters.net

variables. Measurementredundancy and automatedinstrument calibration furtherincrease of the credibility of anindex.

• Availability and negotiability;Standardised and transparent,could be traded in secondarymarkets.

• Reinsurance function; Indexinsurance can be used to moreeasily transfer the risk ofwidespread correlatedagricultural production losses.

• Versatility; Can be easilybundled with other financialservices, facilitating basis riskmanagement.

Threats• Weather cycles; Actuarial

soundness of the premium couldbe undermined by weather cyclesthat change the probability of theinsured events, for example, ElNiño events.

• When designing a contract,significant care must be taken toassure that the insured has nobetter information about thelikelihood and magnitude of lossthan does the insurer.

SWOT Analysis of Index Insurance ProductsStrengths• Lower moral hazard since the

indemnity does not depend on theindividual producer's realisedyield,

• Less adverse selection since theindemnity is based on widelyavailable information, so thereare few informationalasymmetries to be exploited,

• Lower administrative costs asunderwriting and inspections ofindividual farms is not required,

• Standardised and transparentstructure due to uniformstructure of contracts.

Weaknesses• Without sufficient correlation

between the index and actuallosses, index insurance is notan effective risk managementtool. This is mitigated by self-insurance of smaller basis riskby farmer; supplemental productsunderwritten by private insurers;blending index insurance andrural finance; and offeringcoverage only for extreme events.

• Precise actuarial modelling isrequired; Insurers mustunderstand the statisticalproperties of the underlying index.

• Education; Required by users toassess whether index insurancewill provide effective riskmanagement.

• Market size; the market is still inits infancy in developing countriesand has some start-up costs.

• Microclimates; Make rainfall orarea-yield index based contractsdifficult for more frequent andlocalised events.

• Forecasts; Asymmetricinformation about the likelihoodof an event in the near future willcreate the potential forintertemporal adverse selection.

• Not appropriate in highly spatiallyheterogeneous production areas orwith commodities grown inmicroclimates. In this case, indexinsurances will only work if it ishighly localised, and/or if it canbe written so that it protects onlyagainst the most extreme lossevents.

Opportunities• New innovations in technology,

including the low-cost weatherstations that can be placed inmany locations where weathervariables can be measured, andalso the types of measurable

Date post:	06-Mar-2018
Category:	Documents
Upload:	trinhthuan
View:	212 times
Download:	0 times

International Tsunami Programme - ProVention · PDF fileSWOT Analysis of Index Insurance...

Documents