Microinsurance and the Need for Appropriate Reinsurance
Reinsurance is an important management tool for insurance companies. Management of insurance companies purchase reinsurance for several primary reasons:
Managing risk: For most microinsurance schemes, there is little need for reinsurance if the probability of claim such as hospitalisation rates is very predictable and if the benefit amount is relatively modest. In India where micro health insurance plans cover small amounts of hospitalisation benefits such as 5000 Rs ($111) with an incidence rate of hospitalisation at 3% of the population, costs are predictable and are not likely to vary much. In general, events with a high probability of occurring and with low payouts in most cases require only catastrophe reinsurance.
It is the authors’ experience that many of the creditor life insurance, term life insurance, and savings products offered by microinsurance programmes have little need for reinsurance beyond catastrophic coverage (although occasionally some initially require surplus or quota share reinsurance). With the support of a technical resource centre such as RIMANSI (Risk Management Solutions) in the Philippines, these programmes can become viable and build up capital within a relatively short period. Although it was itself initially subsidised, RIMANSI has estimated that it can deliver ongoing technical support and other services to its microinsurer clients at a cost of just 1-2% of the premiums generated within its network. This is a very cost effective strategy to ensure microinsurer viability and a good alternative to a permanent subsidy.
Increase capacity: A secondary purpose of reinsurance is to receive technical expertise so that the microinsurance management can improve their skills. When reinsurance is purchased, the reinsurer will have an interest in coaching and improving management skills. This could be a win-win set-up and in terms of capacity building is very important.
In start-up situations when the capacity of the microinsurance is nascent, reinsurance may be required more for gaining access to technical assistance than for the cession of risk. From a purely mathematical basis, loss models can be developed to help management decide on an appropriate reinsurance level. However, mathematical models are limited when a new product is developed since no one knows the true underlying risk.
Capital relief: Finally, reinsurance is used as surplus or capital relief. This use of reinsurance may be efficient if the capital relief required is small relative to the size of the organisation. However, the cost of this surplus relief should be measured against other alternatives. In the writers’ experience this has often been the most expensive form of raising capital.
The level and type of reinsurance chosen by a company primarily depends on the relative importance of these three factors. In some markets, like Canadian health care insurance, less than 1% of premium is used to reinsure risk. For creditor life insurance, the only reinsurance purchased is for catastrophic events; again the cost is minimal to the insurance operations. In other situations such as insuring an oil refinery, the main insurer would reinsure the vast majority of risks.
Too much reinsurance may be too costly and ineffective for microinsurance. The role of management is to determine the objectives they have for reinsurance and to monitor that it meets those objectives. Unusual claims such as a tsunami, earthquake and other major calamities should be reinsured. The cost of this type of reinsurance is relatively inexpensive and should easily be obtained by registered insurance companies.
In conclusion it is essential that prior to having an active reinsurance market, there has to be active, soundly managed and viable primary insurance markets or the potential for a market to become viable. Bringing in subsidies to the market via reinsurance may prevent the insuring organisations from achieving the discipline required to achieve this viability.
Source: Denis Garand and John Wipf, "The Role of Reinsurance" in Microinsurance: Improving risk management for the poor N°11, 2006.
Capacity building: Evidence suggests that microinsurance schemes often lack technical knowledge at the community level. Seeing as insurance relies on comprehensive data and sound underwriting expertise to be financially sustainable, developing appropriate data collection processes and training the management is one of the key steps microinsurance providers must take to grow.
The important role of reinsurers today, and their interest in the development of the insurance sector notably at the micro level, implies carrying a share of the responsibility to create the missing “industrial infrastructure” for microinsurance, which they can assume by supporting institutionalisation of training structures. The insurance industry, which is likely to benefit from such training, could make a tangible contribution to the development of training programmes, both in cash and in kind.
Scaling up: It is necessary to consider ways in which the reinsurance industry can increase its penetration into the low-income segment of the industry. Two courses of action seem particularly opportune:
- Focus on building up the capacity of microinsurance schemes to assume a growing range of insurance activities, rather than limiting micro schemes to the role of agents. This is particularly important in product types where the potential for conflict of interest between the agent (representing the insurance underwriter) and the microinsurance scheme (representing the clients) is acute.
- Create a reinsurance facility that would service this market segment until it becomes sufficiently attractive for commercial insurers to manifest more interest, possibly with some public funding.
Partnerships: Partnerships usually succeed when both sides consider the relationship to be beneficial. Reinsurers may find in microinsurers capable partners that simplify the process of entering the low-income market, and thus change the business paradigm of insurance. At the other end of the partnership continuum, microinsurance schemes are also subject to internal and external pressures that favour partnerships with insurers and reinsurers.
The table below illustrates both internal factors (those arising from internal and organisational constraints) and external factors (demanded by external stakeholders and regulations) that favour partnerships for reinsurers.
Partnership factors for an insurance or reinsurance company
Internal factors: Corporate social responsibility; risk diversification; securing or growing revenue; push for new markets and innovative products.
External factors: Growing competition in traditional markets; shrinking margins in traditional markets; regulatory requirements; political and activist pressure; liberalisation of previously closed markets.
Partnership factors for a microinsurance institution
Internal factors: Access to professional management practices; access to financial resources; implementation of standard insurance practices; support in expanding products and coverage; risk diversification or need to acquire reinsurance.
External factors: Regulatory pressure to institutionalise or collaborate with a registered insurance; documentation requirements by donors and/or government.
Reinsurers have a vital role to play in the success of microinsurance schemes. They can make a concrete contribution to implementing business processes that reduce the long-term cost of underwriting. Partnerships inspired by this motive can be of interest for both sides, as the commercial partners are best placed to adapt tried-and-tested methods of reinsurance, and microinsurers can expand the financial capacity of their schemes and underwrite more and larger risks. Successful partnerships would bring more business for both sides.
Source: David Dror and Thomas Wiechers, “The role of insurers and reinsurers in supporting insurance for the poor”, in Churchill, C. (ed.), 2006: Protecting the Poor: A Microinsurance Compendium. Munich Re Foundation/ILO, Geneva.