‘Compulsory’ is perhaps the most tempting potential characteristic of any insurance business model. It nods to the prospect of complete market coverage. Total. One hundred percent. The need to attract customers becomes unnecessary—the regulation does that for you! And you can begin to imagine a wide range of operational alternatives that open when you don’t have to go scraping for each new application that comes in the door.
For microinsurance programs, therefore, it’s hardly surprising that the subject of compulsory insurance arises from time to time. It looks, smells, and feels like a great way to deliver specific types of protection to the people who need it most. Since insurance can help reduce poverty, facilitate post-disaster recovery, and fuel economic growth by reducing the need for personal savings, it would stand to reason that compulsory microinsurance would be a fantastic way to help get programs up and running—and nurture them to the point where they achieve the scale necessary for self-sustainability and profitability.
With this thinking, it seems like everyone wins when insurance is compulsory.
Of course, we know from mature markets that this isn’t necessarily the case. Across the United States, for example, there are plenty of compulsory insurance markets. There’s nothing quite like being 17 years old in Massachusetts, getting your first car, and realising just how expensive that mandatory insurance is on a monthly basis. But, you swallow the pill. If you want to drive, you need to pay. And the thought of driving without insurance simply never arises. However, even in this case, insurers offer cover for uninsured and underinsured motorist, because even compulsory programs aren’t completely effective. And in some cases, compulsory programs haven’t gained significant penetration. California earthquake cover comes to mind quickly, for example, despite savvy and sophisticated efforts to drive adoption.
The world’s experience with compulsory insurance is a mixed bag. And the fact that there have been some major successes suggests that compulsory programs can make a difference. So, against this backdrop, we ask, Could compulsory microinsurance solve the distribution problem?
Microinsurance: The Distribution Problem
The barriers to microinsurance adoption and penetration are many and well documented. Lack of historical data, political risk, moral hazard—the list goes on. With smaller limits and cautious market entry, though, you can manage most of these risks of loss. A ‘bet only what you can afford to lose’ philosophy—loathsome though it may be in more mature markets—could still enable insurers to get off to a good start in markets where microinsurance may make the most sense.
Distribution, however…that’s a tough one.
Without effective microinsurance distribution, none of the other problems get a chance to happen. Without policies in force, there can be no insured losses—and no subsequent loss data. There wouldn’t be any fraud indicators, rate changes, or renewals. If nobody buys, nothing else happens. Obviously.
And the biggest problem in microinsurance—likewise any emerging market cover—is distribution.
Financial education is the first distribution challenge the insurance industry will need to address. Developing markets arguably struggle with usurious interest rates on short-term loans, a reliance on stored cash as a safety fund, and other financial practices that are ultimately detrimental—but which are unavoidable without greater financial knowledge. So, with insurance, there’s quite the hill to climb.
Think about it for a minute. You approach someone unfamiliar with insurance and say, ‘Give me some money now. And if something bad happens, I’ll give you a lot more than you gave me.’ The whole concept would probably seem more than a tad suspicious. And if you could smell a scam a mile away, you’d probably find a familiar aroma filling your nostrils.
To enter a microinsurance market, therefore, insurers should be ready to kick off the learning process. Investments in insurance education—and savvy local market partnerships for delivering it to potential customers—are quite simply the price of admission to what are effectively untapped potential markets. Even if through public/private partnerships, NGOs, banks, or retailers, insurers need to find a way to get boots on the ground.
Following education, the actual distribution of the product must be tailored to local market conditions. A program in Colombia had policy language printed on the back of a grocery store receipt. All the customer had to do was sign and pay. In Turkey, a telecommunications carrier offers TRY500 in terror protection as a way to retain customers and cultivate loyalty. Some have said that mobile distribution could be realistic. So far, we’ve found that mobile efforts are more focused on insurance operations, such as delivering the policy and paying claims; however, the prospect of mobile distribution remains a discussion point in the global microinsurance community. But policy language and technical engagement would need to fit within a country’s telecommunications infrastructure. This may involve accounting for 2G networks, flip phones, and the use of dated delivery methods.
Now that the prospective customer understands insurance and has a way to take delivery, what’s the next challenge? Pricing. For an actuary, that has some specific implications. But at the risk of heresy, we need to ignore them for a while—a bold statement from a Casualty Actuarial Society working party! (In fairness, it was made by the one non-actuary in the group.) But as with any new product, there’s no substitute for putting the customer first. Premium can be a barrier to microinsurance adoption, particularly if actuaries do their jobs well. In microinsurance—as in so much else—there’s a difference between being right and being effective.
It could pay (literally) to under-price risk to make the cover affordable, drive adoption, affect social impact, and ultimately evolve to an appropriately priced product. There. We said it. The losses you bear may ultimately become a worthy—and effective—investment in market development. If customers can’t afford insurance, distribution won’t happen. And then nothing else does. Of course, this investment in market development could have a positive financial impact outside the microinsurance program itself. An early-stage microinsurance program can help an insurer get access to a new market, where it could drive profit growth either through scale or through access to more profitable lines of business. Additionally, a microinsurance program could serve as a test bed for new technologies or distribution techniques that could later be applied to more mature markets.
Brace yourself: the cost discussion is about to get worse. You’ll need to put some thought into a likely significant frictional cost—your distribution infrastructure. Again, think with many years in mind. Build a smart infrastructure that you can grow into, rather than manage short-term frictional costs only to incur them later many times over. Here’s the rule of thumb: Do you plan to be working in ten years? If so, your future self will thank your current self profusely for making the right investment up front. Is your decision maker about to retire, leaving him impervious to that ten-year ‘thank-you’? He’ll rely on future dividends and share price from the company stock to support his retirement. You still win.
A distribution infrastructure would require both agent and operational elements. For microinsurance, you should embrace the intermediary—that’s a crucial component. Someone local with credibility and access can make all the difference. And you should be ready for a potentially unconventional intermediary. Remember the Colombian grocery store?
An agent or distribution partner can help drive adoption, but the fact remains that the insurance offer could sound awfully fishy to a first-time customer in a developing market. Pay me now, and I may pay you more later. Once you’ve attained some degree of market penetration, the easiest way to make people believe you is to show that you’ve paid claims. There can be some risk in emerging markets, but it may be worth it to turn a blind eye to some of the mitigating factors you’d normally note in a developed market. Pay a claim and non-customers will find out. And they’ll become customers.
One microinsurance program we heard about handled this effectively. In the first year, it paid claims. In the second year, the claimants were pretty much the only people who renewed. Scary thought, right? The scheme was comfortably profitable in the fourth year. Why? The second year was an exercise in establishing trust. It worked.
When it comes to brand, there’s nothing like paying claims.
How Compulsory Is Compulsory?
Given the paucity of data available for emerging markets and microinsurance schemes worldwide, it can be instructive to review some programs that could be seen as proxies for future insurance (and microinsurance) markets. Two that could be particularly helpful are the Turkish Catastrophe Insurance Pool (TCIP) and Romania’s PAID catastrophe program.
Perhaps the best example of a compulsory program gaining traction is the TCIP, which provides relatively inexpensive earthquake protection to insureds in certain parts of Turkey. According to data from XPRIMM, a trade publisher focused on the insurance industry in Central and Eastern Europe, the TCIP reaches 44 percent of its target market. One might think that’s a small number for a compulsory program, but nothing could be further from the truth. Following the 1999 earthquakes in Izmit and Duzce, the TCIP was formed to meet a specific societal need. And in less than 20 years, the organisation has grown to its current level of penetration from a first-year result of 5 percent and has also shown that it pays claims. It’s made clear a difference in the lives of Turkish citizens.
The TCIP has benefited from several regulatory features that support adoption. For example, proof of TCIP coverage can be necessary for access to some utility services and for the property title office. After the first year of cover though, there’s rarely follow-up to ensure that the customer renews the policy. However, the TCIP has invested significantly in earthquake and insurance awareness across the country, which has led to an impressive annual renewal rate, given the lack of enforcement measures after the first year of cover.
On the other hand, PAID, Romania’s catastrophe pool, hasn’t reached the same level of market penetration. It provides broader cover, with landslide and flood in addition to earthquake, and has a sensible price point for its market. However, penetration remains around 20 percent. The scheme is run well, and manages its capital effectively. No head scratching needed—it’s just a good insurance company. But PAID struggles with adoption and has indicated that more government support for enforcement would be the optimal way forward – a common sentiment among catastrophe pools and within the region. In Central and Eastern Europe, there’s a salient interest in strengthening ‘compulsory’ in these programs.
But is that the best way to go forward? Is enforcement really the issue? There are plenty of ways to do it, such as requiring proof of insurance for mortgages (and other bank programs), with annual validation necessary. Unfortunately, this type of approach leads to the potential for considerable operational and compliance overhead, which could make the solution more cumbersome and expensive than the problem. And for a microinsurance program, frictional costs of that nature would impede growth—if not the launch itself.
The other difficulty is that a requirement for coverage that doesn’t come with an integration of financial education into a market’s social fabric likely won’t make much of a difference. At first, compulsory insurance will be seen as something of a tax—a perspective that may change upon claim payment, granted. Yet, that can take years. And even then, the claim payment may seem like a windfall more than a recovery. Further, financial education helps reinforce the value of insurance, which can open up demand for additional products that can help free up personal capital for investment or consumption, ultimately fuelling economic growth.
The Only Way Forward
There’s no silver bullet when it comes to distribution—just hard work. Ultimately, global insurers looking to gain a foothold in emerging markets through microinsurance would be best served by finding local distribution partners to help them understand, engage with, and educate their prospective customers. The key here is to remember that the partners don’t necessarily need to be in the insurance or financial services industries. Cases from Turkey and Colombia, for example, show the value of access to customers—and understanding them—rather than the benefits of understanding the details of insurance protection. This approach may entail some additional expense, but that’s not just an investment in distribution. It’s an investment in creating a new market. And a tangible first step toward delivering a real social impact in the parts of the world that need it most.
Compulsory programs may seem attractive at first glance, but for that approach to work, much of the education and infrastructure needed for voluntary programs would have to be created anyway. In the end, it’s far better to create something of value, make a connection with your target market, and show the benefits you can provide. That’s what will turn an emerging market into a mature one.
Tom Johansmeyer, Assistant Vice President, PCS Strategy and Development, Verisk Insurance Solutions.
April Li, ACAS, Associate Actuary, The Travelers.
Keith Lau, ACAS, PricewaterhouseCoopers LLP.
Scott Swanay, FCAS, Assistant Vice President, XL Catlin.
This article was written as part of a Casualty Actuarial Society working party on microinsurance.