Insurance for the Poor? Stefan Dercon Oxford University Beijing 2007

Risk is Very Costly for the Poor Poor live in high risk environment Poor live in high risk environment With high welfare costs: With high welfare costs: Short-run: consumption/nutrition shortfalls Short-run: consumption/nutrition shortfalls E.g Ethiopia drought 2002? 16% lower consumption E.g Ethiopia drought 2002? 16% lower consumption Long-run: persistent effects Long-run: persistent effects E.g. Ethiopia rural growth in 1990s lower for those affected by famine E.g. Ethiopia rural growth in 1990s lower for those affected by famine Making risk a cause of poverty persistence Making risk a cause of poverty persistence Loss of assets/health/human capital in crisis Loss of assets/health/human capital in crisis Avoidance of high return activities to keep risk low Avoidance of high return activities to keep risk low

How to design better protection? Taking into account: interventions interventions (micro)credit activities, especially using groups (micro)credit activities, especially using groups safety nets safety nets Starting from peoples risk strategies Starting from peoples risk strategies mutual support (risk sharing) via networks and groups mutual support (risk sharing) via networks and groups

The problem of insurance Problem with groups Problem with groups covariate or catastrophic risks covariate or catastrophic risks Problem with insurance provision Problem with insurance provision information problems (adverse selection and moral hazard) information problems (adverse selection and moral hazard) Administration costs Administration costs Problems with risk Problems with risk Risk perception errors Risk perception errors Uncertainty/Ambiguity Uncertainty/Ambiguity

1. Build on Existing Groups Partnership of existing groups (self-help groups, cooperatives, funeral societies) To handle covariate/catastrophic shocks To handle covariate/catastrophic shocks Avoids adverse selection Avoids adverse selection Reduces costs including of monitoring Reduces costs including of monitoring (delegated monitor model) Avoids crowding out of informal support networks Avoids crowding out of informal support networks Given much ambiguity, mutual insurer model (=make groups shareholders) superior to just offering insurance to groups Given much ambiguity, mutual insurer model (=make groups shareholders) superior to just offering insurance to groups

2. Tailor products to problems Different risks have different informational/verification problems Different risks have different informational/verification problems Health – adverse selection Health – adverse selection Crop failure – moral hazard/verification Crop failure – moral hazard/verification Death – no incentive problem (verification?) Death – no incentive problem (verification?) Property/fire – moral hazard Property/fire – moral hazard Innovations Innovations SEWA: life insurance SEWA: life insurance Indexed Products for Rainfall Indexed Products for Rainfall

3.Insurance is always sold but never bought Designing product easy and hypothetical demand is high Designing product easy and hypothetical demand is high Insurance uptake is rarely swift or high Insurance uptake is rarely swift or high Ambiguity can help to explain Ambiguity can help to explain Investing in data and in education about insurance… Investing in data and in education about insurance… Increases costs and reduces benefits Increases costs and reduces benefits Rainfall insurance experiments: success but (s)low uptake. Dangerous! Rainfall insurance experiments: success but (s)low uptake. Dangerous! Advantage of dealing with groups. Advantage of dealing with groups.

4. Insurance crowds out credit Individual credit provision: Individual credit provision: If enforcement is imperfect in credit market, If enforcement is imperfect in credit market, then making defaulting on loan less painful would reduce credit provision (as incentives to be careless are stronger) then making defaulting on loan less painful would reduce credit provision (as incentives to be careless are stronger) Group-based credit provision: Group-based credit provision: Insurance would undermine incentives for repayment by group Insurance would undermine incentives for repayment by group

4. Implications of crowding out? Problem is especially there for business- related risks (with moral hazard); Problem is especially there for business- related risks (with moral hazard); Indexed products would help (rainfall); Indexed products would help (rainfall); There would be a case for monopoly power for credit and insurance provision in poor settings There would be a case for monopoly power for credit and insurance provision in poor settings Case for interlinked contracts within microfinance; Case for interlinked contracts within microfinance; Crowding out of credit with safety nets? Crowding out of credit with safety nets? E.g. workfare programmes? E.g. workfare programmes? Exception: if repayment perfectly enforceable, insurance would crowd in credit. Exception: if repayment perfectly enforceable, insurance would crowd in credit. E.g. Fertiliser in Ethiopia. E.g. Fertiliser in Ethiopia.

5. Is microcredit is overrated? Emphasis on microcredit and productive asset creation by the poor for poverty reduction is EXCESSIVE. Emphasis on microcredit and productive asset creation by the poor for poverty reduction is EXCESSIVE. As if poverty reduction is best achieved via enterpreneurial activities… As if poverty reduction is best achieved via enterpreneurial activities… Evidence on welfare impact of credit: Karlan and Zinman (2006).: substantial from impact offering consumption credit Evidence on welfare impact of credit: Karlan and Zinman (2006).: substantial from impact offering consumption credit

6. Joined-up thinking Microinsurance, savings, microcredit and safety nets: Microinsurance, savings, microcredit and safety nets: all mechanisms to fix failures of credit and insurance markets all mechanisms to fix failures of credit and insurance markets in a context of many informal risk strategies already used in a context of many informal risk strategies already used Allow people long-term planning beyond resource constraints at particular periods of time or states of nature Allow people long-term planning beyond resource constraints at particular periods of time or states of nature Most cost-effective solution from integrating thinking around all of them, with trade-offs and complementarities. Most cost-effective solution from integrating thinking around all of them, with trade-offs and complementarities.