FAI asked Samantha Duncan to tell us about the research papers and books that have influenced how she thinks about insurance. This is what she told us:
My thinking on insurance has evolved and been influenced by personal experiences, but also some books and papers. I am a practitioner at heart, and my earliest thinking came from spending time inside the homes of poor people across Latin America and Asia; getting to know them, their families, and how they live their lives. However, there have also been a number of research papers and books that have had a tremendous impact on my thinking and work. I’ve outlined some of the ideas that have deeply resonated with me below.
Insight 1: The risks poor people face are debilitating. There is a cycle of poverty.
The simple fact that the majority of the world’s poor don’t live hand-to-mouth is often overlooked. Portfolios of the Poor was a game-changing book in this regard, and in my opinion provides the most comprehensive documentation of this fact across a number of communities and countries. Through financial diaries, the book describes the way in which most poor people are earning; they are working their way out of poverty, but are often set back by one-off shocks or irregular income caused by lack of work. Poor people live in a constant ‘cycle of poverty,’ from which it is hard to escape without meaningful risk mitigation. During my time overseeing a microcredit program in Peru, almost all borrowers experienced delays in payments due to unexpected illness, some had family members pass away and couldn’t repay at all, and still others had successfully used their microcredit to grow their business but had then become the target of theft and vandalism by those less fortunate. The savings of the poor is seldom enough to compensate, so people are left without a safety net. More importantly, however, people are left without an incentive to invest in more productive assets, as the risk of losing everything is too great. At LeapFrog we use the term “safety nets and springboards.” It is the fundamental promise of insurance to break this cycle of poverty.
Insight 2: The need to manage risk is not new. Informal mechanisms are long-standing.
Another critical insight from Portfolios of the Poor is that poor people are already highly sophisticated in their ability to manage risk and smooth consumption. Informal financial services constitute the bulk of financial transactions, and the easiest forms to ponder include in-house savings pots and loans from family members, local stores and money-lenders. But informal insurance mechanisms go much deeper, and are very much embedded in many cultures and traditional bonds. One of the most fascinating accounts of this can be found in Karl Jackson’s Traditional Authority, Islam and Rebellion: A study of Indonesian Political Behavior, which describes the Patron-Client relationship that defines traditional and political life in Indonesia. In its simplest form, someone more economically fortunate (the Patron) provides a cash buffer in times of need for someone more vulnerable (the Client). The Client is indebted to the Patron and maintains the relationship by paying forward his risks (or a premium) to the Patron. The structure exists all the way up the economic pyramid (everyone is both a patron and a client to/of someone), and while Jackson’s focus is on the political implications of the structure, the clear message, as it relates to insurance, is that risk mitigation techniques are long-standing. Appreciation of the value of insurance is somewhat innate.
Insight 3: Informal insurance is not optimal.
The Economics of Microfinance and The Fortune at the Bottom of the Pyramid do a good job of teaching us that the cost structures of informal providers, while often economically rational, can make financial services prohibitively expensive (Armendáriz and Morduch), and poor people often pay a premium due to lack of viable distribution and scale (Prahalad). In the particular case of insurance, the foundational demand-side study by Jim Roth, Michael McCord and Dominic Liber, The Landscape of Microinsurance in the World’s 100 Poorest Countries, emphasizes that informal mechanisms can also be unsafe, especially when risks are concentrated in communities and pricing does not account for the entirety of the risk. The challenge for formal providers then is providing a better and more cost-effective means of mitigating risk than informal channels, but achieving this in a way that is trusted by poor people the way that informal mechanisms are.
Insight 3: Trust is critical.
Insurance is very distinct from credit. Insurance requires you to give up cash today to compensate against an event that may or may not happen in the future. Moreover, you are required to entrust that cash to an external party, and trust the party to give it back promptly in time of need. How trust is a critical barrier in the uptake of insurance is well documented by a recent paper by the Microinsurance Innovation Facility at the International Labor Organization (ILO), titled Why People Don’t Buy Microinsurance and What We Can Do About It. Other factors that influence uptake among poor people include liquidity constraints and the quality of the client value proposition, which indicates the importance of investing in financial literacy and awareness. On a practical basis, the critical importance of trust and literacy forces insurers to forge close partnerships with trust-based organizations such as community groups, microfinance institutions or others that not only know the client best, but are often best positioned to educate the client on the benefits of insurance and its ultimate value.
Insight 4: Scale is necessary, and possible.
The concept and various actors at play in the provision of formal insurance to the poor is well documented in Protecting the Poor: A Microinsurance Compendiumand The Landscape of Microinsurance in the World’s 100 Poorest Countries. There are a few critical insights from these texts that have influenced my thinking. First, insurance, by definition, only works if you can spread risk across many insured, and the greater the scale you are able to achieve, the cheaper individual policies can become. Second, there is now strong evidence on the enormous, pent-up demand for insurance: Lloyds estimates that between 1.5 and 3.0 billion low income people can and will pay for insurance services they value (see Insurance in Developing Countries: Exploring Opportunities in Microinsurance). That scale is both necessary and possible has defined our investment thesis at LeapFrog, and it is for this reason that we only invest in commercial enterprises that are committed to serving this emerging segment sustainably, and—by virtue of already operating at scale—have the capacity and expertise to extend cost-effective and affordable insurance to millions of previously underserved customers. The practical guide entitled Making Insurance Work for Microfinance Institutions provides a good illustration of how this can be achieved. The central point is that in many instances the pipes for insurance have already been laid: microfinance institutions, post offices, community based organizations such as churches, mobile network operators and agricultural distributors can all aggregate and enable the distribution of insurance to millions of low income people, providing a truly powerful means for providing safety nets and springboards at scale.
Insight 5: Safety nets and springboards for the poor: we’ve walked this path before.
The recent evidence on the ability of insurance to provide safety nets and springboards for the poor is still evolving, but one recent study titled How Does Risk Management Influence Production Decisions? Evidence from a Field Experiment provides positive evidence of the ‘springboard’ effect of insurance on the willingness of Indian farmers to invest in more productive crops. As this evidence evolves, however, I think it important to keep in mind that we have walked this path before. Against the Gods: The Remarkable Story of Risk documents the earliest thinking on risk, from Greek and Roman probabilities through to the way in which risk mitigation fuelled the Industrial Revolution and the formation of society as we know it today. Prior to the Industrial Revolution most people were poor, but the aggregation of people in communities (employment-based, religious) made the mass mitigation of risk through insurance achievable. So hundreds of years ago insurance enabled them to think differently about risk. At that time, with the knowledge that they had a safety net to protect against the downside, they used insurance as a springboard: to invest, plan and think forward to a life without poverty.