Small fortunes

The rise of microcredit – small-scale loans designed specifically to service individuals on super-low incomes – has rightly been hailed as a revolutionary development in the fight against global poverty. During the past few years, ­however, voices within the microfinance industry have begun to question whether credit, once considered the primary lever by which to elevate people above the poverty line, is in fact only part of the broader picture. “There are three things to think about when aiming to reduce poverty: to increase income, to increase assets, and the final one is to manage risk,” says Barbara Magnoni, president at EA Consultants, an advisory firm specialising in microfinance.

Despite strong campaigning by some microfinance organisations to promote savings habits among low-income communities, a family’s savings are rarely substantial enough to accommodate emergencies. Events such as a death in the family requiring a costly funeral, or a major weather disaster, continue to wipe out families’ physical and financial assets. Across vast swathes of the globe, populations subsisting below the poverty line have had little if any access to financial products designed to protect them against such risks. Africa is especially lacking in this regard: the entire continent, excluding South Africa, generates only 0.2% of global insurance spending, according to insurance giant Swiss Re, leaving some 250 million people exposed to the full catastrophic force of crime, disease and the elements.

Although such individuals might be able to raise themselves above the poverty line through the use of microcredit, it is microinsurance, many argue, that will keep them there. “Microinsurance looks to address this third issue, about managing risk, in the way increasing income and assets cannot,” says Ms Magnoni.

Through products such as health, property, livestock, funeral and crop microinsurances – designed specifically to meet both the needs of the poor and the rhythm of their financial lives – many poor communities in regions including Africa, South America, India and China, are beginning to take control of their risk and liquidity ­management.

In particular, crop insurance, by which smallholder farmers are protected against the impact of drought, flood and typhoon, is considered to be an especially ­critical tool in the fight against global poverty because it helps to unlock rural lending and investment. By ­protecting their assets through crop microinsurance, farmers can secure credit from lenders, including microcreditors, that have historically been deterred by farming communities’ exposure to weather disasters. In turn, farmers are able to purchase agricultural inputs, such as fertiliser and high-yield seeds, and go on to generate a surplus and diversify their income. Microinsurance enthusiasts even argue that such crop insurance products help farmers adapt to climate change, from which poor rural communities are at most risk.

All of this might seem a little overblown were it not for the fact that the World Bank agrees. In a recent column on how to tackle the global food crisis, published by the Financial Times, Robert Zoellick, president of the World Bank Group, underlined the importance of developing innovative instruments for risk management and crop insurance for small farmers – an area in which the World Bank is now playing an active role.

But profitably delivering such low-margin insurance products is extremely challenging. This is especially true of microcrop insurance, where the complexity of administering to small-scale subsistence farmers located in widely dispersed areas renders such policies prohibitively expensive. In the Philippines, for example, the cost of enrolment, claim filling, processing and loss adjustment pushes premiums as high as 20% of the sum insured, meaning the government is forced to heavily subsidise such policies.

As such, the back offices of most global and even local insurance agencies are not set up to efficiently administer to products so miniscule in size. “How do you administer a policy for 30 cents?” asks Aaron Oxley, CTO of global microinsurance organisation Micro Insurance Agency (MIA), whose job it is to do just this. “The answer is through super-efficient business processes,” he says.

Weather-linked products

Founded in 2005 by parent company Opportunity International, among the world’s largest microfinance networks, MIA is something of a specialist in this regard. As a designer, distributor and administrator of insurance products specifically for the poor, the organisation has to think dynamically when it comes to the technological and operational aspects of delivering crop insurance. Working in conjunction with the World Bank and several other partners, MIA has become a recognised pioneer in delivering inexpensive, accessible microcrop insurance to poor communities, through the development of the world’s first weather index-linked micro­insurance products.

Weather index-linked insurance attempts to solve the operational costs associated with traditional indemnity products, by eliminating entirely the costly claim and verification process through the use of raw meteorological (met) data. Under MIA’s model, farms are tied to a nearby weather station, where the recorded weather conditions are used as a proxy for the weather experienced at the farm. The data provided from this measurement effectively covers up to 2000 farmers within a set radius of the weather station. In the case of weather-related disasters, for example, payouts are issued automatically, requiring no claim forms or verification. This in turn reduces the cost of the product to between 5% and 10% of the sum insured, says MIA.

By drawing up careful models of seed behaviour and harvest cycles, MIA has been able to develop particularly complex drought insurance products. Through a detailed understanding of the characteristics of particular seeds MIA is even able to issue farmers with automatic pre-emptive payouts halfway through the growing season when the data indicates that the crop, in not having received rainfall during specific phases of the cycle, will be ruined.

“If the rain falls below the trigger threshold, we perform an automatic payout. This means we don’t have to deal with the forms, or send out loss adjustors: so we’ve vastly simplified the technology process,” says Mr Oxley.

MIA is planning to launch an innovative new typhoon insurance product which takes a similar approach. Instead of using local met office data, however, MIA plans to exploit satellite technology, linking farmers to a known global positioning system (GPS) location no more than two miles from their farm. In the event of a typhoon, MIA will be able to use satellite data to determine its path and wind speed. This information is then used to issue automatic payout to farmers, based on both the severity of the typhoon and its proximity to the farm.

In developing and modelling the typhoon product, MIA has collaborated with several global met associations and typhoon centres in order to gather historical typhoon data. According to Mr Oxley, the complex modelling and pricing work can be performed for an entire global region, allowing the organisation to provide coverage, at least in theory, for large regions of the planet’s rural poor.

The use of satellite information, in this instance, is especially important, says Mr Oxley, because it reduces MIA’s dependence on data provided by local met offices, which have suffered severe and sustained under-investment in many parts of the developing world. “If you go to any developing country and you talk to the head of its met office, it is understaffed, under-funded and underappreciated,” says Mr Oxley. “That’s why being able to use satellite-based technology is a massive breakthrough, because you don’t need to spend millions of dollars rolling out met office infrastructure and you don’t need to go to the met offices and beg them for data.” Mr Oxley believes the model can be leveraged to diversify into livestock insurance too.

Partner-agency model

Underpinning the delivery of the weather index products lies a technology platform that, in much the same way, leverages existing distributed technology infrastructure. In adopting what is known as the partner-agency model, MIA has been able to effectively outsource its entire front office to local partner organisations, such as microfinance lenders, rural banks, trade unions and co-­operatives. By using these partners to enrol rural farmers in insurance schemes (for which these agents take a commission), MIA avoids the major cost of reaching the poor directly, networking the cost instead across multiple organisations.

This strategy is critical to the delivery of economical insurance policies because the cost of delivering such products increases the closer the insurance broker gets to the end client. “There is no way we could reach these people directly,” says Mr Oxley. “Instead, we focus on open networks, primarily the internet,” he says. By ­moving to a software-as-a-service (SaaS) model – in which MIA’s information capture system will be hosted on the web and accessible via a normal internet connection – MIA is in the process of enabling its front-office agents to interface remotely with its middle-to-back office systems.

Agents will be able to input client information which will then be uploaded remotely into MIA’s core system, eMerge on T24, a core banking platform which has been developed for microfinance and community banking institutions. Provided by Temenos, eMerge was originally chosen by Opportunity International as its core system, which MIA has customised in house in order to create an entirely new and unique insurance module and, in turn, build industry-specific tools.

For example, MIA has built a tool that allows the organisation to effectively transform standard e-mail into a sophisticated reporting function. Reports that would normally be printed out and then sent physically to the relevant parties are instead automatically sent via e-mail to MIA’s partners in the local regions. MIA is able to send reports to every branch manager of every partner institution it works with automatically on a weekly or even daily basis, and these reports can be compressed and encrypted to ensure security and minimise storage costs.

Through such measures, MIA has pushed the boundaries of efficiency within tight fiscal constraints, eliminating significantly time-consuming and cum­bersome paper processing that would otherwise bloat operational costs and inflate premiums. From client-onboarding to claims processing and payout, MIA has found innovative ways to leverage existing networks and resources to fit technology solutions to the very specific problems of servicing the poor on a mass basis.

Basis risk

But MIA does not pretend that the platform or the resulting products are perfect. Decades of accurate historic data, for example, is required to properly price a weather index product and preferred information is not always available, meaning calculations must sometimes be performed using proxy data thereby increasing the margin of error. By failing to verify the damage on the ground, such products suffer “basis risk”, that is the risk of the experienced loss failing to match the calculated loss: in the other words, the computer may get it wrong. This is especially true of rainfall, for example, where satellite technology is sometimes unable to distinguish between strong water vapour and an actual downpour.

Efforts are under way, particularly in India, to close the gap and more closely link the weather indices to the actual results. In the meantime, the price of speed and efficiency is nevertheless occasional errors, but it is a price many believe is worth paying.

These issues, says Mr McCord, underline a major debate central to the fledgling industry: “How much do we think that technology can impact the distribution of insurance for low-income people and how much human intervention will we need?” To what extent, furthermore, can the technology used to reach such individuals throughout the globe be standardised?

After all, says Mr Oxley: “We have to take a platform to them because they are not going to come to us.”