It is expensive to be poor - such is the way modern civilisation has been constructed. Poverty is a vicious cycle, as the poor are disadvantaged in terms of living conditions, education, at higher risk of falling into crime, and are more likely to be unemployed. Further, it is extremely difficult to break out of the poverty trap - it takes a combination of tenacity, help from good Samaritans, skill and luck to do so.
The poverty premium refers to the additional costs and friction faced by the poor for essential goods and services.
Poverty Premium in Insurance
Insurance premiums reflect the cost of the risk, that is, the likelihood of the insured to fall ill, die, get into an accident, be affected by floods etc.
We price based on risk factors including age, gender, occupation, medical history, family history, lifestyle, sometimes the place of residence/zipcode, marital status, the size of the coverage (higher covers may get cheaper costs per 1000 insured) etc.
Many of these factors used, including occupation, medical & family history, lifestyle and size of coverage will disadvantage the poor. They are more likely to be in hazardous professions, have medical issues or have family members with medical issues due to lack of good quality housing, food and care, be more likely to have poor lifestyle, and will buy smaller coverage amounts.
This could result in more expensive premiums, resulting in the poor paying a large percentage of their disposable income for insurance or not being able to afford insurance at all.
Further, insurance premiums usually need to be paid regularly, on time, either monthly, quarterly, half yearly or annually. If premiums are not paid on time, the coverage may be discontinued resulting in the insured losing much needed coverage.
For the poor who barely make ends meet, it would be a very tall ask to commit a portion of their income regularly to an intangible service such as insurance.
Can we afford to do nothing about it?
No, we can't.
Death of an uninsured breadwinner can push a normal household to the brink of poverty. A poor household can become destitute and be driven to desperation when a breadwinner dies without insurance.
The same can be said about critical illness and flood insurance.
We can't sit back and watch our poor friends suffer, as the fabric of human existence is built on social wellbeing. Society as a whole suffers when the poor and weak aren't taken care of, resulting in rising crime rates, rising costs, scarcity of essential goods, a weaker economy and ultimately a weaker nation.
Relying on public and private aid alone is not a sustainable approach and is not efficient either. We need to relook at the way we build and deliver financial services, in this case insurance, to address this gap.
Financial Inclusivity in Insurance
Financial inclusion means to include the poor and underprivileged into the financial system. This requires rethinking the features of the service, the way in which it is built, priced, marketed and delivered.
In insurance this can come in a few ways (there may be others) - including microinsurance, risk pooling (instead of risk transfer), group insurance by employers, specific types of insurance needed by the poor including crop insurance, government-backed schemes, etc.
Let's look at microinsurance and risk pooling in more depth.
Microinsurance
Microinsurance is bite-sized insurance, providing essential coverage at very affordable prices. We are advised to follow the SUAVE principle in designing microinsurance products, which is:
S - Simple. Product features and processes need to be kept simple.
U - Understandable. Terms & Conditions need to be easily understood by the clients.
A - Accessible. The insurance service needs to be easily accessible by the client at points of purchase, service and claims.
V - Value. The price and coverage levels need to be matched with the clients affordability and needs.
E - Efficient. The processes around marketing, purchase, servicing and claims need to be very cost and time efficient.
These principles require rethinking and reinventing every step of the traditional insurance model. In fact, it may be wise to completely segregate this development process from the mainstream insurance processes.
Regulators like Bank Negara (Malaysia) have introduced specific regulations (Perlindungan Tenang in Malaysia) to promote and assist the development of microinsurance models, but there is still much more to be done in reducing the regulatory red tape.
Another aspect that is crucial is that microinsurance can be and must be operated profitably. There is a place for aid and donations, but microinsurance cannot be operated by the insurer as a charity service.
With rare exceptions, investors look for returns on their capital, and so only a profitable microinsurance model is sustainable, otherwise it will become a short-term charity effort.
Remember, our goal is to remodel the insurance service for financial inclusion, which is a long term solution hence profitability is essential.
Risk Pooling vs Risk Transfer
These terms look similar but have very different implications. Traditional insurers are built on the risk transfer concept - the insured pays a premium in return for the insurer taking on the risk. The risk then belongs to the insurer, who pays out the claim when the insured event happens.
Effectively, the insurer is a black box where the customer does not know what happens to the premium, and the black box promises to make the claim payment if and when the insured event takes place.
In the risk transfer model, it is important to charge to the customer his/her fair premium. The fair premium is calculated based on many risk factors, including demographic, socio-economic, medical history and lifestyle.
As the relationship here is only between the insured and the insurer, the insurer has an obligation to provide the appropriate premium to the insured.
The insurance market is also competitive, and customers can compare between various offerings by insurers to find the best product and service.
Risk pooling on the other hand involves pooling together the entire group, where the concept of mutual aid/assistance comes into focus. The members of the group make a commitment to support each other by pooling the risk, and the insurer is the administrator of the group.
The Takaful and P2P (Peer-to-peer) insurance models are built on this concept.
In this model, the focus shifts away from individualised pricing, to a price structure that includes everyone in the group.
Addressing the poverty premium..
Is definitely possible, and we have started taking steps in the right direction.
Let us keep walking in this direction to shift the needle towards wider financial inclusivity.
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