Last updated on March 5, 2011
More often than not, economic underdevelopment is explained by development economists as being the consequence of multiple market failures. Among these market failures is the lack of insurance markets in most developing countries, which forces individuals and households into sinking considerable resources into averting major risks.
Suppose you are the head of a rural household in an African country. One such risk is the risk you will lose your assets. For example, you could lose some of your land as a consequence of land redistribution within the community, or a disease could decimate a significant fraction of your livestock.
For many smallholders, such asset losses often means a descent into chronic poverty, or what the literature refers to as a stochastic poverty trap. In this case, the term “stochastic” simply means that the descent into poverty is the result of chance events, or risks. As a consequence of such risks, economists have come to the conclusion that smallholders often smooth their assets instead of smoothing their consumption.
In other words, instead of selling off assets in order to maintain their consumption at a given level (consumption smoothing; e.g., if I lost my job, I might sell my house, some of my guitars, etc.), the poor in developing countries often drastically lower their level of consumption in order to maintain their assets at a given level (asset smoothing, e.g., they may eat only one or two meals a day so as to avoid having to sell off some of their livestock) given that selling off assets may well mean a descent into chronic poverty. Or, as my colleague Anirudh Krishna would put it, chronic poverty is often only one illness away.
Given the lack of insurance markets, one possible policy response is to offer micro-insurance contracts. That is, to sell these smallholders an insurance policy designed to protect them against crop failure, for example, which would be tied to the level of rainfall in their area.
For those of you who are interested in micro-insurance, I had saved this article from The Guardian for later. The article does a good job of explaining one of the issues behind the low demand for micro-insurance:
“[D]espite the buzz surrounding micro-insurance, the industry’s reach is still limited. The 150 million people currently holding policies represent only a small fraction (around 5%) of a potential market of up to 3 billion.
Unlike microfinance programmes that provide people with instant cash, the insurance industry has so far struggled to overcome the simple problem of trying to ask poor people to pay for something they might never use.
Richard Leftley, the chief executive of UK-based MicroEnsure, one of the leading micro-insurance companies, says that it has all but scraped (sic) the idea of trying to sell policies direct. He says turning up in towns and villages and asking poor families to buy insurance simply doesn’t work. ‘Trying to explain to someone with no prior experience of insurance that if you pay even just a little bit every month then someone will pay you back if your crops failed or your child is hospitalised is often met with a perfectly understandable ‘yeah right’ response,’ he says.”
Given that this is an issue I am currently working on in Mali, expect this blog to feature more posts about micro-insurance over the coming year or so.