According to the 2004 Microcredit Summit Campaign report, there are around 3,000 microfinance programs across the world servicing over 80 million people. These figures, while impressive, remain a drop in the ocean and moreover, getting access to microcredit does not necessarily mean getting out of poverty. While that would be a ridiculous simplification of the problem, the extension of credit to a broader range of financial services has proved its worth and its further development can help more people in meaningful and long-term ways to ensure steady movement up and out of poverty. In particular, insurance on loan repayments should be an integral part of financial services on offer, and Affiliate Professor at INSEAD, Loic Sadoulet tells us both why and how.
In a bid to boost microcredit and microfinance programmes, The United Nations General Assembly has decreed 2005 as the International Year of Microcredit, sponsored by major microfinance institutions (MFIs), government bodies, non-governmental organisations and other UN divisions. What better time then to look at how other microfinance services, and specifically microinsurance, can be more widely offered and better adapted to facilitate financial and therefore life security for its clients-the world's poor.
In this chapter, Learning from Visa®? Incorporating Insurance Provisions in Microfinance Contracts from Insurance Against Poverty, Professor Sadoulet examines the pluses of extending insurance coverage to microcredit borrowers and in a no-nonsense way successfully puts forth the case for generalised insurance coverage on microcredit loan repayments. Recognising just how risky poor peoples' lives really are: how a family illness, fluctuating weather conditions or machinery break-down can severely impact both income earning and/or loan repayment capabilities, insurance is a must to ensure continuous movement towards financial stability.
Today, in the microcredit area, failure to repay a loan means exclusion from any future loan possibilities. The ramifications for the ongoing financial stability of the person or group in question are obvious: a return to square one - or sometimes worse, as additional debts or expenses may have been incurred in the wake of optimism brought about through access to the microcredit loan.
But in such an obviously risk-laden environment, how can MFIs ensure adequate protection for their repayment insurance, to not find themselves on the receiving end of systematic loan repayment failure? Sadoulet sensibly proposes the application of an adapted system in some ways similar to the US credit card system, where a client builds a credit rating. Rather than relying on savings or collateral as a guarantee, this method meshes well with the actual microcredit loan system based on successful repayments leading to further loans. This provides the opportunity for a MFI to build a credit story for each of its borrowers based on their ongoing repayment history.
Each MFI would set their threshold credit-repayment performance levels that once attained would automatically qualify the borrower for loan repayment insurance, and a simple mechanism to price the loan contracts. While this review of Sadoulet's work presents a simplified view of this logic, the actual book chapter provides the formulae to calculate borrower reputation and thresholds, insurance premiums, the risks associated with false claims, and possible cut-off limits to deter fraudulent claims.
In many cases, this kind of repayment insurance would be workable without important institutional capabilities as no new information is required, the contract is simple to implement, and building reputation for insurance purposes is less costly than building savings. And as Professor Sadoulet's studies have shown, and contrary to what some may believe, poor borrowers are willing to pay a substantial insurance premium to protect their financial security.
The chapter closes with a few vital structural and operational points regarding the actual MFIs organisational requirements to support repayment insurance. Of particular importance for example, would be the MFIs own ability to pay out on insurance claims. As many MFIs work in small geographic areas, they could find themselves with large collective insurance payouts if there were for instance, a large local fire or flood. The MFIs must in turn be insured to the correct levels to cover such eventualities and there are also issues regarding accounting rules, transparency and administrative burden to be taken into account.
However, some MFIs already have the structural and organisation capabilities to implement systematic repayment insurance. And there would be nothing like a few examples of well-implemented microinsurance to get the other MFIs up and out of the starting blocks. Let's hope that the 2005 International Year of Microcredit will see that happen.
Oxford University Press, 2004