Weather-Indexed Insurance: Why Isn't It Working?
This post was originally posted on the CFI-Blog Website.
Weather-indexed insurance is brilliant. It's just not working. It's brilliant because it solves one of the basic challenges of insurance: moral hazard. Under the principle of moral hazard, having insurance tends to make an individual's behavior riskier, increasing the likelihood that the product will be used. If I have fantastic health insurance, for example, I may be more likely to make riskier life decisions because I don't feel the financial effects of the consequences of those decisions quite so acutely. If insurance is tied to the weather, however, nothing an individual does (unless you believe in the efficacy of a rain dance) will "trigger" the insurance. Weather-indexed insurance is not a new phenomenon.
Over the last decade we've heard exciting stories about weather-indexed crop microinsurance and the lifeline it offers to farmers given our world's quickly-changing climate. Weather-indexed insurance was bundled with agricultural inputs like seeds or livestock, and the product was lauded as a way to increase the inclusion of poor people in insurance. Amazing, right? So why, after a decade, aren't customers buying? In India, for example, only 5 percent of farmers have taken it up where available.
- It's complicated. Insurance is incredibly complex to explain to a consumer. There are no easy examples for consumers to reference in their mental maps of products. The concept has no analogues in the local culture.
- It costs a lot. Low-value insurance is very expensive for companies to offer, and weather-indexed insurance is no exception. While the weather-based trigger makes it cheap to determine when claims are valid, the product requires a critical mass of people to break even, and it is costly to acquire all of those customers.
- And it's undervalued. At the same time, customers often under-value insurance. In experiments looking at whether insurance products are priced appropriately vis-à-vis customer perception, there is skepticism regarding the price of premiums for an intangible product. A number of years ago, some researchers discovered that even when subsidized so that insurance would yield an expected return of 181 percent, only half of households offered the product decided to purchase it.
- Making an insurance claim is annoying, and recourse mechanisms are not great. Weather-indexed insurance targets individuals living in remote areas who might lack experience with insurance claims or formal financial services. Moreover, available weather data has been a limiting factor for the scope and accuracy of the services' automation. Recourse mechanisms are often a struggle with financial services for the base of the pyramid, and there have been documented incidences of similar issues in the weather-indexed insurance segment.
- "Freemiums" can give insurance a bad rap. A "freemium" is an insurance product offered for free alongside another product that the customer is paying for. For example, rental car insurance comes with a credit card. Credit life insurance comes with a microloan. Health insurance comes with a mobile wallet. The problem is that customers often don't know they have the product, which can reduce the offering's credibility. The freemium approach has been met with success in some cases, but to achieve this, it's essential that customers have a strong awareness and understanding of the product.
- Governments aren't really on board, even though the product would increase economic growth. Noteworthy exceptions to this are the governments of Canada, India, and the United States, which subsidize premiums by at least 50 percent. However, such involvement by many governments in Africa, for example, would likely not be affordable.
These results are not new. It's just that the industry has not found compelling solutions to these problems. It's no wonder weather-indexed insurance for low-income populations continues to limp along, even though it is one of the financial sector's greatest inventions (in this blogger's opinion). The best way forward for weather-indexed insurance is either providing it for free (which is why Shawn Cole advocates so strongly for public-private partnerships) or bundling both the price and the service with existing financial products. And ensuring that individuals sufficiently understand the products and their benefits, and that the products work well - i.e. making a claim or a complaint is as seamless as possible. But I'd love to be proven wrong-do you know an example of a weather-indexed insurance that's working?
About the Author
Sonja Kelly conducts and facilitates financial inclusion research at CFI, directing the CFI Fellows Program, developing frameworks to understand critical concepts like financial health and financial capability, and facilitating the Global Microscope research. She serves as research lead on many topics related to financial inclusion. In her own research and work, Sonja focuses on regulation and policy, the role of banks in financial inclusion, and especially vulnerable populations. Sonja has a doctorate in international relations from American University, where her dissertation focused on financial inclusion policy and regulation. She has previously worked at the World Bank, the Consultative Group to Assist the Poor, and Opportunity International. Sonja is currently a member of the board of directors of People Reaching People, and has held volunteer positions as president of the Washington DC chapter of Women Advancing Microfinance, and as president of the steering committee for Northwest Chicago Young Life.