A wide variety of financial products and other tools can help an individual or a family to manage risk (or prepare for and cope with an unexpected “event” or “shock”), including:
- Savings, including formal and informal cash savings as well as accumulation of assets;
- Loans, from formal and informal sources;
- Insurance products;
- Family and community networks, in the form of cash or in-kind gifts or loans;
- Current income, to the extent it can be diverted to cover unexpected costs.
For low-income families, many of these tools are constrained by limited income-earning capacity, low savings rates and balances, low credit access and a limited availability of funds in their communities. The relevancy and value of an insurance product is therefore potentially large but depends on a number of factors. If the potential damage (e.g. loss of funds for a family) is substantial, but has a low likelihood of occurrence, insurance is likely to be a relevant tool. Indeed, the principle of pooling risks amongst many people helps to provide for an insurance product that comes with appropriate and relatively high compensations. If the alternative tools mentioned above are accessible, low in cost compared to insurance, and adequate to cover the cost of the shock, then insurance is unlikely to be the best option. This may be the case when the cost is low or the event is predictable.
It is not always useful, let alone necessary, for a low-income person to use insurance products in addition to the other tools available to them to manage a particular risk. However, as illustrated in the image below, in many cases insurance may play a valuable role in replacing other strategies that are not preferred, or in covering additional costs for which those other strategies are insufficient. The area of overlap between the insurance benefit and the other strategies in the image indicates where insurance may partially replace these other strategies. The remaining portion of the insurance benefit shows how it may be used to cover costs that these other strategies cannot. For example, insurance may help a low-income household to avoid depleting its limited savings after a shock, and may also cover additional costs that those savings would in any case have been insufficient to cover.
- Ralf Radermacher & Katja Roth (2014). A Practical Guide to Impact Assessments in Microinsurance. Luxembourg: Microinsurance Network.
- Emily Zimmerman, Barbara Magnoni & Michael J. McCord (2013). Beyond the actuary's guess - lessons from 15 studies on client value of microinsurance. Appleton: MicroInsurance Centre.