Risk can be broadly defined as the chance of a loss or the likelihood that an adverse event or “shock” will occur. Low-income people face a wide range of risks, to which they are particularly vulnerable. A disease, the death of a member of the household, an accident, a natural disaster, or a poor growing season can have devastating financial consequences for low-income families.
Low-income people use a wide variety of strategies to manage risks and to cope with their consequences when they occur:
- Diversifying their activities, assets, and sources of income, including through migration of one or more family members;
- Informal self-help, investing in different socio-economic and/or identity-based networks;
- Saving, which allows for self-welfare to cope with future expenses, predicted or not;
- Emergency credit from formal and informal lenders;
- Selling assets or reducing consumption to cover the cost of a shock.
These strategies, however, can have significant adverse consequences for low-income families. Diversifying income-earning activities may help to mitigate risk, but may also reduce income-earning ability. When a shock occurs, depleting savings, selling assets, or reducing expenditures on important goods such as food, health care, or education, can impair a family’s long-term ability to progress out of poverty. Resorting to expensive formal loans can cover immediate costs, but leave the family with ongoing obligations that are difficult to fulfil. Family and friends can often help, but are a limited resource, particularly in low-income communities.
As such, insurance may provide a valuable alternative or complement to the many strategies low-income families already use to cope with risk. When faced with a financial shock, insurance may cover costs that those existing strategies cannot and help clients to avoid the most inefficient or burdensome strategies. Even before such a shock has occurred, the security provided by an insurance product may help them to avoid some costly or otherwise non-preferred risk mitigation strategies, such as growing subsistence crops or sending a family member to work abroad.
- Barbara Magnoni, Michael J. McCord & Emily Zimmerman (2012). MILK Brief #9: What is "Client Math?. Appleton: MicroInsurance Centre.
- MILK Project “Client Math” briefs, available at http://www.microinsurancecentre.org/milk-project/milk-docs.html