How insurance works, how microinsurance helps

2020 Honda CR-V. Black Edition. Full Option. Tear-rubber, as they call it. I wasn’t even driving that fast on the motorway. Well, it is the motorway after all but I was driving at about 50mph. Not sure how or why it happened; all I heard was a big bang and my rear mirror was smashed to pieces. The boot and bumper

Read full articlewere damaged and in one blink, the value of the car probably got cut in half.

This was about a year ago. And no I hadn’t got around to comprehensive insurance. It’s one of those things I assigned to one of my staff and ended up costing me the proverbial arm and a leg. With the proper insurance cover, I would have spent far less getting Bambi back into shape. Yes, I named the car Bambi. That’s how much I loved it.

LIFE is uncertain. The business environment is just as uncertain, anything can be expected at any stage. So, it's your choice to remain exposed to the many risks that exist or provide yourself with some cover via insurance. Insurance is designed to provide cover for anything that can go wrong. However, you have to pay a certain premium to get coverage.

The idea of insurance is based on the probability of happening. If the risk of incidence is higher, you are expected to pay a higher premium and vice versa. For instance, if you are getting insurance cover on your car, the premium to be paid is different if the car is of higher value and different if the car is valued lower.
In some cases, the premium to be paid is different if the car is parked inside your home and different if the car is parked outside your home.

The concept is simple, the probability of an incident with your car parked outside is more than with your car parked inside your home. Hence, there is a difference in premium.

Overall, if you are covered in the insurance, you write off (purchase) policy, pay a premium, and get a promise to be compensated if anything goes wrong within the covered area.

What’s covered in the insurance?

Insurance companies cover a range of risks, including your life to loss of the asset. Generally, risk coverage includes health, life, disability, chronic illness, hospitalization, medical care, property damage, loss on business assets, long-term care, child plans, auto insurance, and anything covered in the insurance policy.
Basically, it gives you peace of mind in terms of survival and continuity, of you yourself and your business. Although insurance is a cost, it saves you from a greater loss like in my case with Bambi. Hence, insurance comes with various advantages.

Advantages of insurance coverage

Advantages of insurance include but are not limited to the following;

- Economic and financial protection - Insurance coverage protects your property and other revenue-generating assets. So, your financial interest is protected to a greater extent, and the risk of loss is transferred to the insurance company against payment of nominal premium.

- Maintenance of living standards – Unexpected losses can impact your living standard. However, insurance cover provides financial protection in terms of money. So, it gives you peace of mind to sustain financial prosperity.

- Helps to promote foreign trade – Those in the Import/Export business will tell you the risk is massive in international trade. So, traders do not risk sailing the ships without insurance. Hence, overall insurance activity is necessary for international trade to flourish. Almost everyone that trades internationally factors in insurance as a standard cost.

- Helps with business sustainability – One fire outbreak in the warehouse might bankrupt the business. However, insurance coverage against such incidence might result in business continuity and sustainability.

- Helps to boost the investment industry – The premium collected by the insurance companies is invested in Government and corporate sectors. This boosts up the investment industry and overall trade in the economy.

- Helps to raise bank loans – If your business assets are insured, it leads to enhanced credibility in the eyes of the banks and other institutions to raise the finance. It's because they believe their collateral is safe and free from multiple risks. (Kullabs, n.d.)

Disadvantages of insurance coverage

Disadvantages of insurance include the following

- The process to file the claim involves multiple procedural formalities. So, it’s not always easy to prove the incident and receive the claim.
- All types of losses may not be covered in the insurance policy.
- In some cases, the size of the claim may be relatively small. In fact, the amount received under a claim may be smaller than the total premium paid over time.

How do insurance companies make money?

An insurance policy provides cover for the potential of the loss in exchange for the premium. The company collects premium (revenue) from multiple clients. It means they have massive credit (incoming) of the revenue against the promise to pay the claim (compensation) if anything goes wrong in the covered insurance area.

However, not all policies receive a claim. In fact, 90% of the life insurance policies cost nothing to the companies against the premium received as these policies get lapse (Scott, 2012). When you fail to pay your insurance premiums on time or after the grace period, the benefits to the policyholder get terminated, or in technical terms, get 'lapsed'.

Furthermore, the premium is collected by the insurance companies from time to time. So, they invest the same in equity and debt instruments to earn a return on the investment.

That's an additional source of income for insurance companies.

Overall, there are three types of cash inflows for insurance companies. These cash flows include the income for policy write-off, the periodic premium for the cover, and the return generated on the investment. The insurance claims and administrative expenses are paid from the revenue, and the remaining amount is just profit for the insurance companies.

Statistics show that 2020 was a blessing for insurance companies selling auto insurance. Their profit during the year amounted to $30 billion globally (Consumerfed, 2021). This was due to pandemic-related measures taken by Governments that led to a significant drop in traffic and claims for motor accidents.

Somehow, there was a surprising increase in the profit of health insurance companies during the pandemic as well. Health insurance companies made almost twice as much profit in 2020 than the year before. Shocking, right? It was a sharp decline in elective care during the pandemic that led to a sharp decline in health care expenditure (Caroline F. Plott, Allen B. Kachalia, & Joshua M. Sharfstein, 2020).

Simply put, imagine you paid healthcare premiums but due to the immense pressure on healthcare systems from the pandemic, you did not have access to healthcare including hospitals, emergency services, and medical physicians. This means the insurance companies got fewer claims and therefore made massive profits.

Is insurance all about big businesses and wealthy individuals?

It is a myth that insurance is all about big businesses and wealthy individuals. That is just not true; in fact, microinsurance is all about low risk, low premiums, and low amounts of claims (KAGAN, 2021). So, it’s about coverage of risk for low-income people. The risk may fall in the areas of injury, illness, death, and damage to low-valued assets.

The basic working mechanism for microinsurance is the same as main insurance. However, the difference lies in areas of the risk volume. So, the microinsurance companies target low-income households and businesses with a low footing of assets. Hence, it’s a promissory tool of protection for the people with a lower source of income. However, people's lower subscription of the voluntary cover has been shedding doubts on the viability of microinsurance being an effective tool to manage the risk. (Dror, 2014)

The main aspects of the doubts root from the limited income of the target audience, a lack of resources, quality & price equilibrium, and the most important is the limited credibility of the insurer.

That is why when one is choosing a microinsurance partner, most people go with the big brands that are known for their quality and sheer market size. Giants seldom fight over peanuts, so they aim for quality towards quantity. That said, microinsurance is a potential lifesaver for the millions of low-income households in Africa if they pair with a competent microinsurance company that can cover their basic needs through their quality service everywhere you go.

Microinsurance with perspective on South Africa, as a case study.
South Africa has an innovative insurance market and is considered to be one of the leading microinsurance jurisdictions in Africa. Currently, there is no significant presence of traditional insurance in South Africa. It seems to be on account of the following three concerns.

- Problem with affordability.
- A buy/sell mismatch of holder/policy.
(Abou Malima, n.d.)

These concerns lead to a mismatch between the people who understand the need and those who actually buy the policy. For instance, as per their National Treasury, 74% of the people recognize the importance of insurance, but only 34% consider covering the risk via insurance.

So, microinsurance seems to be a logical choice for the people of South Africa in terms of affordability and effectiveness in reducing the mentioned mismatch. Hence, it's a logical approach while analyzing the economic environment of South Africa.
There are four main methods microinsurance companies deliver services: partner-agent model, full-service model, provider-driven model, and mutual/community-based model (Abou Malima, n.d.).

In the partner-agent model, there is a partnership between the microinsurance provider and an agent that is primarily responsible for marketing to clients whereas in the full-service model the microinsurer is responsible for the design, development as well as marketing of the insurance package to clients.

In the provider-driven model, the individual pays the premium directly to the service provider such as a hospital and the provider is responsible for the design and development of the microinsurance package.

In the mutual/community-based model the policyholder is responsible for every part of the microinsurance policy and is effectively the insurer and the insured.

Profitability aspects of the microinsurance

The business model of the microinsurance companies is based on the philosophy of low margin and higher volume. The business model remains the same as traditional insurance providers. However, the difference is that their premium is lower. Hence, the potential to invest excess cash and earn a return is also limited. So, revenue growth is key to achieving business profitability (Abou Malima, n.d.).

Conclusion

No business in the world exists without risk. Sometimes, the risk might materialize and cause greater loss. So, insurance is designed to cover potential business risks and help the business face them if they do arise. However, it's not free, and a certain premium is payable against the risk transfer.

In simple words, the person or business pays a premium to the insurance companies; the insurance companies promise to provide compensation if there is a loss/incident on the covered asset. So, the payment of a premium brings peace of mind to the person or business. It's very important to note that the significance of insurance services is not limited to just business but also all aspects of an individual person's life.

There is an increasing trend of microinsurance which is about giving cover on lower risk against lower premiums. The policies of microinsurance target low-income people and provide cover on the lower valued assets. The business model of microinsurance is the same as traditional insurance. However, the risk covered, the premium received, and the claim volume is smaller in comparison.

The insurance penetration in the African market is significantly low due to the fact that people can not afford the premiums. Hence microinsurance provides a unique opportunity to capture a larger proportion of the market. It’s also good to note that choosing a capable microinsurance partner can change the lives of millions of low-income households that need that cover to sustainably go on with their daily lives.

I hope you enjoyed the read. Hit me up and let’s keep the conversation going! I read all the feedback you send. Also, feel free to throw at me topics you’d like to read or hear my thoughts on.