Eden Packer examines the benefits of informal insurance amongst the extremely poor and its sustainability
The life of the median earner in Uganda is vastly different to that of the UK. The current 2017 vegetable shortage has broccoli purchases limited to 3 per customer in supermarkets. For consumers in the UK, this just means switching to a substitute for a while. To a subsistence farmer, however, bad weather can mean the loss of half the year’s income.
Living under $1.90 a day puts a person in extreme poverty according to the World Bank, and all aspects of their daily lives are fraught with economic dangers. Slight inconveniences the developing world shrugs off as background noise can be life-altering. Limited job security and brevity of employment mean a slight labour shock in an urban environment but can take a large chunk out of the labourer’s consumption, most of which is spent on vital goods and services. Small business owners can be pushed into a poverty trap by theft, seeing limited assistance from generally sluggish, and often somewhat corrupt institutions. Falling ill grinds any form of productivity to a halt, sometimes for prolonged periods, which is often made more severe by lack of access to basic healthcare. Large fractions of the year’s income can be lost. Unlike financial gamblers in New York or London, the isolated farmer is entirely liable.
In a setting as old as time where the market for insurance is limited, the poor treat their lives like hedge-fund managers, their current and future assets a portfolio that needs diversification. This starts with the family. High fertility rates, not without their developmental issues, ensure multiple income streams. Where poverty is worst, ages in which productive work begins can be far younger than in mature economies. Having many children further serves to ensure a degree of protection for the parents in later life.
Many people choose to spread their assets thin in ways rarely seen in the developed world in order to reduce income uncertainty. With crops, professions and even whole geographical areas at risk of dangerous shocks, an individual can meaningfully reduce their risk by holding many different professions as the chance of work dropping off for all of them simultaneously is small. It is not uncommon for a family of three to share seven different professions, and even those working in time consuming agriculture often spend less than half their time in the fields. The production of simple goods such as jewellery and clothing is a popular branch of secondary work in India. Women spend an hour selling in the markets then move onto other work. Whilst demand in this market can often be volatile, jobs have reasonably low barriers to entry and the hire-and-fire culture of urban environments also allows for quick replacement of faltering sources of income. Increasingly, urbanisation in Benin does not always consist of whole families. Several members migrate for periods of weeks or months for short-term work, thus ensuring a shock in either location is cushioned. Plots of land in nearby, but distinctively different areas of the same town can guard against flooding or other location-specific damages.
In addition to occupational lifestyles, the larger community often plays a crucial role in savings and risk mitigation. In India in particular, marriage can be used to cement relationships between families, one benefit of which is the assumption that members will help others out at the event of a shock to income. General networks of friends and associates are used in this manner. In communities often based on ethnicity or religion, located mostly in rural settings, these arrangements consist of informal loans and gifts to one another when required. Savings clubs, such as a Rotating Savings and Credit Association (ROSCA), are widely used in Africa. The ROSCA system consists of individuals or groups depositing a fixed amount into a pot on a regular basis, upon which members take it in turns to receive the full contents. No profit is made, but this allows for the achievement of cyclical large useful sums, rather than regular negligible amounts, in addition to preserving one’s money at a zero interest rate into the future.
Elegant solutions or sticky safety nets?
Choosing to spread yourself so thin has important opportunity costs: women taking on three or more professions sacrifice efficiency and quality compared to those who specialise in one craft. This is pertinent in agriculture, as limited time spent on farming often means non irrigated land is worked, massively lowering productivity. The hesitancy of migrants to search for good long term urban jobs in order to be available for return home to the countryside keeps them working in traditionally unskilled roles.
Poor people are often extremely risk-averse. As mentioned, large falls in consumption and available income are possible. This, combined with heavily tradition-centred community, means disproportionally more weight is given to a damaging loss when compared to a substantial gain. Farmers more at risk to uncertain weather patterns employ a more conservative capital usage, at the expense of realisable output gains. Upgrading the technology at hand isn’t any more of an option when it involves spending large sums on new crop seeds, compared to just saving some from the previous harvest. Far more time is spent protecting against a catastrophic faltering than is efficient.
The “helping-out” system has its own problems in its reliance on moral outreach. Gifts, loans and other assets tend to find recipients in other individuals and families, as this aid feels far more personal, meaning health problems where help is needed for hospital care receive far less attention than damage to property, which can be directly replaced.
The insurer-consumer divide, and bridging it
Formal insurance possesses large potential to improve on the unreliability and inefficiencies of the informal risk-minimising economic lifestyle. Micro-finance institutions are a buzz-word in development economics, seen by many as the solution to a vast untapped market. However, selling a relatively modern and innovative product to buyers with lives steeped in tradition proves difficult: how do you sell insurance to those who have never heard of the concept?
Quite separate are the issues in the informational divide between formal finance and rural consumers. Participants may experience moral hazard when a purchaser behaves more erratically now that they know they don’t bear all the damage of their losses. Lack of reliable information about market demand can grind the whole industry to a halt. Akerlof’s adverse selection principle is common even in private health insurance in developed economies such as the USA, when those under higher health risk are more likely to look for insurance, pushing up prices to inviable heights for the average person, in developing countries the fallout of a bad illness worsens the division resultant from information asymmetry. Furthermore, premiums can be exceptionally difficult to calculate for an individual, where a slightly mispriced policy makes a large difference to incomes.
A complete re-structuring of the risk management of those in poverty is more of a pipe dream than a possibility. However, insurers are adopting a new long term strategy in establishing gradual partnerships with the community as a whole. Through beginning to work with local saving funds, insurers can make the industry far less alien to consumers. Lloyds advocates insuring whole groups of people rather than individuals, removing the information uncertainty from the equation. Effective insurance creates a knock-on effect; with increased collateral, subsistence farmers experience less of a liquidity constraint from local banks able to purchase loans to upgrade their equipment. With time and patience in learning to understand the communities of the extremely poor, micro-finance can boost productivity, lifting huge numbers out of poverty traps and into prosperous specialised work. The informal economy makes up over a third of many developing countries’ output and contains billions of workers. It’s probably fair to say that safety for our subsistence farmer will see widespread benefits.