Micro-insurance is quickly emerging as an important microfinance service as practitioners explore innovative models and as low-income consumers understand the concept of risk transfer. While it is understood that risk alleviation is part of the role that microfinance plays in economic growth, there are plenty of hurdles for insurance providers to overcome before this service gains popularity.

Some of these issues were outlined in a recent article by Forbes Magazine, Micro Insurance: A Safety Net With Too Many Holes, and they have been excerpted below.

A Need For Large Volume in Micro Insurance Products

While microfinance model based on micro lending can survive with a few clients, the same cannot be said for insurance offers in a micro scale, because it hampers with the basic Law of Large Numbers.

…volume became a big issue for a micro livestock insurance network in Burkina Faso, which had initially shown a lot of promise. The problem…was scale: Many subgroups within the network had only a few members. “If something happened to several of their oxen at the same time, there was a problem,” Neil Doherty, a Wharton professor, says. “They needed the benefit of large numbers,” which might have been achieved if the plan’s providers had diversified into other types of insurance. The program eventually folded, a fate shared by many micro-insurance plans, he adds.

The Issue of Trust Between the Micro Insurer and Client

Unlike the case in credit, where the micro-entrepreneur borrows the money and takes up the responsibility of returning it, insurance reverses the responsibility of risk.

In micro lending, the provider puts up the capital and trusts the customer to pay it back; in insurance, the policyholder pays up front and hopes the provider keeps its promise to make a payment in accordance with the contractual terms. For a tranche of society that probably has never used–let alone heard of–these insurance products, it’s an enormous leap of faith.

The solution pointed out is two-fold: flexible repayment schedules and insurance models that are tailored to the micro entrepreneurs needs, which, in itself, is another problem.

Highly Personalized Products Needed

Each village and each community face different kinds of risks that need to be insured (crop insurance, life insurance, health insurance, home insurance, etc.) and knowing these minor distinctions is vital to the adoption of any insurance product.

An insurer can’t just offer what they always do but at a reduced price…A product really has to be redesigned after assessing what the local needs are, and it has to be accessible.

A Lack of Understanding About Insurance

Insurance isn’t a very popular financial service in many developing economies (China and India, being exceptions) because many fail to appreciate the importance of transferring risk. While the upper and middle class would venture only so far as to sign up for car insurance, the idea of a steady cash outflow to recover from something that may or may not occur, simply evades the poor, who are already hard up on cash.

Perhaps these signal institutional and organizational weaknesses that will be overcome as more efficient and comprehensive microfinance models are discovered. Insurance practitioners will have to realize the nuances of the microfinance sector and re-learn many old concepts first.

Are there any other pitfalls micro-insurers will need to address in your opinion? I would love to hear your views. You may also like to view other articles about microfinance theory and practice or read up on challenges faced by microfinance providers and micro entrepreneurs in general.