The preceding discussion suggests that, both state and market-based systems as well as member and private household-based systems have intrinsic - albeit different - strengths and weaknesses. The question arises as to what extent the provision of risk management instruments can be organized in a complementary way. The idea of organizing synergy, partnership and coproduction in the provision of insurance has for some time been a major component in the discussions of welfare reform in industrialized countries. Recently, the debate has been extended to apply to developing countries
(Robinson and White, 1997; UNCDF, 2000; URT, 2001) and micro insurance was the preferred option. Loewe, (2002, 2006) consider micro insurance as a social security instrument that improves wellbeing of the low-income households. In this case, micro insurance focuses on extending social protection to the informal sector households in the absence of appropriate government schemes. However, Churchill (2006) defines micro insurance as a risk management technique for households against specific risks in exchange for regular premium payments in proportion to the probability and cost of the risk involved.
It appears that there are two dimensions of the micro insurance concept derived from the definition, first the concept of micro insurance as a social protection instrument. The proponents of these arguments argued that informal households have little or no security of employment, and have low earnings and their incomes do fluctuate. Whenever they are unable to work for whatever reason they have no income security. A brief period of incapacity can leave the worker and her/his family without enough income to live on. The sickness of a family member can result in costs which destroy the delicate balance of the households‘ budget (Milinga, 2002; Cohen, et al. 2005; Cohen and Sebstand, 2005). To reduce poverty and vulnerability of low income households there is an emerging consensus among IADB (2000), ADB (2005), World Bank (2001), ILO (2000) and Holzmann (2001) to include micro insurance within the social protection framework.
The major motivation for social protection interest in micro insurance is that certain households have been excluded from existing insurance schemes because (i) formal insurers have done little to reach out to those segments which are outside the formal economy (for example low income households, informal sectors, rural households and some formal sector employees (ii) the excluded group lack the empowerment and capacity to access formal insurance (iii) there is the need to extend and strengthen risk and resource pooling at different levels to help excluded households take advantage of potential benefits of risk and resource pooling. Micro insurance is essentially a variety of strategies to overcome these obstacles. However, micro insurance demand perspectives has been limited by a small research base and much of the existing literature on micro insurance focuses on supply and institutional issues (McCord, 2001; McCord and Osinde, 2005).
Secondly, the concept of micro insurance focused on developing an appropriate business model that enables the poor to be a profitable (or sustainable) market segment for commercial or cooperative insurers. In this case insurance companies have to design a micro insurance product for households who are engaged in informal sector activities (Van Ginneken, 1997). This means that commercial insurers perceive micro insurance as a potential instrument to reach underserved markets. Arun and Steiner (2008) argued that commercial insurers in Ghana regard micro-insurance to be a way to expand their market reach and secure future profits, but not in Sri-Lanka. The definition of micro
insurance is essentially the same as private insurance except micro insurance is clearly for a prescribed target market. McCord and Churchill (2005) indicates a distinction between private insurance and micro insurance on six points i) clients ii) distribution models iii) policies iv) premium collection, v) control of insurance (moral hazards and adverse selection) and vi) claims handling. Regardless of which dimension to view micro insurance, the intention is to provide protection to an uninsured population. In essence, micro insurance has the same purpose as conventional insurance, to allow the customer whether an individual or a business entity to transfer risk and purchase the security they need to grow their business. Micro insurance demand in the informal sector with the promise of profits and welfare gains to households has to find ways of balancing three competing objectives a) provide coverage to meet the needs of the target population b) minimize operational costs to the insurer c) minimize the price including the transaction costs for clients to enhance affordability and accessibility. For the present discussion we adopt a broad definition of micro insurance as an aspect of insurance for managing risks among low-income households in the informal sector. The study considers micro insurance to play a dual role that is both developing an ideal business model and a valuable social protection instrument for informal sector households. 3.2.4.1 Why are micro insurance services needed in the informal sector
The developments in insurance reforms (see discussion in chapter two), were found to have less effect in the informal sector. As a result Churchill (2002), Hess and Sykora (2005), and Hochrainer et al. (2007) pointed out that informal households throughout the world face twin disadvantages; first is the difficulty in generating regular income while the second is vulnerability to economic, political and physical downturns. Indeed, Ahuja and Jutting (2004), Hoeppe and Gurenko (2006) and Linnerooth-Bayer and Mechler (2006) argued that informal households are more vulnerable to risky events than the formal sector workers given their working environment, their economic activities, and these risks impede their efforts from breaking the vicious cycle of poverty. Thus, any risk management strategy will reduce poverty and improve the informal household‘s wellbeing.
Studies by Brown and Churchill (1999, 2000), CGAP (2003a, 2003b), CPRIC (2004) and MRF (2006) considered micro insurance as one of the financial risk management strategies that can help the low income household to deal with risk effectively. The presence of risks strongly influences household economic behaviour; they engage in low-productive activities because they are less risky and the potential consequences of failure are lower (Wood, 2003). In this way, households are frequently constrained to a basic livelihood or subsistence approach for survival which, in turn, promotes the development of poverty traps. An effective risk management tool is necessary for household development. The effects of access to micro insurance services are twofold; access to
insurance services increases the risk bearing capacity of the households. Insurance covering sickness or death of a working family member can help to avoid severe shortfall on household earned income, and also decreases the use of costly informal self-insurance techniques. Figure 3.2 illustrates the effect of micro insurance to the household wellbeing.
Figure 3.2: Effect of micro insurance to the household wellbeing
Source: Author synthesis of the effect of micro insurance service
This underscores the critical importance of micro insurance in the informal sector. Micro insurance reduces poverty by reducing income swings, fostering long-term investment in human capital and compensating against risk exposures. Studies by Young (2006), Besley (1995a), Townsend (1995), Morduch (1995; 1999b), Bardhan and Udry (1999), Dercon, (2002; 2005), Osgood and Warren, (2007) and De Waal, et al. (2004) argued that insurance reduces vulnerability as households replace the uncertain prospect of large losses with the certainty of making small, regular premium payments. It is within this context that Tanzania needs to extend micro insurance cover to informal sector households. To do so, there is a need to understand the micro insurance demand perspectives in the informal sector. The next section provides unresolved issues in the literature which warrant further investigation.