Low Takeup and Microinsurance:  Lessons from U.S. Insurance Markets

George ZanjaniRisk Management and Insurance DepartmentRisk Management and Insurance Department

Georgia State University

RoadmapRoadmap

• Is not insuring common in other insurance markets?

• Why don’t people buy insurance?  Is this economically rational?rational?

• What have we learned from experience with public and private solutions in the U S ? Can take up beand private solutions in the U.S.?  Can take‐up be improved?

Hi h L T kHigh vs. Low Take‐up

• “High” participation rate marketso Homeowners  ‐ 96% of owner‐occupied homes (Source:  AP (2011)) o Auto Liability ‐ 86% of drivers (Source:  IRC (2011)) y ( ( ))

o Health  – 86% of civilian non‐institutionalized population (Source:  Current Population Survey 2005) 

o Life – 78% of families  (Source:  ACLI 2010)

High vs. Low Take‐up:  Low take‐up not h h b iuncommon when purchase not being 

forced or subsidized

• “Low” participation rate marketso Long‐term care (CA) ‐ <10% of people aged 50+ in 2002 (Source: AHIP)o Renters (CA) – 24% of renters (Source:  IRC  Survey (2000))o Flood – 50% in SFHAs ; 1% outside SFHAs (Source: Dixon et al. 2006)o Political Risk ‐ <10% of emerging markets FDI (Source: West (1999))

o Earthquake (CA) ‐ 12% of residential market in 2010 (Source: California DOI)

Why are people uninsured?• Flood Insurance (Browne and Hoyt (2000))

1. Price 2. Income3. Risk Perceptions

• Health insurance (Congressional Budget Office (2003))o #1 reason: high cost (71%)o #1 reason:  high cost (71%)o #2 reason:  lack of access to employer sponsored plan (62%)

• Auto Insurance (California DOI, 1998)d ’ d i ( d) ( 9%)o #1 reason:  don’t need it (car not used)  (49%)

o #2 reason:  cost (30%)

• Earthquake Insuranceqo Kunreuther (1978) – surveys suggest lack of information/persuasiono Palm (1995) – surveys suggest cost is top reason … “lack of need” a second

• Political Risk Insuranceo Hamdani et al. (2004) – cost, gaps in coverage (basis risk)

Why might cost be high?Why might cost be high?

• Demand side reasonso Credit constraintso Risk perceptions

• Supply side reasonso Information problemso Distribution costso Undiversifiable risks

Why are people uninsured?y p pMICROINSURANCE

Cole et al. (2011), “Barriers to Household Risk Management: Evidence from India”

Is it “rational” to not buy subsidized insurance? A simple modelinsurance?  A simple model

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0:][ I W: wealthr:  interest rate:  insurance loadingU : utility in the “loss” state

First order conditionsUL:  utility in the  loss  state UH:  utility in the “no loss” state 

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Is this “rational”?  Results from a l d lsimple economic model

1. If there are no credit constraints, full insurance is optimal when actuarially fair =0)

2. If borrowing constraints bind (underinsurance is optimal even under actuarially fair pricing.

3. If borrowing constraints bind ( AND the consumer is completely uninsured (, insurance would be a suboptimal use of additional resources should they besuboptimal use of additional resources should they be made available (insurance is dominated by fertilizer).

Is this “rational”? Policy ImplicationsIs this  rational ?  Policy Implications

• Not buying insurance may be rational in the presence of y g y pcredit constraints, even if insurance is subsidized.

• Improving credit conditions (or some other problem) may be the more important policy initiative: Insurance subsidies may be strictly dominated by other types ofsubsidies may be strictly dominated by other types of financial assistance.

• Ins rance p rchase ma ltimatel helped MORE b• Insurance purchase may ultimately helped MORE by addressing another problem area. 

The road ahead in public intervention:The road ahead in public intervention:  some U.S. initiatives aimed at boosting 

ktake‐up rates

Federal Policy Response – National l dFlood Insurance Program

• Antecedentso Lack of insurance industry interest in federal initiativeso Hurricane Betsy; Mississippi River flooding 1965o Few have coverage

• National Flood Insurance Act of 1968• Created the National Flood Insurance Program • Made flood insurance available in communities enacting floodplain• Made flood insurance available in communities enacting floodplain management ordinances• Subsidization of existing high risk properties

But participation was low.

Source: Pasterick (1998)

Federal Policy Response – National l dFlood Insurance Program

Fl d Di t P t ti A t f 1973• Flood Disaster Protection Act of 1973• Conditioned certain types of federal assistance on community participation in the NFIP.• Made flood ins rance p rchase mandator for an federall related• Made flood insurance  purchase mandatory for any federally related mortgage  on a high risk (SFHA) property• Conditioned disaster assistance to individual on future flood insurance purchaseinsurance purchase 

• National Flood Insurance Reform Act of 1994• Toughens mandatory purchase requirement• Toughens mandatory purchase requirement

• Flood insurance must be included in escrow account• Requires coverage to be maintained, not just purchased at loan inceptioninception• Empowers lenders to force‐place coverage in cases of lapsation

Source: Pasterick (1998)

Federal Policy Response – National l dFlood Insurance Program

• Where are we now?• 50% penetration in high risk areas (SFHAs)• 50% penetration in high risk areas (SFHAs)• very little purchase outside of high risk areas

Source: Dixon et al. (2006)

Federal Policy Response – Crop Insurance

Federal Policy Response – Crop Insurance

1938 – Federal Crop Insurance Corporation formed. Participation is low for1938  Federal Crop Insurance Corporation formed.  Participation is low for the next several decades

1980 – Federal Crop Insurance Act of 1980.  Recognizes that freely given aid is competing with crop insurance; introduces significant subsidy to premium (30%).

Participation rises but still not high “enough”.  Reaches 20% in the 1980’s.

1994 ‐ Federal Crop Insurance Reform Act of 1994.  Requires individuals to p qbuy in order to be eligible for disaster assistance or price support payments.  Introduces more subsidies.

Participation continues to rise…

Crop InsuranceCrop Insurance

Source: “Crop Insurance: Background Statistics on Participation and Results”, FAPRI‐MU Report #10‐10

Federal Policy Response – Terrorism kRisk Insurance Program

• Terrorism Risk Insurance Act of 2002Terrorism Risk Insurance Act of 2002

• Establishes heavily subsidized federal reinsurance “backstop” for licensed commercial lines underwriters.

• Mandatory offer law:  Commercial Insurers must make a separate offer of terrorism coverage.

• Penetration rises from 27% in 2003 to 58% in 2005 (PWG Report on Terrorism Insurance (2005))

State (California) Intervention –h kEarthquake Insurance

• California Earthquake Authority (1996)• California Earthquake Authority (1996)

o Quasi‐state institution assumes responsibility for pricing and marketing for nearly ¾ of residential earthquake policies in force Formed in wake offor nearly ¾ of residential earthquake policies in force.  Formed in wake of market turmoil following the 1994 Northridge Earthquake.

o Contract design set by statute.g y

o Policies sold through participating carriers.

o No overall subsidies in theory, though pricing within geographic zones involves cross subsidies.

O P i l f 32% i 1996 20% i 1997 do Outcome:  Penetration plummets from 32% in 1996 to 20% in 1997 and continues to fall  to 11% by 2009.

Ratio of Earthquake Policies Sold to Residential Property

0,4

q p yPolicies Sold in California, 1996-2009

0 30,3

0,2

0,11996 1998 2000 2002 2004 2006 2008

Overall CEA Companies Non-CEA Companies

Lessons Learned• Creating an insurance market does not guarantee participation.

• Participation rates can be raised with carrots … and sticks.  You may need both.

Mandatory purchase requirementso Mandatory purchase requirementso Subsidies

• Involvement of private insurer infrastructure has beenInvolvement of private insurer infrastructure has been essential.  Incentives for private providers matter.

o Distributiono Serviceo Claims handlingo Contract design

• Be careful what you wish for• Be careful what you wish for….

b d l f l l d d ( l b )Subsidies encourage cultivation of marginal land and crops (Glauber 2004)Preservation of existing high risk properties:  1 in 4 NFIP policies are subsidized

Private Market Approaches in U.S. Microinsurance (and other markets)Microinsurance (and other markets)

Microinsurance in the U.S.Microinsurance in the U.S.

Life and Disability Insurance in the 19th  and early 20th centuriesLife and Disability Insurance in the 19 and early 20 centuries

Industrial Life Insurance• Small contract valuesSmall contract values• Sold by door‐to‐door salesmen• Weekly premiums, hand‐collected

Fraternal Insurance• Small to medium contract values (burial insurance)• Delivered through fraternal societies

Microinsurance in the U.S.Microinsurance in the U.S.

Issues – Similar to those surrounding microinsurance todayg y

Industrial Life Insurance• Very high cost distribution system• Were the poor being served?  Or swindled?

Fraternal Insurance• Low cost distribution system using existing social infrastructure• Many failed to use actuarial pricing methods• Insolvencies followed in the 1900’s, followed by regulation

Source:  Zanjani (2004)

Microinsurance in the USMicroinsurance in the US

• Private providers reached the poor through innovations in marketing and distribution.

• Supplanted by group insurance marketed through pp y g p gemployers, which appeared in the 1910’s.  Group insurance also became important in health markets.

• Penetration rate of private life and private health insurance is high in the current day.  But it did not happen overnight!

Earthquake Insurance

• Interesting counterfactual relative to flood insurance –Interesting counterfactual relative to flood insurance highlights the pros and cons of private market solutions

A f i l f k t i C lif i (1968 1996)• A fairly free market in California (1968‐1996)o Insurers are required by 1985 Mandatory Offer Law to make an offer of earthquake insurance (conforming to statutory coverage minimums) but face little other regulationminimums) but face little other regulation.

o Penetration rises from nearly nothing in the 1970’s to over one third by 1994third by 1994.

o Crisis develops after 1994 Northridge Earthquake

California Earthquake Premiums Written, 1916-2003 (Log

10.000.000.000

q , ( gScale)

Source: Author calculations based on data from California DOI, and NAIC

100.000.000

1.000.000.000

1.000.000

10.000.000

10.000

100.000

100

1.000

1916 1924 1932 1940 1948 1956 1964 1972 1980 1988 1996

Roth data NAIC plus CEA data

Parting ThoughtsParting ThoughtsProblems in microinsurance markets are similar to those experienced in the pastexperienced in the past

‐ low take‐up not uncommon‐ high distribution costs creating concerns about equity

Boosting penetration: Carrots and sticks‐ subsidies‐mandatory requirements‐ reliance on private service provision‐ where is the right balance between public and private?

Choose carefully:  Once in place, public programs may be hard to remove

‐ problems associated with subsidies for high risk areasproblems associated with subsidies for high risk areas

ReferencesACLI (2010), Life Insurance Fact Book.

AHIP (2004), Research Findings:  Long‐Term Care Insurance in 2002.

Associated Press (Harry Weber and Mike Schneider), 5/26/11, “Homeowners in most tornado‐prone states often uninsured.”

Browne, M.J., and R.E. Hoyt, (2000), “The Demand for Flood Insurance: Empirical Evidence” Journal of Risk and Uncertainty

California Department of Insurance Policy Research Bureau (1998), “California’s Uninsured,” Report.

Cole, S., X. Gine, J. Tobacman, P. Topalova, R. Townsend, J. Vickery (2011), “Barriers to Household Risk Management: Evidence from India,” working paper.Evidence from India,  working paper.

Dixon, L., N. Clancy, S. Seabury, and L. Overton (2006), “The National Flood Insurance Program’s Market Penetration Rate: Estimates and Policy Implications,” RAND Technical Report, http://www.rand.org/pubs/technical_reports/2006/RAND_TR300.sum.pdf

Glauber, J.W.. (2004), “Crop Insurance Reconsidered,” American Journal of Agricultural Economics

Hamdani K Liebers E and Zanjani G (2005) “An Overview of Political Risk Insurance ” CGFS Publications No 22Hamdani, K., Liebers, E., and  Zanjani, G. (2005),  An Overview of Political Risk Insurance,  CGFS Publications No. 22.

Insurance Research Council (2011), Uninsured Motorists, 2011 edition

Kunreuther, H. (1978), Disaster Insurance Protection: Public Policy Lessons, Wiley: New York.

Palm, R. (1995), Earthquake Insurance: A Longitudinal Study of California Homeowners, Westview Press: Boulder, CO.

Pasterick, E. (1998), “The National Flood Insurance Program,” in Paying the Price: The Status and Role of Insurance Against Natural Disasters in the United States.  Kunruether and Roth, Sr. (eds.) Joseph Henry Press:  Washington, D.C.

Presidential Working Group on Financial Markets, Report on Terrorism Insurance, http://www.treasury.gov/resource‐center/fin‐mkts/Documents/report.pdf

Roth, Jr., R. (1998), “Earthquake Insurance Protection in California,” in Paying the Price: The Status and Role of Insurance Against Natural Disasters in the United States.  Kunruether and Roth, Sr. (eds.) Joseph Henry Press:  Washington, D.C.

West, G.T. (1999), “Political Risk Investment Insurance: A Renaissance,” Journal of Project Finance, vol. 5, issue 2.

Zanjani, G. (2004), “The Rise and Fall of Fraternal Life Insurance” working paper.