An actuarial toolkit for microinsurance Daniel Clarke University of Oxford and UK actuarial microinsurance working party 22 May 2012
Overview 1. Poverty and Risk 2. The UK Actuarial Profession Microinsurance Working Party 3. Two topics covered in the agricultural toolkit 4. Beyond the microinsurance toolkit Daniel Clarke - http://www.stats.ox.ac.uk/~clarke/ 2
1. Poverty and Risk
Being poor is risky ‘One of the least remarked -on problems of living on two dollars a day is that you don’t literally get that amount each day. The two dollars a day is just an average over time. You make more on some days, less on others, and often get no income at all.’ ‘How do you make sure there is something to eat and drink every day, and not just on the days you earn? If that seems hard enough, how do you deal with emergencies?’ Portfolios of the Poor, Collins et al. (2009) Daniel Clarke - http://www.stats.ox.ac.uk/~clarke/ 4
Protection against shocks is typically incomplete • Exposure to risk leads to cautious behaviour… – Avoid costly inputs, choose safe activities, etc. • … and cautious financial arrangements – Keep unproductive liquid assets and small stocks – Informal / semiformal mutual support • However, still exposed to shocks… Daniel Clarke - http://www.stats.ox.ac.uk/~clarke/ 5
Lots of uninsured risk Households reporting a particular event or shock affecting their wealth or standard of living considerably in last four years, Ethiopia 2002-2006 Shock Rural (%) Urban (%) Illness in family 37 35 Death in family 8 14 Theft/crime 17 9 Increased input prices 37 19 Decreased output prices 9 1 Livestock death 38 7 Crop pests 39 5 Natural disaster (including drought) 63 7 Job loss 9 18 Source: Woldehanna (2010), using Young lives data Daniel Clarke - http://www.stats.ox.ac.uk/~clarke/ 6
So insurance is the answer to risk? • Pay a premium in good years to smooth out the worst years Net annual income No insurance 0 1 2 3 4 Year Daniel Clarke - http://www.stats.ox.ac.uk/~clarke/ 7
So insurance is the answer to risk? • Pay a premium in good years to smooth out the worst years Net annual income No insurance With insurance 0 1 2 3 4 Year • Offering insurance may help people to design incrementally better risk management strategies Daniel Clarke - http://www.stats.ox.ac.uk/~clarke/ 8
So insurance is the answer to risk? • Better insurance could have large benefits but… • … so could – Better risk mitigation – Less painful risk retention through smoothing shocks over time • Better savings • Better credit markets – Better social protection/social safety nets Dealing with risk Insurance Actuarial Insurance functions Daniel Clarke - http://www.stats.ox.ac.uk/~clarke/ 9
Microinsurance is… “…not a specific product or product line. It is also not limited to a specific provider type. Microinsurance is the provision of cover to a specific market segment, i.e., low- income persons.” IAIS Issues Paper (2007) Daniel Clarke - http://www.stats.ox.ac.uk/~clarke/ 10
2. The UK Actuarial Profession Microinsurance Working Party
Work by UK actuaries on microinsurance: The Microinsurance Working Party • October 2009-September 2010 (5 members) – Microinsurance Working Party formed following GIRO 2009 to review literature on crop microinsurance from an actuarial perspective – Won the Brian Hey Prize at GIRO 2010 • October 2010-July 2011 (>10 active members) – Members from UK, USA, West Africa, Mexico, Caribbean, Jordan, Pakistan, India etc – Working out what to do next, in collaboration with partners (IAA and microinsurance organisations) • July 2011-present (>15 active members + partners) – Development of an educational tool for microinsurance (the ‘microinsurance toolkit’) – Funding from the UK Actuarial Profession for dissemination • November 2012 – Launch of microinsurance toolkit at the International Microinsurance Conference Daniel Clarke - http://www.stats.ox.ac.uk/~clarke/ 12
What is ? • Educational resource for technical microinsurance practitioners • To be publicly available – not linked to a specific educational program or qualification • Being developed on a volunteer basis by qualified actuaries • Covering life, health and agricultural insurance • Consists of set of spreadsheets and supporting documentation • For more information see http://www.stats.ox.ac.uk/actuarialtoolkit • Or email actuarialtoolkit@stats.ox.ac.uk Daniel Clarke - http://www.stats.ox.ac.uk/~clarke/ 13
For example, the agricultural insurance toolkit covers 1. An overall illustrative calculation to show how different pieces of the puzzle connect 2. Index insurance product design 3. Data cleaning 4. Detrending 5. Overfitting 6. Credibility theory and portfolio approaches to pricing 7. Capital and reinsurance 8. Reserving and margins 9. Expenses 10. Glossary Daniel Clarke - http://www.stats.ox.ac.uk/~clarke/ 14
Daniel Clarke - http://www.stats.ox.ac.uk/~clarke/ 15
3. Two topics covered in the agricultural toolkit • Portfolio-based approaches to pricing • Trends
1. Porfolio-based approaches to pricing • Historical yields vary significantly from subdistrict to subdistrict • Statistical question : how much of this variation is statistically significant • Actuarial questions : how much of this variation should be reflected in Historical claim payment rates at prices? How much should 90 % coverage level, prices be smoothed? Rice crop, Andhra Pradesh, India
Smoothing premium rates using Credibility Theory 𝑆𝑏𝑢𝑓 1 𝑆𝑏𝑢𝑓 2 = 4% × 𝑎 = 12% × 𝑎 +8% × (1 − 𝑎) +8% × (1 − 𝑎) Premium rate 4% 12% 8% • Blue rates are for no smoothing • Green rate is for full smoothing • Red rates are consistent with Credibility Theory – Z is between 0 (‘no credibility’) and 1 (‘full credibility’) Credibility Factor 𝑎 is an intuitive intermediate calculation • that can be calculated using statistical techniques, and scrutinised by senior management
2. Trends 150 150 Yield (kg/ha) Yield (kg/ha) 100 100 50 50 0 0 1 2 3 4 5 6 7 8 9 10 1 2 3 4 5 6 7 8 9 10 Year number Year number • These two yield histories have the same mean and standard deviation but should they be treated the same?
Allowance for trends can make a big difference to rates For example • Use of improved seeds (Bt cotton) led to dramatic increase in average cotton yields across India • Ratemaking without allowance for this technological trend led to high premium rates and low demand – Trend in yields mistaken for uncertainty • Application of detrending methodology provided sound justification for rate reductions of: Madhya Gujarat Maharashtra Pradesh Percentage reduction 47% 78% 54%
4. Beyond the microinsurance toolkit
Target outcomes of the toolkit project 1. Stepping stone for traditional actuaries interested in working in microinsurance. – E.g. Two members of the working party have moved from UK traditional actuarial work to full time microinsurance work. – UK Actuarial Profession funding for volunteers to attend the International Microinsurance Conference this November. 2. Building awareness of actuarial functions within the microinsurance and donor community. 3. Networking between actuaries with interest in microinsurance. 4. Tool to support microinsurance educators 5. Stepping stone for the profession? – If so, what is next? Daniel Clarke - http://www.stats.ox.ac.uk/~clarke/ 22
How to develop the actuarial function in developing countries? Need a wage premium for actuarial services ⇒ need: 1. Appropriate accreditation – Affordable – Inappropriate for traditional insurance • Need large gap between qualification and Associate/Fellow of UK/US profession – Continuing (and local) 2. Reserved functions – Market forces unlikely to be sufficient Daniel Clarke - http://www.stats.ox.ac.uk/~clarke/ 23
Challenge : Design a sub- $1,000 ‘bare bones’ actuarial qualification for microinsurance practitioners (You’re allowed initial fixed costs to be financed by aid organisations) Daniel Clarke - http://www.stats.ox.ac.uk/~clarke/ 24
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