managing risk.pdf

Managing Risk and Creating Value with Microfinance57measured in an objective and transparent way. The level can be verified by a specialized institution, and levels arefrequently reported (daily if possible). A historical record of the outcome enables the system to set acceptableand unacceptable outcome ranges. In some cases, MFIs provide this product as part of a package of services.The index is based on historical data on rainfall and yields for certain products, and payment is generatedautomatically after verification.The most effective indexed insurance systems have transparent contracts, low administrative costs, andstandardized contracts for small producers, and they fully cover costs without requiring ongoing subsidies.This approach makes weather the variable, but the specific outcome is chosen because it directly affects thelevel of crop production and the household income. Examples of these weather variables include rainfall,temperature, and wind. Some indexes use satellites to confirm certain aspects, such as vegetation loss, dailysunshine requirements, animal losses, and hurricane paths to determine affected areas. Box 4.1 provides anexample of the mechanism of weather-indexed insurance.Box 4.1 The Mechanisms of a Weather-Indexed Insurance SystemThe following illustrates the mechanisms used in a weather-indexed insurance system.Assume that the expected value of the harvest of a crop is US$10,000. If rainfall is less than 1,000 millimeters(mm) over a specific period, it is considered a drought. The esmated loss of crop sales income has been setat US$10 per mm. Rainfall is measured at 700 mm for the period; the loss is 300 mm of rainfall—resulngin US$3,000 in lost income. This is the amount that would be automacally compensated by the weatherbasedindex insurance system.Source: Adapted by authors from Arce (2007).Delivery of the ProductWhether it is a life insurance product, a weather-indexed product, or another type of coverage, the efficiency andscale of coverage depends, in part, on the supply chain. This chain includes all actors involved in the promotion,delivery, servicing, and risk-sharing (reinsurance) required for the effective provision of microinsurance. Table4.3 illustrates the actors involved and the challenges of coordination that can develop in microinsurance.The four institutional models to deliver microinsurance are (1) the partner-agent model, (2) the cooperativemodel, (3) the mutual-based association model, and (4) the community-based model (see table 4.4). Underthe partner-agent model, insurance companies underwrite the contracts and agents distribute the insuranceproducts. Under the cooperative model, the insurance company performs both functions of underwriting anddistributing the products. Under the mutual-based association model, the owners are the policyholders, butthe insurance is professionally managed by an insurance expert. Under the community-based model, localcommunities are the owners and managers. The organization serves, is accountable to, and is governed by alocal constituency with limited resources. Those resources might include the residents of a village or membersof a market group, or they might represent single or multiple communities or a network of communities withsimilar interests.