This article responds to a comment on my last blog about earthquake insurance by a reader who noted that many Asians are not keen on purchasing insurance because they find it too expensive, claims officers are corrupt, or it brings bad luck.
I see risk management as a basic human instinct. It’s not that people do not insure – people prefer “self-insurance” to purchasing affordable insurance. Insurance is often viewed as a product of the sophisticated, capitalistic system of the West. And those who are outside this cultural group are less likely to value insurance protection. They rely on informal insurance, such as a family network. Therefore, you are right when you say that Asians are typically less focused on buying insurance. It is also this same set of people who hold the belief that insurance has no value, and consider any money spent on insurance to be a waste. It is often futile to discuss with them their potential risks, or how insurance can be helpful and will have any impact. There are also those who are in denial of known risk – the “it won’t happen to me” self-insurance plan. I see it all the time. They clearly understand the risks that can be economically insured, but the risk is ignored. For example, except for third-party liability for cars, purchasing insurance is voluntary, and many people don’t believe in buying something that they are not required to buy, regardless of the value. Many people buying insurance don’t have the experience or understanding of potential financial risks. For example, many among the middle-class can afford health insurance, but choose not to buy it. What they don’t realize is that a major injury or illness can cost far more than they think. Their choice not to buy at least a catastrophic health insurance plan speaks to the lack of understanding of their potential risk. At the same time, some people misunderstand their risk. One example is buying accident insurance instead of life insurance. Most people don’t realize that you are four times more likely to die of an illness rather than by an accident.
Insurance is not cheap On insurance being expensive, there is no denial of this fact. Transferring risk comes at a price. In a typical insurance arrangement, for every $1 of premium paid to an insurance company, one might expect to receive on average between $0.20 and $0.70 in claim payments over the long term. The return depends on the details of the contract, such as the type of insurance purchased and the statistical characteristics of the portfolio that is insured. The remaining $0.80 to $0.30 covers administrative costs, capital costs, and profit for the insurance company. Experience shows that for more frequent events—where the insurance premium is quite large relative to required reserves—retention is typically cheaper than risk transfer. However, for large infrequent events the reverse typically holds true. The cost of retaining risk for a pool is the cost of capital minus the investment return achieved on investing that capital in liquid assets. This might typically lead to a cost of $0.10 - 0.50 for every $1 of retention through reserves. Comparing retention with reinsurance therefore requires a comparison of a cost typically expressed as a percentage of the reinsurance premium $0.30 – 0.80 with a cost expressed as a percentage of reserves (1–5%), which in turn depends on the relationship between the reserves required and the reinsurance premium. Since insurance companies focus on making large claim payments in years that are extremely bad, insurance needs to be complemented by other mechanisms like contingent funds that finance smaller, more frequent events to widen coverage and keep premiums affordable.
Moreover, traditional insurance purchases are often made through high-touch transactions, where the nature and extent of a company’s interaction with the buyer and/or end user involve extended conversations with an agent or broker. Unfortunately, small ticket insurance policies often cannot support costly distribution. Today, insurers often look to alternative channels—such as financial institutions, utility companies, retail chains, and even telecommunications operators— to reduce costs and expand the scale of insurance by leveraging their existing infrastructure and customer relationships.
Lack of trust and awareness The biggest hurdle facing the insurance industry is that consumers simply don’t trust insurance companies. Added to this is lack of awareness and failure of professional advice. Due to excessive fragmentation of the insurance market, many insurers don’t have the critical size to build adequate risk pools, underwrite contracts, and innovate. The lack of professional skills in the industry has been another major deterrent. Finally, weaknesses in regulation and consumer protection (resulting inter alia in lack of transparency and lack of trust) have also hindered the development of the sector. There is a scramble for market share with generous takeover terms and limited underwriting offered for entire books of business. This has unfortunately bred an insurance culture that sees the market as a cake from which product manufacturers take the biggest slice possible. In life insurance, thinly-veiled product churning disguised as "advice" to generate upfront commissions impacts the sustainability of the sector, thereby increasing costs for consumers and compromising on advisors’ professional standards. Tackling these obstacles must be an over-riding priority for all insurance companies. Having a customer base that is both unresponsive and potentially volatile is the worst possible state of affairs for the development the insurance market. There should be a joint industry-government program to educate the public about the role of insurance and generate greater trust in the sector. The implementation of effective consumer recourse mechanisms and professional training of insurance intermediaries are an intrinsic part of such a program.
The road ahead A majority of Asian countries have an alarming underinsurance problem – too few people have adequate risk cover in the event of life's inevitable mishaps, sickness or even their untimely demise. Insurance market development will need to be tailored to the location, community, national development orientation, and stage of market development of each individual country. At the heart of this solution is repairing trust within the risk insurance ecosystem, so the industry can become client-centric. Instead of building products that would do well financially, the industry should build and price products according to what the client demands, in a new paradigm of transparency. Under a prudential regulatory regime, the insurance regulator should allow for a proportionate regulatory treatment, by tailoring regulation with the risk characteristic of the product. The last mile is really the face to the consumer. Lower costs and greater efficiency might be achieved by rationalizing the use of low-touch sales strategies through alternative channels, while remaining mindful to the profile of the appropriate target niches for each channel. Sustainability of operations will come from forward thinking, sound product design, fair pricing, professional standards for advice eliminating poor practices, ethical claims management, and appropriate underwriting.