Insurance Theory and Challenges Facing the Development of Microinsurance Markets

Microinsurance institutions and instruments have developed rapidly over the last decade, with policies covering tens of millions in the base of the economic pyramid for markets in Africa, Asia, and Latin America. Ranging from simple policies providing life or health insurance to complex policies covering catastrophic risks for small landholders, it is a market with proven potential which demands closer attention. Notwithstanding the development, microinsurance markets have received relatively little interest in the academy. This paper examines some of the critical elements of insurance theory that may help us understand the challenges facing microinsurance markets and how these markets can better serve the needs of their customers. These elements include: basic utility theory as it relates to the demand for insurance and the willingness to pay at the base of the economic pyramid; the analysis of how dealing with multiple sources of risk will impact the propensity to consume insurance; the formation of pooling and separating equilibriums when information regarding risks is limited; and a unique twist on the underinvestment problem that arises at the base of the economic pyramid where entrepreneurs will not undertake positive net present value projects when there are significant levels of background risk.