Risk, if left unmanaged by people with low incomes, may render their attempts to exit poverty more difficult. It may also increase the likelihood of a return or new entrance to poverty for those who hover just above the poverty line (see previous posting), and may increase the chances of personal loan default for the minority of low-income individuals with current access to microcredit (small value loans usually provided to help the entrepreneurial poor to develop microenterprises).
Low-income persons, by virtue of their disadvantaged circumstances, may face many of the same risks, although to a greater degree, as the more well-to-do. The poor tend to be geographically and socially marginalized, forcing them to live in riskier areas, to undertake riskier activities, and keeping them highly dependent on their monthly, weekly or daily ability to earn wages. Most discouraging perhaps, is the fact that the poor have fewer pre- and post-loss recourses at their disposal to help them manage their exposure to risk.
When entering and participating in the microinsurance market, it is imperative for existing and potential micro(re)insurance organizations to have a solid understanding of how low-income persons tend to manage risk at present, generally without the aid of traditional risk transfer mechanisms such as insurance.
Here we provide a review of various risk management elements as they apply to the specific circumstances of people with low incomes.
Micro Risk Management Methods:
- Avoidance: Risk avoidance is the only proven way to eliminate loss potential, though the poor often do not have this option because of the limits imposed on their mobility as a result of their socioeconomic circumstances.
- Diversification of income: Working multiple jobs (e.g. one in agriculture and another in manufacturing) can provide a buffer against income insecurity that may occur as a result of “external” factors, such as fluctuation in food prices or drought. However, “internal” risk factors, such as onset of illness, can create difficulty for an individual working even one job, much less two.
- Diversification of assets: Owning a combination of both financial and tangible assets (livestock) is a form of risk control that is extremely valuable in mitigating the negative fallout of risk. However, without a formal mechanism to facilitate savings (a bank account) or adequate protections to ensure the value of tradable assets (asset insurance) this method of risk control, maintaining a combination of asset types, can be difficult to continue following a loss. Alternatively, for poor populations intangible assets - such as a vibrant, functioning social network - are perhaps most valuable and in larger supply. With a network of family and community members to rely upon, the effects of idiosyncratic and unpredictable events can often be mitigated. However, such systems are susceptible to breaking down especially if a large-scale event impacts many people in a given community.
- Reducing consumption (post loss): After a loss, the poor may be able to manage their additional costs or reduced means by diminishing their expenditures in one manner or another. Unfortunately this often results in malnutrition or some other undesirable end.
- Increasing workload (post loss): To finance the cost of a loss a poor family may often be compelled to work longer hours, to take on additional jobs or to pull their children out of school in order to supplement family wages.
- Relocation (post loss): After a home is damaged or destroyed a family may often be forced to relocate to another area, with the likelihood of having even fewer resources at their disposal to support such relocation.
- Emergency loan (post loss): If a poor family’s liquidity is compromised post loss, emergency loans are often available via local lenders or microfinance institutions. Such loans however, are sometimes offered with excessively high interest rates and may compound the burden of loss recovery with the burden of additional debts, even if reasonably priced.
- Asset sales (post loss): After an adverse loss event, poor families can choose to sell productive assets, such as livestock, to pay for the costs of recovery, though this leaves them without the financial or physical benefit of the productive asset going forward.
- Savings (pre-loss): If a family has had the foresight and the ability to set aside some funds for a rainy day, these can be spent post loss to help rebuild their lives accordingly.
- Microinsurance (pre-loss): As a proactive method, microinsurance is more advantageous than other forms of micro risk management. It is now increasingly being recognized as an essential financial tool for poverty alleviation and economic development efforts worldwide by a wide variety of organizations across the for-profit and nonprofit business spectrum.