Beyond the numbers: Tailoring insurance cover for MSMEs
Beyond the numbers: Tailoring insurance cover for MSMEs24 January, 2018 •
Micro, small and medium-sized enterprises (MSMEs) are the lifeblood of most economies globally. They are recognised as one of the primary engines for growth and employment, making up at least 90% of businesses and more than 50% of employment worldwide.
Policy-makers and donors are increasingly pushing MSME development, and global initiatives such as the Sustainable Development Goals are encouraging MSME development explicitly. And rightly so.
MSMEs are vulnerable to shocks and are often financially stressed. Most small enterprises never develop their business beyond a certain scale, and only a small minority of them manage to upgrade to the next level of productivity, income and employment.
Assisting these businesses in growing into sustainable, inclusive contributors to the economy has benefits on many levels. The resulting benefits, however, vary significantly between the different businesses, especially in emerging markets.
Formal small and medium-sized enterprises contribute up to 40% of emerging-market GDP, while micro-businesses are less important for GDP, despite their large numbers. They often operate on the fringes of the economy. That said, micro-businesses contribute substantially to sustaining individuals’ livelihoods in the absence of formal employment opportunities and, by extension, to poverty reduction, social and political stability. So, even though they fulfil a different role, it is also an important one.
Universally, MSMEs are most commonly disaggregated based on their number of employees: roughly 1 to 9 employees for micro-businesses, 1 to 49 employees for small businesses and 50 to 250 employees for medium-sized businesses. Yet, this definition often falls short of offering a useful segmentor for policy interventions or private-sector target markets. But why?
Because MSMEs are highly heterogeneous. Apart from their differing roles in society and the economy, they have different financial and non-financial needs. The number of employees they have does play a role, but other factors (like the sector, formality status, location and access to network) influence their needs equally, if not more.
Imagine two hypothetical new businesses in Malawi. The first business is run by a husband and wife who sell second-hand clothes. After failing to secure formal employment, they started the business out of necessity. The second business is a small IT service provider with six skilled technicians. In view of the traditional definition, both of these firms fall into the micro-business category, given their number of employees. Yet, it is clear that they have unique needs and will, over time, make different contributions to policy objectives (like growth, employment and innovation).
However, what they do unfortunately have in common is that they are likely to fail because most small businesses fail within the early years of establishment. Competition, poor management, and unformed business plans and ideas all contribute towards what is a natural evolutionary process within economic markets. However, it is also true that many promising businesses fail simply because they face a large exogenous risk event (such as flooding or fire).
Insurance products enable businesses to better manage their risks and to transfer some of their risk to the insurance risk pool. Yet, emerging market MSME insurance penetration is excruciatingly low.
Designing appropriate insurance products that are valuable to policyholders requires a detailed understanding of MSME needs – data that insurers cannot obtain easily. To reach scale in a difficult business environment (think small premiums, inaccessible policy-holders, expensive fraud detection etc.), insurance providers have to rely on aggregation. But aggregation by number of employees is not likely to reflect the heterogenous MSME needs, and take-up is likely to be low.
In our hypothetical Malawi example (given that both businesses would be in the same category), both businesses could be offered flood insurance. Yet, this policy is more appropriate for the IT specialist, given the business’s expensive equipment that is prone to water damage. For the clothes seller, flooding is not as threatening, and the policy premium might be more useful if it were invested in more stock.
This example highlights the necessity to engage segmentors that are more useful to divide MSMEs into insurance target markets. Key useful division characteristics include:
- Personal vs business insurance needs: Our demand-side research across six countries identified the primary insurance needs for most self-employed individuals or small businesses to be personal rather than business-driven: the most front-of-mind risks were an illness in the household and the death of a household member. Therefore, insurers can distinguish between MSMEs that strictly separate personal and business interests and those where the line between personal and business is less clear-cut.
- Motivation and skill: Our research has shown that the more educated and motivated a business owner is, the more employees he/she has and, most importantly, the more likely he/she is to have business insurance. Motivation and education influence whether a business owner can afford insurance policies and whether there is recognition of the importance of insurance in order to achieve his/her aspirations.
- Growth characteristics: Apart from the distinction between personal versus business needs, motivation and education, empirical evidence on the determinants of business growth has identified further possible insurance segmentors. In addition to entrepreneur characteristics (age, gender, education motivation, etc.), enterprise characteristics (such as enterprise age, location or sector) play a role, as well as personal/business networks and the business environment (competition, regulatory environment and market conditions).
Segmenting MSMEs more usefully not only isolates the common specific needs of different target markets within MSMEs. It is also relevant in considering how to target interventions.
The clear majority of MSMEs in emerging countries have primarily personal insurance needs. Serving these enterprises will, therefore, help protect the livelihoods of numerous people. However, over the longer term, research shows that most survivalist enterprises are unlikely to grow. Hence, for policymakers and donors that have objectives to increase growth, quality employment or innovation within an economy, targeting the smaller number of aspirational enterprises that are more likely to grow their business may have the bigger impact on these objectives.
Whichever objectives policymakers are trying to fulfil, it is vital that MSME assistance be sufficiently targeted so that it is valuable to those who need it most. Insurance needs assessments can’t solely focus on the number of employees but should take the full circumstance of the business into account – no matter the size.