18
May

Natural Catastrophe Insurance – In Conversation with Mr. Ulrich Hess

By Vipul Sekhsaria, IFMR Holdings

In the below video we share a brief conversation with Mr. Ulrich Hess, GIZ. Mr. Hess is currently a Senior Advisor, InsuResilience Initiative at GIZ, and has worked extensively in the field of natural catastrophe risk insurance market. In the video he shares his insights on the impact of natural disasters on the livelihoods of households and the risks associated with it. He also talks about the challenges in designing a natural catastrophe insurance product and addressing issues associated with both inefficiencies and effective delivery of the product.

10
May

Developing the Natural Catastrophe Risk Insurance Market for Low-Income Households in India

By Vipul Sekhsaria, IFMR Holdings

Natural disasters leave behind them a tale of death and destruction that affects the economy on the whole and severely impacts communities, especially low-income households, which bear its brunt. While little can be done to prevent natural calamities like floods, cyclones, drought etc. from occurring, what perhaps can and should be done is how best households, especially the vulnerable ones, can mitigate the financial losses that such calamities have on their lives.

Flood & Drought Risk

In terms of number of people affected, India tops the list of 163 nations affected by river floods as cited by World Resources Institute[1]. Close to 76% of India’s 7,516 km long coastline, is prone to cyclones with over 40 million hectares (12 per cent of land)[2] being prone to floods and river erosion. Floods can severely disrupt livelihoods, especially in low-resource settings. Flooded households are affected by a plethora of adverse conditions including food insecurity due to crop failure or affordability concerns due to sudden price changes. Daily care of children is importantly challenged during floods as in worst scenarios all basic services become disrupted, including water and sanitation conditions, or the provision of basic community health and social services.

Like flood, drought in India is also a major disruptor of financial well-being with 68% of the country being prone to it in varying degrees[3]. It is difficult to provide a precise and universally accepted definition of drought due to its varying characteristics and impact across different regions such as rainfall patterns, human response and resilience etc. Last year (2016) more than 300 million people living in 256 districts were affected by drought after two years of sparse monsoon rains[4]. The latest findings suggest that while there have been alternate dry and wet spells over the past three decades, the frequency and intensity of drought years has been increasing – for instance Tamil Nadu was declared drought hit in January 2017 after it recorded the worst rainfall in 140 years[5]. What’s important to note is that while the direct effect of drought could be on the farmer and the agriculture economy, but due to its high incidence, the local rural economy also gets severely affected thereby expanding its impact base beyond the farm sector to rural labourers and small rural businesses.

Natural Catastrophe (Nat-Cat) Insurance

Given the fragile economic livelihoods of the underlying households that microfinance institutions and small business lenders serve, even significantly diversified originators typically have a large percentage of their capital at risk in case of a localised natural catastrophe, resulting in a higher cost of capital. This leads to either no catastrophe cover or cover that is unaffordable to people living on low incomes. Further a majority of households never have access to any insurance that protect their assets and livelihoods in the event of a shock. The existing PMFBY (Pradhan Mantri Fasal Bima Yojana – Prime Minister’s Crop Insurance Program) is a restructured Weather Based Crop Insurance Scheme covering only Farmers – it does not take care of many other rural customer segments like Labourers, Small businesses that form 60% of the rural population. Even for farmers it doesn’t provide the much-needed liquidity during the constrained circumstances of a natural disaster like flood nor any protection towards assets other than crops (example: house & contents, livestock, other small holdings). The PMFBY structure is also highly subsidised by the government (to an extent of 90% subsidy)[6], which is a good first step to drive adoption, but without an exit strategy, the long term continuance of subsidy always remain questionable.

India was the first developing country to pilot weather indexed insurance and, despite the recent spread of weather indexed insurance programs across the world, more farmers purchase weather indexed insurance in India than in any other country. However, despite the large public subsidy, as mentioned above, a significant majority of India’s farmers have remained uninsured largely due to issues in design, particularly the long delays in claims settlement.

In terms of product development, designing an Index Based Parametric Cover is somewhat comfortable at a portfolio level rather than at the individual level (micro level), since at a portfolio level, rate makers have access to more managed data of the spread and concentration of assets across the geography. The return periods of the calamities and the portfolio data make it possible to arrive at a commercial rate for the Index Based cover. Recent experience suggest that while products are available but they are also limited to perils like Earthquake which are usually perceived as low-frequency event affecting a much smaller geography in India and therefore are of lesser demand as against for Flood and Drought.

More products for protection around Flood and Drought should also appear in the near future but cost of such solutions is yet to be evaluated. It’s worth mentioning here that, trigger of such portfolio level product results in a payoff to the risk originator (Micro Finance Institutions or similar) to cushion their own portfolio from delayed receipts of the loan repayments due to the stressed situation caused by the catastrophe. The challenge in this segment as it seems is that most originators who are already working on tight margins find it difficult to cover the cost of an earthquake protection product at a portfolio level and the high price still continues to be a dampener.

Designing a Nat-Cat Micro product

While the subject of Index Based Parametric cover is largely centred around loss of assets (whether fixed or movable), there has been very little or no work done so far as to protect the loss of Individual Income due to the incidence of perils like say, flood and drought, through an Index Based Parametric cover. The advantage of originating such cover is making the end consumer (micro level) ‘Nat-Cat-Resilient’.

The biggest challenge in developing the Nat-Cat Micro product is the absence of structured income data at the micro level. In absence of any close estimate of the different income profiles and the effect of Nat-Cat perils on this income, it is not possible to initiate the ratemaking of the risk – ‘Loss of Income’. Since the potential customers are mostly from unorganized sector, a great deal of primary research work will be involved in estimating the different income profiles of the constituent occupation classes.

To address this challenge we have undertaken a detailed primary research activity (details on which we will share in subsequent posts) to capture insights on the impact of natural calamities on income of rural customers, length of the impact as well as coping mechanisms. Joining in this detailed research work is a leading DFI (GIZ InsuResilience Direct Insurance Implementation Team) who has partnered with IFMR Holdings (IFMRH) in developing Catastrophe risk protection market along with weather based technical service provider based in India. In its current phase the goal of this project is to develop probability curves that can be externally assessed and then used to pilot differing approaches like the one detailed above as a “Micro Nat-Cat Product”. If successful, the aim would be to make these probability curves available to others to develop similar coverage and products to serve a much larger population in India.

As part of this blog series we intend to share insights from our research and interactions with expert stakeholders in subsequent posts.



[1] http://www.livemint.com/Politics/hjUVTrwyI0I4p4b4enBg1K/India-tops-list-of-nations-at-risk-from-floods.html
[2] http://www.worldfocus.in/magazine/disaster-management-in-india/
[3] http://www.ijesmjournal.com/issues%20PDF%20file/Archive-2017/Jan-Mar.-2017/4.pdf
[4] http://www.thehindu.com/todays-paper/tp-in-school/Reeling-under-dry-spell/article17052569.ece
[5] http://www.business-standard.com/article/economy-policy/ne-monsoon-worst-in-140-years-144-farmers-dead-tn-declares-drought-117011100782_1.html
[6] http://indianexpress.com/article/business/business-others/pradhan-mantri-fasal-bima-yojana-crop-insurance-plan-to-entail-rs-8-8k-cr-outgo/

4
May

Leveraging Fintech for Risk-based Pricing & Personalisation

By Bindu Ananth

Much of the focus of fintech vis-Ã -vis financial inclusion has been on payments and the ability to transfer money with relative ease using a mobile phone and an app such as the Unified Payment Interface (UPI)/Bharat Interface for Money (BHIM), or using the USSD protocol in case of feature phones. Here, I want to discuss two fintech applications that have received less attention, but which can be transformative for financial inclusion. These include risk-based pricing of microloans and personalised financial advice.

A central feature of finance, especially lending, is information asymmetry. The customer knows more about her creditworthiness than the lender. This is aggravated if the customer has no collateral to offer, which would otherwise serve as a ‘signal’ to the lender. Therefore, there is often a significant risk premium built into the pricing of the loan that buffers the profitability of the lender against credit losses. But we expect that over time, as lenders learn more about the creditworthiness of various customers, the same will be reflected in lower risk premiums.

However, if you look at the microfinance industry as an illustration, you will see in spite of several customer groups having over 10 years of credit track records (this data is available through the credit bureau for at least five years now due to the guidelines of the Reserve Bank of India or RBI), pricing to customers has remained largely the same (the annualised percentage rates of interest lie between 22 and 26 per cent) and there is no distinction between newly-acquired and vintage customers. At the same time, one growing category of fintech companies is digital credit providers – they underwrite loans to customers based on a combination of data points such as credit record, tax data (if available) and bank statement analysis, among others. Some companies also take as input psychometric data such as entrepreneurialism and honesty in dealings to construct a picture of the customer. To a large extent, microlenders and digital lenders currently serve different customer segments – the former tends to serve more unbanked customers and informal sector workers. But these two worlds will soon collide and it is reasonable to expect a lot more risk-based pricing for these customers that will take as input various aspects of a customer’s behaviour and attitude. This will be the great leveller in retail credit: A poor woman who is an agricultural worker with a strong repayment ethic and ambitious goals for the future should be able to borrow at the same risk premium as her urban counterpart who is a salaried worker.

While the rich have private bankers that provide customised financial advice, this service is equally important to low-income households for whom even small financial mistakes can have costly consequences. Yet, most efforts in financial inclusion take a standardised view of customers and have cookie-cutter distribution models.

There have been a few experiments in customised distribution approaches, notably the Kshetriya Gramin Financial Services (KGFS) model that uses a combination of product rules and trained front-line employees in remote rural markets. However, by and large, customisation has been associated with high operating costs and the need for specialised staff at the customer interface. Fintech will mount a significant challenge to this traditionally-held wisdom. One application of fintech, specifically the supervised machine-learning models, is building recommendation engines that can construct customised financial portfolios based on inputs such as age, risk-taking ability and investment horizons. Even if in the near future it does not seem likely or even desirable that a rural customer uses a recommendation engine of this nature in a self-service mode, say, through an app to buy mutual fund and insurance, this can be plugged into systems and processes of existing service providers with a sales force that interacts with this customer segment. Such integrations can significantly enhance the quality and comprehensiveness of the proposition to the customer relative to the mono-product focus (usually loans) prevalent in financial inclusion.

Finally, some cautionary thoughts. Financial inclusion has been notoriously driven by supply-side considerations and poor understanding of customer needs and preferences, resulting in outcomes such as dormant bank accounts. It is not obvious that fintech-based approaches will not fall into the same trap. For example, proponents of mobile banking for financial inclusion have not sufficiently appreciated the challenges regarding a woman’s access to private transactions on the phone even where the household has a phone. Many women seek confidentiality even from other members of the household when it comes to financial transactions, particularly savings activity. Local language interfaces are difficult to support on Chinese-manufactured feature phones that account for a large share of the rural market. These have important design implications and must be taken into account if fintech has to reach its potential. Confidence of the customer is an important factor in widespread adoption of these services. Besides good design of services and affordability, this requires a regulatory framework that enhances customer protection and providers not taking a narrow ‘buyer beware’ approach.

This article first appeared in the latest edition of Business Today magazine under the headline ‘New Tools’.

26
Apr

Comments on the RBI Draft Master Directions on Issuance and Operation of Prepaid Payment Instruments in India

By Bhusan Jatania, IFMR Finance Foundation

The Reserve Bank of India (RBI) released the Master Directions on Issuance and Operation of Pre-paid Payment Instruments (PPIs) in India (Draft Circular) on 20 March 2017. The IFMR Finance Foundation’s Future of Finance Initiative has provided its response to the Draft Circular.

While the Draft Circular builds upon a series of PPI related circulars issued by the RBI, it proposes significant changes such as:

  • increasing a PPI issuer’s net-worth requirement to Rs. 25 crores (from the existing Rs. 1 crore),
  • allowing PPI issuers to access payment systems in the future (without providing details),
  • requiring comprehensive system audit of PPI issuers on an annual basis (and before granting licenses to new applicants), and
  • compulsory conversion of existing PPIs (which hold minimum information about the user) to full KYC PPIs (this has to be achieved within 60 days of the Draft Circular coming into force).

In our comments to RBI we have recommended that the Draft Circular:

  • provide a higher standard of customer data protection,
  • create a more level-playing field for bank-led and non-bank led PPI issuers, and
  • clarify customer liability for unauthorised / fraudulent transactions involving PPIs.

In our response we have also compared the Draft Circular to the recent draft rules for security of prepaid payment instruments released by the Ministry of Electronics & Information Technology on 8 March 2017 (to which we also provided a response, available here).

We believe that the proposed regulatory revamp of wallet providers is driven by the principle that emergence of dominance should lead to greater supervision. The RBI appears to have taken a view that the digital payments sector, characterised by significant user expansion, has emerging customer abuse, data security and systemic risk considerations. And while the industry has raised some concerns of regulatory extravagance around the Draft Circular, it should largely be seen as a step in the right direction.

Our response to RBI’s public consultation is available here.


About the Future of Finance Initiative:

The Future of Finance Initiative (FFI) is housed within IFMR Finance Foundation and aims to promote policy and regulatory strategies that protect citizens accessing finance given the sweeping changes that are reshaping retail financial services in India – including those driven by Indiastack, Payments Banks, mobile usage and the growing P2P market.

24
Apr

A Brief Comparison of Ombudsmen Frameworks – Part 2

By Madhu Srinivas, IFMR Finance Foundation

Following our initial post on a brief comparison of grievance redressal mechanisms existing in India for financial services, at first glance it can be seen that there is considerable variation in the process elements among the various sector ombudsmen. This is indicative of varying processes, approach and service levels of the redress mechanisms. Let us delve on some common observations we made from the comparisons.

Recognition of Misselling, or a lack thereof

The Report of the Governing Body of Insurance Council (GBIC)[1] has made the following observation in its analysis of the complaints received against Life Insurers – “In most cases of mis-selling the financial underwriting rules have been disregarded by the underwriter. So mis-selling which could have been arrested at the underwriting stage instead gets an impetus when the underwriter clears long premium paying term plans even though the proposer does not have the paying capacity to maintain the policy beyond the initial first payment.

Our cursory analysis in the previous blog post[2] reveals that there is no recognition of unsuitable sale as a separate category of complaints (beyond process-level complaints). Current supervisory mechanisms also have minimal efforts directed towards systematic detection of conduct violations on a regular manner, such as for violations of affordability assessments across all lending channels, and if such efforts exist, they are not placed proactively by the supervisor in the public domain. There is therefore a systematic under-representation of, and a lack of adequate evidence on the extent of unsuitable sale to households occurring in today’s context (products being unsuited to client needs, unfair contract terms, misleading conduct and market practices of intermediaries and so on). There is inadequate information about ‘misconduct’ practices feeding back to regulators and supervisors providing no respite for consumers even in the longer run. This would substantially underestimate the occurrence of, and the costs to customers on being mis-sold unsuitable products, and consequently reduce the impetus for regulatory action on the same.

Feedback Loops into Regulation and Supervision

The grievance redressal function can act as a powerful feedback loop to the regulator and can inform their regulatory and supervisory approaches as well as actions. We cannot definitively conclude whether regular feedback loops exist and if they do, whether regulators take these as inputs into supervisory processes, and further into updations in regulations (simply because these are not available in the public domain).

However, we looked at requirements placed in the respective Ombudsmen Schemes to see if such requirements are there on paper atleast. We found the following requirements which we think are inadequate for the purpose:

  • From the Banking Ombudsman Scheme[3]The Banking Ombudsman shall send to the Governor, Reserve Bank, a report, as on 30th June every year, containing a general review of the activities of his Office during the preceding financial year and shall furnish such other information as the Reserve Bank may direct and the Reserve Bank may, if it considers necessary in the public interest so to do, publish the report and the information received from the Banking Ombudsman in such consolidated form or otherwise as it deems fit.”
  • The Governing Body of Insurance Council (GBIC) has been established under Redressal of Public Grievances Rules 1998 (RPG), to set-up and facilitate the Institution of Insurance Ombudsman in India. From the RPG “The Ombudsman shall furnish a report every year containing a general review of the activities of the office of the Ombudsman during preceding financial year to the Central Government and such other information as may be considered necessary by it. In the Annual Report, the Ombudsman will make an annual review of the quality of services rendered by the insurer and make recommendations to improve these services.” [4]

The Report of the FRA Task Force[5] points out that “a large number of complaints on a particular issue (for example, misselling in Unit Linked Insurance Plans (ULIP) resulted in consumers losing more than a trillion rupees over the 2005-2012 period) reflect regulatory and supervisory gaps, creating a conflict of interest unless feedback from complaints flows to the regulator through an independent mechanism.” It has recommended the requirement for a research team under the proposed FRA to analyse complaints data and provide feedback to the regulator on areas for improvement in regulation or supervision[6]. We can therefore conclude that such feedback loops do not exist currently.

Powers of ombudsmen/regulators to take action against non-compliant providers

There seems to be a patchy framework around powers of ombudsmen and even the regulators to take action against financial services providers who do not comply with an award made by the Ombudsmen.

RBI / Banking Ombudsman

Section 35A(1) of Banking Regulation Act, 1949, empowers the RBI to give directions to the banking company, where it is satisfied that such directions

– are in the interests of public

– are in the interests of the banking policy

– are to prevent the affairs of any banking company being conducted in a manner detrimental to the interests of the depositors or in a manner prejudicial to the interests of the banking company;

The banking company is bound to comply with such directions.[7]

SEBI SCORES In case of non-redress of a grievance by an intermediary after having being called upon by the SEBI Board in writing to redress the grievances of investors, then such an intermediary shall be liable to a penalty which shall not be less than one lakh rupees but which may extend to one lakh rupees for each day during which such failure continues subject to a maximum of one crore rupees[8]
IRDAI / Insurance Ombudsman

The GBIC cannot penalise Insurance companies for not complying with the award given by it.

Currently, there are no penal provisions available in the RPG for the non-implementation of the award passed by Insurance Ombudsman. Section 16(2) of the RPG provides that the Ombudsman cannot award compensation for an amount exceeding twenty lakh rupees. The compensation cannot exceed the amount that covers the loss suffered by the complainant as a direct consequence of the insured peril. [9]

Unregulated, unlicensed or illegal services

The current redress mechanisms do not admit complaints arising from unregulated, unlicensed or illegal services. The only recourse left to victims in such cases is to approach the police and the courts. This is a big lacuna in the redressal mechanism and it needs addressing. One of the more recent attempts to fill this lacuna is RBI’s Sachet initiative.

To sum up, it is clear that there is significant variation among the grievance redressal mechanisms in place for the Banking, Insurance, Pensions and Capital Market sectors. There is a very strong case to be made for the creation of the Financial Redress Agency (FRA) as the single agency that can act on behalf of aggrieved customers – an idea that is not new and one that has been effectively set up and is running in many other jurisdictions.


[1] Pg 33 Consolidated Annual Report of the office of the Governing Body of Insurance Council (GBIC), 2015-16
[2] http://www.ifmr.co.in/blog/2017/04/10/a-brief-comparison-of-ombudsmen-frameworks-part-1/; https://ajayshahblog.blogspot.in/2017/01/establishing-financial-redress-agency.html
[3] https://rbidocs.rbi.org.in/rdocs/Content/PDFs/67933.pdf
[4] http://www.gbic.co.in/notification/Redressal%20of%20Public%20Grievances%20Rules,%201998%20-%20copy.pdf
[5] Pg 10, Report of the Task Force on Financial Redress Agency, Government of India, June 2016
[6] Pg 15, Report of the Task Force on Financial Redress Agency, Government of India June 2016
[7] Pg 142 Report of the Task Force on Financial Redress Agency, Government of India June 2016
[8] See Section 15C of Securities and Exchange Board of India Act, 1992
[9] See Page 32 of the GBIC, Consolidated Annual Report of the Governing Body of Insurance Council & Offices of the Insurance Ombudsmen for the year 2014-15. Also, See Pg 143, Report of the Task Force on Financial Redress Agency, Government of India, June 2016