Micro Health Insurance I: An Introduction

During my time here I am working on a project to asses the impact of health insurance in rural India. Health shocks (accidents, prolonged illnesses, the need to be hospitalized) are among the biggest and least predictable forms of uncertainty that a poor family faces. There are two important economic costs associated with illness: the cost of the medical care for diagnosis and treatment, and the loss in income associated with reduced labor supply and productivity. However, less than 1% of households in rural India are estimated to have formal health insurance policies. Without insurance or access to credit, these shocks may sharply lower consumption in the short-term or decrease investments in very productive assets. In the extreme case the absence of insurance can lead to a poverty trap, where due to illness the family receives less income which impedes them to get proper medical attention, which prolongs the illness, which results in less income and so on.

With credit the household can smooth consumption and investment in face of the health shock (that is, to maintain a more stable level of consumption without sharp fluctuations due to unexpected events), but it might be very expensive smoothing compared to insurance, since with insurance the household only pays a premium that is the cost of the shock weighted by its probability, and with credit the household pays the full amount of the medical expenses plus the interest on the loan. Preliminary data from the project shows that most households borrow in order to cover medical expenses, which leads to the question on how are they going to repay (especially if that money is not being used in any productive investment). The most probable answer is by lowering consumption, which will leave the family worse off.

In reality there are many informal insurance mechanisms (outside the market), especially in traditional rural areas. These mechanisms are effective (and sometimes efficient) in dealing with idiosyncratic shocks, but not systemic shocks that affect the whole community. In addition, as traditional communities modernize, many of these mechanisms are weakened by societal transformation due to migration, diversification of income sources, splitting of households, among other reasons. The availability of market-based insurance then becomes more and more important.

So why don't people have formal insurance? Why don't insurance companies offer it? As with any insurance product there are informational asymmetries that lead to adverse selection and moral hazard, plus some special characteristics of health insurance that complicate the incentive design, plus the lack of statistical information on frequency of health events in rural communities that difficult calculating premiums, plus the high transaction costs of offering the insurance in these areas, plus demand-side problems as households are not used to these products. Micro health insurance schemes attempt to overcome these difficulties. How? You will have to wait for a future post. I hope you can bear the suspense...