The Vicious Cycle in Cattle Insurance Schemes

(By Atul and Deepak Alok)

Insurance paradox
For an insurance scheme to work the premium collected and the returns on it should be sufficient to settle claims that arise and to cover the expenses of operations. This would imply that the claim ratio should hover around one for sustainable insurance. The claim rates are high, particularly in the case of cattle insurance. There are also evidences to suggest that, paradoxically; the death rate is higher in the case of insured cattle. Our investigations also pointed out to the incidence of moral hazards (ie. not taking adequate care of the insured cattle) and adverse risk selection (ie. insuring unfit cattle). The insuring companies suspect cheating. The mechanism adopted by them to meet the cost of high claims is that of loading. In order to meet the cost of insurance (claim settlement and operational expenses) the insurance agencies increase the premium rates in proportion of the claim ratio.

Why take Insurance?
Most of the dairy farmers mention high premium rates as a reason for non-participation. Many of these farmers feel a definite need for insurance. The criterion for participating in insurance schemes at the society level is the surplus of the receipts due to claim settlements over the expenses due to premium payments (ie. the total premium paid by the members of the society). Such a criteria makes it difficult for the insurance companies to operate with a reasonable rate of premium. Higher claim ratio leads to loading and ever increasing premium rates. This results in a vicious cycle, which is described later.


Economic Rationality
From the point of economic rationality, a member would be ready to pay premium for an insurance instrument, without expecting any undue returns as long as his marginal utility for the safety provided by the instrument (ie the perceived benefits per incremental unit of premium paid) is greater than his marginal utility for money. The determinants for the former are primarily a) the member’s risk perception based on past experiences b) their own level of economic well being (affordability) and c) awareness about the presence of such an instrument. Once the marginal utility of the safety provided falls below the marginal utility for money spent on premium, the members start expecting returns and view insurance premium as a yield earning investment similar to securities. In fact we observed a high correlation between those who view insurance premium as investment along with safety and those who felt that the premium rate was high.

Role played by Dairy Cooperatives
There is a problem with the way insurance is seen at the society level. When the society is an intermediary between the members and the insurance company, it can clearly see the inflows and the outflows due to insurance. There is a possibility that the society will see this as another investment opportunity, the costs and benefits of which can be calculated on strictly monetary terms. Consider the case of a society, which has 1000 members who contribute Rs 100, each for the life of the members. This means an initial annual outflow of Rs100,000. If the premium rates had been calculated on strict actuarial principles, the amount received as claims will be around Rs100,000 during the year. There is also a possibility that the amount received will be less than Rs100, 000. The society may then feel that it would have been better off if it had kept the money with itself and compensated the members. This feeling may also tempt the societies to adopt fraudulent means to get a sufficient return on their “investment”.

The insurance agencies resort to loading when the claim ratio exceeds one. Thus the premium payable on a scheme increases. The question to be asked is that why did the claim ratio exceed one? Assuming that the initial premium rate was based on a good actuarial model that took into account all the inherent risks, it would seem that some irregularity was committed.

In the case of cattle insurance schemes running across the unions covered, only a few of the societies account for most of the deaths in the entire union. These societies are sporadically distributed in the region and did not record any epidemic. This points to some irregularity, some mechanism to get the maximum returns on the insurance premium paid. Obviously this requires a collusion of the members who participate, the doctors who certify and the authorities of the insurance agencies who monitor. The collusion between any two could result in the establishment of a fraud claim. This artificially inflates the claim ratio. As a result the premium rates increase. When this happens many of the members feel that the premium rates do not justify the real risks to their cattle. They then either pull out of the scheme or continue only if they are certain of returns (claims). Thus, there is an increase in adverse risk selection, and the upward spiral of the premium rates continue. Slowly most of the honest members drop out of the scheme and it degenerates. The scheme even when it is in operation fails to take care of the real insurance needs.

Interestingly, the perception at the society/union level is that while the members are their own, the insurance companies are the other party. Hence they usually condone some of the unscrupulous activities of the members. (In cattle insurance the union doctors limit their roles to identifying the correct animal and usually do not report if the death of the animal is due to negligence or bad Animal Husbandry practices). This precipitates the spiral - a vicious series of cycles, which lead to the failure of the schemes.