Natural Catastrophe Insurance – In Conversation with Mr. Ulrich Hess
– By Shilpa Sathe and Deepti George, IFMR Rural Finance
In the series ‘Finance Matters’, we have examined the various elements that enable the provision of high-quality financial services, particularly for the under-served segments of the population. In this column (the last in this series), we summarise this thinking and paint a vision for the future of financial service access for households.
The current financial system takes a product-menu driven approach, where different providers meet different household requirements such as savings, insurance, credit, pension and payments on a piecemeal basis. The customer takes responsibility for the ultimate outcome, which could be achieving a target annuity during retirement, building the required corpus for a child’s education, or being protected for the full value of human capital.
Today, the disaggregated delivery of financial services has put the onus of taking technically complex financial decisions on the consumer. Even for the highly educated individual, this task has become difficult, if not impossible, given the rapid innovation in the financial marketplace, coupled with limited ability to assess alternatives. Even with easy availability of information, the principal-agent problem remains, with the agent or advisor having limited liability for what she sells.
We have argued in this series that a household needs providers who can offer integrated solutions in a continuous and convenient manner. There is adequate research to show that the financial needs of households are multi-dimensional and one must look to solutions that can necessarily deliver on comprehensiveness. The starting point is a customised financial plan, based on a clear assessment of a household’s financial goals, current and expected cash-flows, appetite for risk, and so on. Specific products are a means to achieve household goals, and not ends in themselves.
Customised plan
This additional responsibility of computation and advice means that the provider will have to take on a more holistic approach, cutting across traditional barriers of institutions and products. Future financial services providers will be akin to general physicians, who bear great responsibility for the health of their patients.
Such a prescriptive approach would also minimise instances of unsuitable advice, such as selling illiquid assets to clients with immediate liquidity requirements, or selling loans that require repayments that do not match the household’s cash-flows.
In such a regime, incentives need to move away from standalone product sale to following a set of protocols that will subsequently enhance the financial well-being of the households served. Such well-being is the state in which a household can optimally choose patterns of consumption over time and in uncertain states of the world.
To choose these patterns of consumption, households should have the ability to grow, manage liquidity and overcome financial shocks, across different periods of time. The integrated approach will equip households with the means to achieve this.
Structural models will have to evolve to incorporate market imperfections such as irrational behaviour, which will necessitate a greater investment in the development of intelligent systems and training resources to deliver high-quality solutions.
Provider’s liability
While developing provider expertise will aid better choice, this approach also calls for extending a provider’s liability to following protocols that are consistent with financial well-being, and for this to be enforceable as a statutory obligation, rather than just a fiduciary one.
This is particularly important because, unlike physical products, financial products lack visibility and, unlike many services, they reveal their real outcomes at a point in time beyond the time of purchase. Clients thus have limited ability to assess upfront, the quality of a product.
This is clearly problematic and highlights the need for ex-post liability regimes in the context of financial service providers. One way this could be addressed is by setting ‘negligence standards’, similar to those in place for consumer products. Customer protection regulation that is currently at a very nascent stage in India will have to evolve to meet these challenges.
The evolution of this fundamentally different approach to product design and delivery stresses the need for functional regulation — that is not product- or institution-based but based on functions served by them. Regulators and policy-makers have a key role to play in aligning the incentives of agencies in the financial market place.
Business model innovation must be encouraged to discover new and integrated approaches to financial services delivery. As discussed earlier, the optimal role of Government is in creating infrastructure — connectivity, unique identity and payment backbone — that will enable all service providers to reduce their cost of operations. Moving ahead, we see no trade-off between ubiquity and quality of services in financial services delivery. Both are achievable.
In summary, a well-functioning financial system should aid transfer of resources across time and different states of the world, helping individuals and organisations manage risk, disseminate price information and align incentives. This is best achieved through the provision of integrated solutions by well-trained providers and requires reliable financial institutions that work towards maximising the financial well-being of clients. Institutional structures and product innovations will need to move together to ensure that the true transformative power of finance is realised.
This article first appeared in The Hindu Business Line
This is an excellent piece. Articulates the new vision of fnancial services very well indeed.
Great article but is it possible to have customization without ‘comprehensiveness’ by a single provider?
Hi Kabir
Thank you for your question.
We have tried to argue through our article that a comprehensive understanding of the households’ cash-flows, goals and risk appetite should necessarily precede financial product sale. However, in the current disaggregated method of product delivery this can prove time-consuming and expensive especially in cases where information about the client is not easily available. This can be largely addressed by having local providers that offer integrated solutions through multiple products at the front-end. The KGFS model is one such example (http://capitalpartners.kgfs.co.in/).
Deepti, thanks for your response and for a great post. I guess I am wondering (out loud) why we can’t we have disaggregated delivery and local providers integrating it at the last mile? Disaggregated product delivery + local aggregation + local customization all made possible by an ecosystem of multiple providers and not under the roof of one provider. And if there is value in aggregation and customization, then why can’t it be a separate business while product delivery is handled by someone else? Either way, thanks for your post and for describing the broader ideas behind KGFS.
I really like the bid about product liability being in sync with those of consumer products. You have, in my opinion, hit the nail on the head on the nature of financial services regulation in a large play that is not just about serving low income persons. The regulatory framework has been driven by risk mitigation rather than consumer liability. e g financial products are difficult to comprehend beyond plain vanilla savings, insurance etc. It is easy to develop a question set that clearly outlines risks, glitches to the buyer (consumer) that isn’t about a 10 page document in small print that even the highly educated don’t comprehend (or read). Plus recourse of the customer to skewed representation by sellers.
The other aspect you may want to consider is the aspect of expected cash flows and risk appetite. It would be reasonable to expect that a daily wage earning / low income household would respond with :
1. Expected cash flows = “i don’t know”
2. Risk appetite = “zero”.
The above context results in one-side borrowing contracts e g bonded labour.
will share with you some ideas to work around this (don’t have cooked thoughts right now), but think you might want to dwell on this part a lot.
Hi Pras,
Thanks for your comments.
We agree with you that information disclosure in the right spirit is clearly an important step towards ensuring consumer protection. More research is however required to answer questions like how much disclosure is optimal, what is the best format and what impact this can have on consumer decision making. Regarding your point on expected cash flows and risk appetite, we take the view that the capability to derive this should be built at the provider’s level. This will require a high-quality enrolment and KYC process done through well-trained staff at the front-end, who engages the customer in simple conversations around their finances. This is where proximity and continuity become important since the customer has a greater incentive to share information with the provider, if he sees a long-term association with him.
Thanks for the article, Shilpa. The main problem is the isolated nature of our financial activities. Whether buying or selling – most of us look at the transaction in isolation. If we rather look at a holistic picture while undertaking the transaction it will be much more logical. But that requires time and expertise and is expensive as one would have thought. An integrated system which can take on this issue is yet to emerge. We, at Futurewise aim to fill the gap by making this critical service available to the masses (read, 25-45 age group) at an extremely affordable price point, all this backed by a robust delivery platform (phone/internet). We are in beta stage and will launch soon. But given our service model I could totally relate to what the article says.