Pricing Funeral (Burial) Insurance in a Microinsurance World with Emphasis on Africa

Funeral (burial) insurance is one of the most common microinsurance policies sold in Africa. Funeral insurance is important because it pays for the cost of funeral arrangements, thus forming an important part of protection for low-income workers. We develop a model of a microinsurance market in an African context where funeral insurance policies are sold to low-income households through a burial society, which contracts with a risk-neutral profit-maximizing monopolistic insurer to supply funeral insurance policies. We assume the burial society is sufficiently large that it has bargaining power and can negotiate on behalf of its members. The burial society requires that the insurer offer separate policies that are affordable to both low-risk and high-risk individuals and waiting periods cannot exceed m months. Applicants for insurance are identical except for their mortality, which is known to the insurer except for a single parameter called the frailty parameter. As death benefits and premiums are low, the insurer cannot afford to use a costly but effective underwriting technology to provide accurate information on each applicant's future mortality. To mitigate the effect of adverse selection, the insurer uses a simple low-cost practical underwriting strategy that requires all applicants to complete a questionnaire on their personal/family medical history, certify their “good health,” and confirm that they are gainfully employed. The insurer also includes a waiting period before policyholders are eligible for death benefits. As there is no established actuarial theory that suggests how the optimum waiting period should be determined, the objective of this article is to establish a sound basis for determining both the premium and the waiting period for these policies. To this end we develop a discounted expected utility model of consumption by members of a burial society and use this model to determine the optimal premiums and waiting periods subject to solvency, lapse, and participation constraints.