Is insurance for rural water supplies a good idea?

Published on: 14/10/2013

Today, I received a question on whether at IRC we know of any experience with insurance for rural water supply. This question has reached us several times in the past year. Whereas my first answer to the question was "No", now a clearer "no, but... maybe" answer starts to emerge. Encouraged by my colleague Catarina Fonseca, I decided to post this emerging answer in a blog.

The background to the question is clear. Water tariffs, where used, are usually set at a level that should cover operational and minor maintenance costs. However, they rarely are sufficient to cover the depreciation or full replacement costs of assets. And even where communities do save for (part of) the replacement costs, these saving are often used as other urgent needs come up. As a result, communities may be able to keep their systems running for a couple of years, but may eventually bump into problems when for example the pump fails or the intake is washed away. They may then not have the funds to replace these. (Local) government may step in to cover some of these costs on an ad hoc basis. In that case, the community is lucky. Otherwise they may need to wait for the next project to come by and build a new system. At IRC, we believe that supporting asset renewal and rehabilitation by financing capital maintenance is an important part of the puzzle of ensuring sustainable water supplies - but a piece of the puzzle for for which there is still big need to come with innovative approaches.

May we request our readers share any experiences or ideas on insurance for capital maintenance, or any other financial products and services to that effect?

The possibility of setting up insurances for capital maintenance is coming up more and more in discussions on this puzzle. Still, to date, to our knowledge insurance schemes have not been used in rural water supply, with exception of isolated initiatives in the north of Ghana with pooled funding for capital maintenance were initiated by an Association of Water and Sanitation Development Boards (AWSDB). This is not surprising, all theoretical considerations point against the sense in insurance for capital maintenance.

First of all, there is a moral hazard. If a community would insure, let's say, its pump, it will have little incentive to maintain it, as the insurance would pay if it fails. And even if community A would do due maintenance, community B with a similar insurance might not do so. An insurer would need to raise the premiums to cover eventual costs. And community A would pay more for the negligence of community B. Secondly, an insurance is meant to cover for events that have a low likelihood of happening, but that would have a potentially big impact and would be beyond one's means to pay. The costs of insuring something against an event that is likely to happen – even if you don't know when – is higher than just saving for it. Compare it with a car or a house insurance. You can insure you car against damage in an accident, an event that is not likely or unsure that it will happen, but that would represent a big financial loss. You cannot insure your car against break-downs due to wear and tear of parts as those are bound to happen sooner or later, such as the replacement of a pair of brakes. It is not cheap to replace the brakes on your car, but neither unaffordable. Likewise, you can insure your house against the unlikely event of a fire, or the collapsing of your roof during a storm, but not against the need to replace the roof because the supporting beams are too old and have started to rot away.

These same principles apply to a water supply system. In theory it would make most (financial) sense to save for replacement of parts that will anyway break down sooner or later. You would only take an insurance for unforeseen events that are not likely to happen. So you would save for the replacement of a broken down pump, but take an insurance for, let's say, the replacement of an intake structure, in case it gets washed away by a flash flood. If you insured a pump, probably the premium you pay is relatively high, as the insurer knows this will happen sooner or later.

There may be hybrids of saving and insuring. For example, by only insuring against untimely breakdown of critical parts like a pump.

In spite of these theoretical considerations, it might still make sense to experiment with insurances, exactly because of the reasons mentioned in the introduction: saving simply doesn't happen. By paying a premium, basically one is saving in an obligatory manner, via the insurance company, but probably at a relatively high cost of capital. In addition, there may be hybrids of saving and insuring. For example, by only insuring against untimely breakdown of critical parts like a pump. So you wouldn't insure a pump per sé, but you would insure against a breakdown before the theoretical expected life-time of that part. So, if a pump has an expected life-time of 10 years, you could insure it for breaking down before it has eight years of functioning. At the same time, the community would still need to save for the eventual replacement after ten years. Such a hybrid, however, doesn't the issue of moral hazard and it would need proper regulation and monitoring – issues typically lacking in many rural settings.

But, in the absence of many other alternative approaches to funding capital maintenance - as also described in this WASHCost Working Paper, it is at least a mechanism to further explore, as it may also trigger thinking on other financial services and products to cover this weakest link in the service delivery life-cycle. And as one request, triggers another: may we request our readers  share any experiences or ideas on insurance for capital maintenance, or any other financial products and services to that effect?