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in economic development?
Lael Brainard
This paper has benefited from the helpful comments of Robert Gibbons,
Daniel Hofmann and Roy Suter.
This is the second paper in the Zurich Government and Industry Affairs thought leadership series.
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What role does insurance play in economic Of course, even if the data did not support
development? Considerable attention has a strong causal role for insurance as an
been devoted to evaluating the relationship engine of overall aggregate growth, there
between economic growth and financial might be a strong case for insuring the
market deepening. Most of what we have poor on social welfare grounds that those
learned relates to banking systems and at or below the poverty line are particularly
securities markets with insurance receiving vulnerable to catastrophic shocks to income
only a passing mention. Yet, while and consumption. And indeed, it appears
insurance, banking, and securities markets that the gap between the potential social
are closely related, insurance fulfills value of insurance and the transactions
somewhat different economic functions costs of provision might be unusually wide
than do other financial services, and in turn for the poorest segment of society, which
requires particular conditions to flourish and explains the growing interest in micro-
to make a full economic contribution. insurance on the part of non governmental
organizations and philanthropic
Fortunately, in the past few years, several
foundations, some of whom are partnering
interesting lines of research have begun to
with commercial providers.
map the specific contributions of insurance
to the economic growth process as well as
Contributions of Insurance to
to the well-being of the poor. The evidence Growth and Development
suggests that insurance contributes Insurance serves a number of valuable
materially to economic growth by improving economic functions that are largely distinct
the investment climate and promoting a from other types of financial intermediaries.
more efficient mix of activities than would In order to highlight specifically the unique
be undertaken in the absence of risk attributes of insurance, it is worth focusing
management instruments. This contribution on those services that are not provided by
is magnified by the complementary other financial services providers, excluding
development of banking and other for instance the contractual savings features
financial systems. of whole or universal life products.
Empirical studies suggest that nonlife The indemnification and risk pooling
insurance contributes to growth in countries properties of insurance facilitate commercial
at many different levels of development. Life transactions and the provision of credit by
insurance makes a substantial contribution mitigating losses as well as the
to growth mostly in wealthier countries, measurement and management of non
since life insurance is typically a smaller part diversifiable risk more generally. Typically
of the total insurance market in low income insurance contracts involve small periodic
countries. The relationship between per payments in return for protection against
capita income levels and insurance uncertain, but potentially severe losses.
penetration is also strong in the reverse Among other things, this income smoothing
direction with rising income a strong effect helps to avoid excessive and costly
driver of life insurance coverage. However, it bankruptcies and facilitates lending to
is difficult to disentangle whether lower businesses. Most fundamentally, the
insurance consumption at lower income availability of insurance enables risk averse
levels reflects reduced demand for life individuals and entrepreneurs to undertake
insurance products or constraints on the higher risk, higher return activities than they
supply side associated with weak regulatory would do in the absence of insurance,
and supervisory environments and high promoting higher productivity and growth.
costs of insurance provision.
A number of factors that might be assumed Indeed, even after controlling for income,
to be strong drivers of insurance market there is substantial heterogeneity in
growth appear much less significant in insurance coverage between regions (with
practice, including demographic factors, Latin America and the Middle East lagging
such as the share of the population that is behind) and even among different countries
approaching or at retirement relative to the within regions (a handful of countries in
share that is young, and the educational Latin America have much deeper insurance
level of the population. Notably, social markets than the remainder). Analysis of
provision of insurance, such as social the heterogeneity even within the group of
security and government health insurance, relatively wealthy OECD member countries
appears to grow in tandem with the leads some analysts to conclude that a full
provision of private insurance perhaps understanding of the relationship between
because both are associated with increasing insurance and growth requires some
incomes rather than acting as substitutes analysis of cultural and institutional
as some have conjectured. In addition, even characteristics within individual countries.7
though urbanization might be expected to
At minimum, the high degree of
lead to growth in insurance coverage due
heterogeneity might suggest that attitudes
to the associated separation from traditional
towards insurance and risk must be taken
informal insurance practices prevalent in
into account in the development of country
rural settings, urbanization does not appear
and regional insurance markets. Related, it
to be a significant driver.
suggests an important role for industry-
wide initiatives on consumer education and
2: Variation in Insurance Coverage.
self-regulation in addition to the
Although the key drivers noted above are
development of trustworthy regulatory and
relatively robust in explaining insurance
supervisory frameworks as the globalization
market coverage, nonetheless there is
of insurance markets proceeds.
substantial variation in insurance coverage
among economies that cannot be fully
Micro-Insurance
explained by these factors. This suggests
The contribution of insurance to an
some idiosyncratic factors may be at work.
economys growth and efficiency is not the
Observers have noted an S-curve only entry point into its role in development.
relationship between per capita income and The contribution of insurance to poverty
insurance penetration: insurance penetration alleviation and the welfare of the poor is
is moderately positively correlated with per also potentially of considerable importance,
capita income within the group of low although the quantitative evidence on this
income countries and the same is true for point is not on very firm grounding.
the highest income countries. However, Nonetheless, case studies and other
within the group of middle income qualitative evidence make a persuasive case
countries, insurance penetration is strongly that the potential social value of so-called
positively correlated with per capita income. micro-insurance provision to poor
This S-curve is somewhat misleading households and small-scale entrepreneurs
however, since it compares countries at warrants a great deal more experimentation
different levels of per capita income, but with business models and products to
does not predict how insurance penetration develop scaleable approaches that combine
will rise as an individual country becomes commercial and philanthropic elements.
wealthier over time.
As noted above, patterns of insurance There are also a variety of mechanisms that
coverage suggest a positive correlation with have emerged at the community level, such
income at least up to a point where the as community pooling of informal insurance
value of insurance begins to diminish contributions to cover burial costs.
relative to the value of overall household Community-based insurance mechanisms
assets. But this does not tell us anything surmount the problems of transactions
about the potential social value of insurance costs and lack of legally enforceable
provision at lower levels of income only contracts through personal relationships
that poor consumers either do not or and piggybacking on traditional small-scale
cannot purchase insurance at currently financial collection mechanisms, similar to
prevailing prices and availability. Moreover, the early stages of micro-credit. However,
insurance market development faces many they offer only feeble protection in the face
special informational challenges that have of community-wide, covariate shocks, since
been extensively documented in economic they do not typically pool risk across
research even in wealthier countries. Put broader populations and are limited in
simply, insurance is likely to be relatively the types of products they can provide.
more expensive even prohibitively so
For micro entrepreneurs and farmers, the
for low income households and small-scale
net result can be a significant drag on
entrepreneurs because of the high
overall economic performance as they
informational problems and transactions
choose to invest in activities that might offer
costs relative to the size of the risk to be
the best risk-return profile from an individual
insured. As a result, most types of insurance
point of view but are suboptimal from an
are simply not available to the vast majority
economy-wide point of view where a higher
of the worlds poorer citizens.8
returning but riskier set of investments
In the absence of risk pooling mechanisms, might lead to better aggregate outcomes.
plunges in incomes due to death, disability,
High transactions costs are the main
and adverse agricultural outcomes often
impediment standing in the way of a
translate into substantial decreases in
systematic shift from informal to formal
consumption and investment that can
mechanisms for managing and pooling risk
permanently set back a poor familys
for poorer households and small
livelihoods and prospects. When drought or
entrepreneurs. As such, the emerging field
floods lead to low agricultural yields, critical
of micro-insurance faces many of the same
health interventions may be delayed,
challenges faced by micro-credit two
education of younger members of a
decades ago in developing creative
household put on hold indefinitely, and
mechanisms for reducing or subsidizing
land, livestock or equipment permanently
transactions costs. Indeed, micro-credit
forfeited. Due to the catastrophic
institutions are among the first to venture
consequence of such losses, there is
into micro-insurance products, and their
extensive evidence that in the absence of
most popular initial insurance product
formal insurance poor households and
offering was credit-life insurance to pay
communities attempt to self-insure
off any debts associated with outstanding
through a combination of building assets9
micro-credit loans in the event of death.
and diversifying sources of income. The
As this field expands, it might follow a
result most likely is investment in a set of
trajectory similar to that of micro-finance,
lower risk but also lower return activities
perhaps starting with NGO providers
and even this degree of self-insurance is
funded on a philanthropic basis, but rapidly
highly incomplete.
business enterprises are undoubtedly these are necessary but not sufficient
preoccupied with managing risk. In the conditions. Insurance market deepening also
absence of risk management tools provided depends on the scale and growth of related
by formal insurance, there will be a tendency markets, including sales of cars and other
to under invest in higher risk, higher return consumer durables, residential and
activities, thus diminishing the potential commercial mortgage markets, business
contribution of the critical small and medium establishments, disposable income, and
sized enterprise sector to employment, commercial and trade transactions, to name
investment, and growth overall. a few. Growth in these related markets is
critical in order for the nascent insurance
In sum, extending accessible insurance
industry to reach scale in developing shared
products to poor households and small
infrastructure, underwriting capacity,
scale entrepreneurs should be a core part of
statistical databases for actuarial purposes,
the agenda of democratizing access to
and the associated skills.
financial assets. When successful programs
are taken to scale, it will not only add A variety of public goods are critical for
measurably to social welfare but also hold jump starting and sustaining the growth of
the promise of generating a more domestic insurance markets. These include
productive and higher growth mix of the collection and sharing of data on a
activities and investments with a payoff consistent basis, common supervisory
perhaps greater than micro-credit. principles, for instance on reserves and
solvency, and consumer education.
Globalization of Insurance markets Recognizing the critical role of such public
Although the evidence suggests that goods, several of the multinational
insurance market deepening should be a development banks, international
priority in the financial sector strategies of associations of regulators and supervisors as
developing countries, awareness of the role well as private sector associations are
of insurance lags behind that of banking already active in providing technical
and capital markets. For these reasons, it is assistance on all of these dimensions.11
important to raise the visibility of this sector
According to an in-depth survey of the
and to clarify what unique regulatory
factors that have slowed the expansion of
provisions might be needed to enable
insurance markets in Latin America, the
insurance market development alongside
regions insurance professionals view the
other facets of financial deepening. For
lack of sufficient education about insurance
many countries, a good starting point
as the greatest impediment to market
would be to include analysis and
development. They also cited lack of
recommendations specifically for insurance
confidence in the effectiveness of the
in financial sector assessments.10
judicial system and law enforcements
1: Institutional Foundations for Insurance failure to collect information about thefts
Market Development and automobile accidents as key
The development of robust insurance impediments to market development.12
markets generally requires many of the
same foundations as for banking and 2: Insurance for Different Stages of
Economic Development
financial market deepening: reasonable
Although there is broad agreement on the
macroeconomic and political stability, clear
need for adequate regulatory and
property rights, enforceability of contracts,
supervisory frameworks, there is some
and safeguards against corruption. However,
debate on the content of these frameworks,
and in particular the extent to which through the growing volume of transactions
developing countries can or should requiring insurance and directly by
harmonize their standards to global best driving privatization and liberalization of
practice or seek some intermediate insurance markets and the migration of
standards. Global best practices relying on new products across borders.
disciplined transparency and corporate
As global insurance companies press
governance are still largely lacking in many
forward on cross-border market
developing countries. For some regions
liberalization, they would be well-advised
within Africa and Latin America, a strong
to advocate just as actively for building
case can be made for the development of
consumer confidence in the regulatory and
regional standards that are common across
supervisory infrastructure of emerging
groups of neighboring countries or Free
insurance markets. Global industry leaders
Trade Agreement (FTA) partners. Regional
may find their victories short lived if they
harmonization offers many benefits, and it
win major concessions in new markets on
can be a step toward global standards.
insurance market liberalization through
The International Association of Insurance
WTO and bilateral free trade agreement
Supervisors has articulated the Core
negotiations, without putting appropriate
Principles of Insurance Supervision, but the
emphasis on the concurrent development
implementation of those Core Principles has
of regulations and prudential supervision as
barely begun.
well as industry self-regulation. The hard
Given the evidence connecting insurance won market opening can backfire when
market takeoff to achievement of middle the actions of a handful of poorly regulated
income status, a case can be made that low domestic providers undermine consumer
income economies below this threshold trust, leading to adverse reputation
should concentrate limited resources on effects for all providers that may take
either specific insurance segments (such years to overcome.
as natural disaster risk mitigation) or other
sectors. In countries with limited capacity, The Road Ahead
it makes sense to undertake institutional The evidence suggests there is substantial
development sequentially for instance potential for insurance to make a greater
focusing initially on laws and regulations contribution to economic growth and social
that are foundational for overall financial welfare in many lower and middle income
sector expansion rather than specific to countries. Indeed, industry experts argue
insurance. In parallel, the growing field of that insurance lags behind other financial
micro-insurance is likely to yield products services in the extent of globalization,
and business models that contribute to providing substantial growth
social welfare and small enterprises in low opportunities.13 The large variation in
income economies, while establishing broad insurance coverage among countries at
familiarity with formal insurance and setting similar income levels, strong trend
the stage for future growth as income rises. aggregate growth and stability in a large
number of lower and middle income
3: Trade and Investment Liberalization economies, and diminishing domestic
and Insurance Markets market concentration in several countries all
Expanding cross-boarder trade and point to significant growth potential for
investment will remain key drivers of insurance with concomitant benefits for
insurance market growth. Trade fuels productivity, growth, and welfare.
insurance market growth both indirectly
1
Marco Arena, Does Insurance Market Activity Promote Economic Growth? A Cross-Country
Study for Industrialized and Developing Countries, World Bank Policy Research Working
Paper 4098, December 2006. M. Conyon and D. Leech, Top Pay Company Performance and
Corporate Governance, Oxford Bulletin of Economics and Statistics, Volume 56, No. 3, pp.
229-47, 1994.
2
Hak Hong Soo, Life Insurance and Economic Growth: Theoretical and Empirical
Investigation, University of Nebraska, Department of Economics, 1996.
3
There is some contrary evidence on this point. Thus, for instance, Adams et al (2005) find
that banking sector growth but not insurance market growth preceded growth in Sweden.
While in some specifications life and nonlife insurance do not appear to be significant
contributors to growth in the presence of an interaction term with banking, subsequent
research such as Ian P. Webb, Martin F. Grace, and Harold D. Skipper, The Effect of Banking
and Insurance on the Growth of Capital and Output, Center for Risk Management and
Insurance Working Paper 02, Georgia State University, 2002, suggests the independent
contribution of insurance is robust to the inclusion of banking sector variables, and higher
levels of insurance and banking penetration jointly produce a greater effect on growth than
their individual contributions combined.
4
Gregorio Impavido, Alberto R. Musalem, and Therry Tressel, Contractual Savings
Institutions and Banks Stability and Efficiency, Policy Research Working Paper,
the World Bank, 2001.
5
Gregorio Impavido, Alberto R. Musalem, and Therry Tressel, The Impact of Contractual
Savings Instritutituions on Securities Markets, World Bank Policy Research Working Paper
2498, 2003.
6
Thorsten Beck and Ian Webb (2003), Economic, Demographic, and Institutional
Determinants of Life Insurance Consumption across Countries, The World Bank Economic
Review, Vol. 17, No. 1, pp. 51-88.
7
Damian Ward and Ralf Zurbruegg, Does Insurance Promote Economic Growth? Evidence
from OECD Countries, The Journal of Risk and Insurance, Vol. 67, No. 4, pp. 489-506, 2003.
8
Jonathan Morduch, Micro-Insurance: the Next Revolution, forthcoming in What have We
Learned about Poverty, Abhijit Banerjee, Roland Benabou, and Dilip Mookherjee (eds.),
Oxford University Press, June 2004, provides an excellent reference for this section. See also
Stijn Claessens, Access to Financial Services: A Review of the Issues and Public Policy
Objectives, World Bank Policy Research Working Paper 3589, May 2005.
9
Caroline Moser, Reducing Global Poverty, Brookings Press, 2007.
Robert Gibbons, The Global Insurance Market Comes of Age, International Insurance
13
10