Insurance Development and Economic Growth

There has been a great interest in the role of financial institutions in economic growth. Economists refer to some work of researchers in the late 19th and early 20th centuries who discussed the significance of finance for economic growth.

In recent times, a number of studies have analysed various issues with respect to the role of the banking sector in economic growth. The most prominent studies have been conducted by Levine and his colleagues.

For instance, King and Levine1 demonstrated the connection between bank development and economic growth, which was confirmed by later studies such as Levine, Beck et al., Levine et al., Rousseau and Wachtel, and Beck and Levine.

The studies of the relationship between financial development and economic growth have been shown to be robust using different econometric methods. For instance, Levine and Zervos3 used crosscountry regressions, whereas Levine4 used cross-country instrumental variables regressions.

The recent studies by Beck et al., Levine et al., and Beck and Levine5 used dynamic panel GMM estimations, whereas Rousseau and Wachtel6 used panel Generalised Method of Moments (GMM) estimation for a Vector Autoregression (VAR) model.

Although comparing with studies on banks’ role in economic growth, the role of insurance is relatively less examined, there has been increasing literature on this issue recently.

Insurance is of great importance to a modern society by making many economic activities possible in addition to its contributions to the economies in terms of its size, employment, managed assets, and so on. In fact, economic growth is characterised by the soundness of a national insurance market.

Outreville emphasised on the importance of property-liability insurance and life insurance, respectively, in developing economies and their growth. Skipper stated that insurance contributed to the economy from the following aspects: ‘‘

Promotes financial stability and reduces anxiety;
Can substitute for government security programs;
Facilitates trade and commerce;
Mobilizes savings;
Enables risk to be managed more efficientl;
Encourages loss mitigation;
Fosters a more efficient capital allocation ’’.

Sigma, Enz, and Ward and Zurbruegg described the relationship between insurance market development and economic development as an ‘‘S Curve’’, which stated the starting sharp and then smooth increase of insurance development corresponding to the lower and higher stages of economic development, respectively.

Ward and Zurbruegg14 argued the insurance contributions to economic growth from the following aspects: risk transfer and indemnification services and financial intermediary services.

They further analysed the above two economic contributions in terms of the following factors: productivity improvement and innovation facilitation for the former services and production efficiency enhancement, investment opportunity increases, reduction in the waste of early monetary realisation, and insurance institutional monitoring benefits for the latter services.

Webb et al. 15 argued that life and property/liability insurers can contribute to economic growth from the following aspects:

Life insurance can increase productivity by reducing the demand for liquidity and by shifting from unproductive use to more productive use of resources. This is similar to the role of banks on investment quality documented by Pagano.
Property/liability insurers provide an extra risk-financing choice, which potentially reduces the probability of firm financial distress and firm bankruptcy costs. This influences investment decisions in a particular economy.
Insurers may potentially increase expected investment returns by reducing the costs of risk financing, because insurers can:

Excel in offering risk-pooling services through the identification of standardised risks and simplification of contracts,
Provide optimal investments and asset-liability matching,
Provide valuable and cost-effective administrative services related to risk management and claims payments, and
Offer products that are tax-deductible business expenses in many markets’’ (p. 6).

Regarding the theoretical relationship between insurance and economic growth, Webb et al. 16 has a detailed argument.

According to Webb et al., based on a Solow-Swan neoclassical growth model, assuming a Cobb-Douglas type of production model, which states that production growth is due to labour, capital, and technology, the following factors should be added in the augmented growth model: financial activities of property/liability insurers and life insurers, which with banks may measure the differences in productivity and investments based on institutional factors and savings rate.

As can be seen from the above analysis, it is expected in this paper that insurance activities should have a positive impact on economic growth. However, this impact may vary across different countries and across different lines of insurance business.

The empirical results of this paper, by employing GMM models on a dynamic panel data set of economies for the period 1994–2005 and controlled by a simple conditioning information set and a policy information set, have shown that insurance development is positively correlated with economic growth.

This paper reports the analysis of insurance development and economic growth by breaking them into life and non-life insurance as well as developed and developing economies.

It has been shown that for the developing economies, the overall insurance development, life insurance and non-life insurance development play a much more important role than they do for the developed economies.

This finding has significant policy implications in that ‘‘it could give empirical ground to the micro-insurance policy strategy of the World Bank and the UN-ISDR and nicely complement the theory of the wealth effects of insurance’’.

The remaining parts of this paper are structured as follows: the following section discusses the data used in the empirical analysis and the econometric methodology. The penultimate section discusses the empirical results. The final section concludes.

Location: Indonesia