Role of the Insurance Industry in Economic Development

What Role has the Insurance industry In Economic development? The insurance industry has come a long way from ship owners, merchants and underwriters gathering in Edward Lloyd’s coffee house in London to discuss their marine voyages to new colonies of the British Empire. Over the years, Insurance has become essential in our everyday lives. Something we just can’t live without. Our Economics and Societies are growing phenomenal rates and have become more and more interconnected on the rest of the world, the risks exposed to us become more unpredictable and hazardous.The need to protect against unfortunate events has been around as long as human beings existed. Individuals have always recognised their need to alleviate risks that have the potential to ruin the. At the dawn of modern history, widely dispersed groups of tightly knit hunter-gatherers, relied almost exclusively on clan relatedness as their only bulwark against the ever-present risk of death, debilitating inju ry and starvation.For those early ancestors, the concept of risk always existed, exclusively in terms of the physical persons of individuals, mitigated by the guarantee of personal and kin relationships, rather than objects and possessions. (Buckham et al 2011, pp. 1-9). According to Lopez and Raymond 1967, in antiquity, a sea loan was the first sign of transferring risk. A number of German and Italian jurists have regarded it as something close to insurance. It involved a ship owner promising to transport goods belonging to a merchant and at the same time providing a loan, somewhat of a guarantee.If the ship and the goods arrived safely to its intended destination, the merchant returned the loan but if they didn’t arrive safely, the loan was not returned. From its origins in ancient times, the insurance industry has evolved into an essential service in our society and a â€Å"key component for economic development† (Liedtke 2007). Our lives are progressing rapidly, th ere is a significant increase in the general population, technology and science is continuously maturing and the world is becoming smaller.The insurance industry is now faced with challenging obstacles through â€Å"the liberalisation of insurance and capital markets, changing demographics, volatile stock markets, the shifting of climate patterns and the rising numbers of natural and manmade disasters and subsequent losses† (Ayadi and O’Brien 2006). â€Å"The global risk landscape is growing and the size of potential losses is continuously increasing† (Coomber 2006). Society has progressed significantly from ancient times and our need of insurance has drastically transformed accordingly.The increasing sense of ambiguity and uncertainty in our lives regarding our future economic prosperity and the devastating impact of catastrophic events has certainly reinforced the need for insurance to shield us against new and emerging risks. This paper asks the imperative qu estion: What role has the insurance industry in our economy development? The Importance of the insurance industry for an economy can only in part be measured by the sheer size of its business, the number of its employees in a given country, the assets under management, or its contribution to the national GDP.But insurance is not just about employment and the financial compensation of Victims. It actually plays a more fundamental role in the workings of a modern society, it creates huge capital assets. Due to the nature of insurance contracts which usually involve long time periods, money coming from insurance, usually stays in the financial market of a given economy for quite some time. It is not a fickle investment capital that rushes around looking for quick gains, it is oriented toward the medium to long term. It creates a stable environment by allocating assets according to market forces where needed (Liedtke 2007).There are six main areas where the insurance industry fosters ec onomic growth. I will now go into detail on these six areas (CEA 2011). Private insurance improves firm’s financial soundness: Insurance allows firms to expand and take on economic risk without the need to set aside capital. If a firm did not have adequate business insurance cover this could be harmful particularly for small firms. Small firms have limited capital and have difficulty in accessing financial markets which make them particularly vulnerable to adverse events.Without insurance large contingency funds would have to be in place to protect firms against risk. For most small firms this would represent more capital than they presently employ which would not be viable for most small firms and this would lead to a reduction the population of firms. Fostering entrepreneurial attitudes, encouraging investment, innovation, market dynamism, and competition: To be innovative you have to take risks. Since entrepreneurs just like ordinary people are characterised by risk aversi on, the willingness to take risks can be considered a scarce resource (Kugler and Ofoghi 2005).More will be produced if greater risk is taking. Well developed insurance markets contribute to the development of an economy by helping to optimise the allocation of the scarce resource of ‘risk taking’ by moving it from a conservative to an innovative and high profits activities. On the other hand uninsured firms are very conservative and generally do not exploit new business opportunities and invest less in innovation and their degree in the global markets is low. Offering social protection alongside the state, releasing pressure on public sector:In all industrialised countries a major problem is not too far down the line. Due to improvements in healthcare and quality of life population’s structures in industrialised countries are changing where people are living a lot longer and at the same time the birth rate has also decreased. People are also expecting to receive a high level of healthcare, pensions, unemployment allowance and other social benefits. This raises great concern as public expenditure will be put under huge pressure and will lead to significant decreases in economic growth.The role of the insurance industry is vital to provide an additional pillar alongside the protection supplied by the state. Insurance products like payment protection insurance play a vital role in protecting household in times of unemployment in an economic downturn. Many industrialised countries such as the United Kingdom provide free healthcare to its citizens. In the future what we are going to see is the health system in these countries being privatised and individuals buying private health insurance. Currently 47% of the Irish population have health insurance (Nolan 2006).Similar systems will have to be introduced to the pension systems. These measures will help reduce government expenditure on these areas and in the long run help with the development of the economy in the countries. Enhancing financial intermediation, creating liquidity and mobilizing savings: Insurers are massive institutional investors in the economy with over 11% of worldwide assets in 2007 (Munich RE 2007). They therefore see benefit in the development of a modern , competitive financial market that facilities firms access to capital and offers a wide range of investment opportunities.In this respect insurance companies look favourably upon initiatives taken by governments to ensure shareholder rights and to maintain high standards of corporate governance. Promoting sensible risk management by firms and households, contributing to sustainable and responsible development: Insurers risk assessment is reflected through in price and policy conditions. In this way they offer firms and households an indicator of their level of risk. Firms and households in can take action to reduce the risk by engaging in risk management.Risk management is the process of gauging or accessing risk and developing strategies to manage it (Squiddo 2012). Therefore by means of risk pricing insurance encourages sensible risk management. Both the client and the insurer benefits from sensible risk management as the client’s premiums are reduced and the chances of the insurance company having a claim are also reduced. This process influences investment decisions and thus contributes to the development of the economy. Fosters stable consumption throughout life: Consumption is the main driver of economic growth as its accounts for over 80% of GDP.By having insurance it offers lifelong financial protection and allows stable consumption throughout an individual’s life. * Insurance for house and other damages allow individuals to secure assets in case of an adverse event. * Liability insurance covers household for damages that might occur to other people. * Life insurance protects relatives in the event of a death and also provides financial support in retirem ent. * Health and accident insurance provides cover when it is needed most. * Credit insurance eases consumption but does protect against excessive debt through pricing and acceptation policies.Another new phenomenon in the insurance industry is Micro insurance. It aims to alleviate poverty, distribute products in new ways and create sustainable financial growth for individuals, families and small scale businesses in underdeveloped countries. The need to provide insurance products is vital if their economies are to develop. People in underdeveloped countries are most at risk to adverse events and they have a significant negative impact on their lives. When a hurricane, flood or other adverse events occur and their homes are destroyed or their livestock is wiped out, these people have no financial compensation.These communities have to start from scratch. Insurance companies recognise that the poor require a range of insurance products that meet their needs. Zurich was an early mover in micro insurance, when it started its first micro insurance programme in Bolivia in 1999. It hasn’t been an easy move due to a lack of trust and confidence by people in underdeveloped countries but if these problems can be resolved there is huge potential for growth in the market and also for a dramatic improvement in economic development in these countries (Pope 2011).Conclusion: When we think of economic development, most attention is devoted to the relationship between the financial markets and economic development with insurance only receiving a passing mention. However in recent times there have been several interesting lines of research into the role the insurance industry plays in economics development. I have shown in this paper how the insurance sector plays a fundamental role in the development of our economy and without insurance we would live in a world that would be less economically developed and much less stable.Insurance supports research and development, i nnovation and new technologies, it supports economic stability and sustainable growth and also supports the sustainable use of resources and helps modernise social protections systems. The evidence suggests that there is substantial potential for the insurance industry to make a greater contribution to economic growth especially in lower and middle income countries. Currently insurance lags behind financial services in the extent of globalisation, but if we can continue to expand the insurance industry we will see substantial growth opportunities.Bibliography Ayadi, R. and O’Brien, C. 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