What Drives the Development of the Insurance Sector?

The insurance sector can play a critical role in financial and economic development in various ways. The sector helps pool risk and reduces the impact of large losses on firms and households—with a beneficial impact on output, investment, innovation, and competition. As financial intermediaries with long investment horizons, life insurance companies can contribute to the provision of long-term finance and more effective risk management. Moreover, the insurance sector can also improve the efficiency of other segments of the financial sector, such as banking and bond markets, by enhancing the value of collateral through property insurance and reducing losses at default through credit guarantees and enhancements.

Indeed, a growing literature finds that there is a causal relationship between insurance sector development and economic growth. However, there have been few studies that conduct look at what drives the development of the insurance sector. Of the literature that does exist, most focuses on the growth of the life sector as measured by life insurance premiums.

In “What Drives the Development of the Insurance Sector?”, Roberto Rocha, Rodney Lester, and I aimed to fill this gap by analyzing both life and non-life insurance activity in a group of 90 developing and developed countries for period 2000-08. In particular, we assessed the joint impact of a broad set of potential determinants, including new variables that have not yet been tested. Table 1 provides an overview of previous life insurance research, with grey boxes indicating areas that were not studied in the paper indicated. To our knowledge, little research has been done on the insurance sector outside of life insurance.

Table 1: Main Drivers of the Development of the Life Insurance Sector: Expected and Actual Results (Click on the image for a larger version of the graph.)

Notes: 1) N/S = Not significant; 2) Share of rural population; 3) Negative for first term, positive for quadratic term

Our life insurance results confirm some of the previous empirical research and add a few additional findings. We find that income is an important driver of life insurance, but that the size of a country’s population and population density are also important drivers. Past research had surprisingly overlooked these two variables, which show the importance of larger clienteles, deeper risk pools and scale economies, and easier distribution channels. We also find that inflation strongly hinders the life insurance sector’s development, in line with previous research. Our results also confirm that a high young-age dependency ratio drives the demand for insurance against mortality risk, while a high old dependency ratio drives the demand for insurance against loss of income at old age. Further, we confirm that predominance of a Muslim population tends to hinder the development of the life insurance sector as insurance may have unfavorable religious connotations. The results also suggest that a large social security system inhibits development of the life insurance sector by partially reducing the need for insurance but also by reducing the level of disposable income net of taxes and contributions. Finally, our findings show that strong private ownership and a sound legal framework promote the development of the life sector, as do well-functioning credit and bond markets.

The non-life insurance sector results are largely consistent with the life insurance findings. In particular, income is an important driver and Muslim predominance slows the sector’s development. The results also show the importance of institutional and market structure. As in the case of life insurance, private ownership of the industry, a strong legal framework and developed credit markets promote the development of the non-life sector. Additionally, we find distinctive additional effects of personal vehicle penetration and trade activity, particularly in small countries.

Some of the insurance sector drivers are not within the reach of policy-makers or can only be influenced over long period of time. However, the results indicate that supportive policies can contribute to the acceleration of the sector’s development. They show, for example, the importance of a stable macroeconomic framework and low inflation for the sector’s development. The positive impact of private ownership on the sector’s growth is another important finding, as the state still plays a predominant role in many countries. The insurance sector flourishes under a supportive legal framework, and also benefits significantly from developed credit and bond markets. Finally, religion plays an important role, suggesting the need for more progress in introducing insurance institutions and products more harmonized with religious beliefs, such as the case of Takaful arrangements in Muslim countries.

Further Reading:

Feyen, Erik, Roberto Rocha, Rodney Lester (2011). “What Drives the Development of the Insurance Sector? An Empirical Analysis Based on a Panel of Developed and Developing Countries”. World Bank Policy Research Working Paper 5572.