As noted above, patterns of insurancecoverage suggest a positive correlation withincome – at least up to a point where thevalue of insurance begins to diminishrelative to the value of overall householdassets. But this does not tell us anythingabout the potential social value of insuranceprovision at lower levels of income – onlythat poor consumers either do not orcannot purchase insurance at currentlyprevailing prices and availability. Moreover,insurance market development faces manyspecial informational challenges that havebeen extensively documented in economicresearch even in wealthier countries. Putsimply, insurance is likely to be relativelymore expensive – even prohibitively so –for low income households and small-scaleentrepreneurs because of the highinformational problems and transactionscosts relative to the size of the risk to beinsured. As a result, most types of insuranceare simply not available to the vast majorityof the world’s poorer citizens.
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In the absence of risk pooling mechanisms,plunges in incomes due to death, disability,and adverse agricultural outcomes oftentranslate into substantial decreases inconsumption and investment that canpermanently set back a poor family’slivelihoods and prospects. When drought orfloods lead to low agricultural yields, criticalhealth interventions may be delayed,education of younger members of ahousehold put on hold indefinitely, andland, livestock or equipment permanentlyforfeited. Due to the catastrophicconsequence of such losses, there isextensive evidence that in the absence offormal insurance poor households andcommunities attempt to ‘self-insure’through a combination of building assets
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and diversifying sources of income. Theresult most likely is investment in a set oflower risk but also lower return activities –and even this degree of self-insurance ishighly incomplete.There are also a variety of mechanisms thathave emerged at the community level, suchas community pooling of informal insurancecontributions to cover burial costs.Community-based insurance mechanismssurmount the problems of transactionscosts and lack of legally enforceablecontracts through personal relationshipsand piggybacking on traditional small-scalefinancial collection mechanisms, similar tothe early stages of micro-credit. However,they offer only feeble protection in the faceof community-wide, covariate shocks, sincethey do not typically pool risk acrossbroader populations and are limited inthe types of products they can provide.For micro entrepreneurs and farmers, thenet result can be a significant drag onoverall economic performance as theychoose to invest in activities that might offerthe best risk-return profile from an individualpoint of view but are suboptimal from aneconomy-wide point of view where a higherreturning but riskier set of investmentsmight lead to better aggregate outcomes.High transactions costs are the mainimpediment standing in the way of asystematic shift from informal to formalmechanisms for managing and pooling riskfor poorer households and smallentrepreneurs. As such, the emerging fieldof micro-insurance faces many of the samechallenges faced by micro-credit twodecades ago in developing creativemechanisms for reducing or subsidizingtransactions costs. Indeed, micro-creditinstitutions are among the first to ventureinto micro-insurance products, and theirmost popular initial insurance productoffering was ‘credit-life’ insurance to payoff any debts associated with outstandingmicro-credit loans in the event of death.As this field expands, it might follow atrajectory similar to that of micro-finance,perhaps starting with NGO providersfunded on a philanthropic basis, but rapidly
What is the role of insurance in economic development?
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expanding to include commercial partnersas financial intermediaries as scaleablebusiness models emerge.In parallel, in some countries the publicsector is taking a greater interest in theprovision of social insurance to poorerpopulations – through subsidized publicinsurance schemes for health, naturaldisasters, or weather-related crop insurance.Government mandates for compulsoryinsurance also expand the coveredpopulation although the difficulty ofachieving risk-based pricing can lead tomarket distortions.
1: Household Insurance:
Micro-finance providers and othercommunity-based financial intermediarieshave begun to diversify into insuranceproducts. In Uganda, 2 million people havepurchased life insurance bundled withsavings and micro-credit. Burial insurance isgrowing rapidly in other areas, and there aresome experiments with property insurancesuch as for livestock and dwellings.
2: Natural Disasters, Weather, andCrop Insurance
There should be enormous potential fornatural disaster and weather insurance toimprove the performance of lower incomeeconomies, which tend to be morevulnerable to high volatility in incomes dueto commodity price fluctuations and naturaldisasters due to poor building codes andinfrastructure. Current investments in newproducts and innovations in weather andnatural disaster insurance should befollowed closely, as it is anticipated thatclimate change will exacerbate theincidence of weather patterns and naturaldisasters in many poor areas.In recent years, the World Bank and otherdonors have been involved in experimentsin countries such as Turkey and Mexico thatprovide earthquake risk insurance financedthrough a combination of reinsurance andthe capital markets. In areas of Asiaand Africa, there is growing interest inweather derivatives to insure againstweather-associated agricultural losses.These are designed to sidestep thetraditional incentive (moral hazard)problems associated with crop insuranceby using independent measurements ofweather outcomes such as rainfall ratherthan crop yields.
3: Health Insurance
As with the wealthier economies, thedevelopment of health insurance markets indeveloping economies depends on thecomposition of health delivery providers –whether private or public – and thegovernment’s involvement in healthinsurance provision. However, there is astrong tendency in poorer economies forhouseholds to bear responsibility for payinga much higher proportion of overall healthcosts out of pocket than in richereconomies, which leads to underinvestmentin health services (particularly on thepreventive side) and vulnerability to health-related consumption shocks. Thus, a strongcase can be made for improving healthoutcomes in poor countries through a variedcombination of public and private insuranceprovision depending on the institutionalsetting. Indeed, countries such as Mexicoand Colombia have undertaken interestingreforms in this area in recent years, and thisis likely to be an area of strong growth.
4: Small-Scale Entrepreneurs
The economic contribution of smallenterprises to middle- and high-incomeeconomies is well-known. However, in manypoor economies, start-ups and small-scaleenterprise fall short of their potential due toa variety of barriers, including access tocapital. As attention to these barriers grows,it is critical to put insurance high on the list.While the risk appetite of large corporationscan be debated, small scale entrepreneurswhose household wealth is tied up in their
What is the role of insurance in economic development?
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business enterprises are undoubtedlypreoccupied with managing risk. In theabsence of risk management tools providedby formal insurance, there will be a tendencyto under invest in higher risk, higher returnactivities, thus diminishing the potentialcontribution of the critical small and mediumsized enterprise sector to employment,investment, and growth overall.In sum, extending accessible insuranceproducts to poor households and smallscale entrepreneurs should be a core part ofthe agenda of democratizing access tofinancial assets. When successful programsare taken to scale, it will not only addmeasurably to social welfare but also holdthe promise of generating a moreproductive and higher growth mix ofactivities and investments – with a payoffperhaps greater than micro-credit.
Globalization of Insurance markets
Although the evidence suggests thatinsurance market deepening should be apriority in the financial sector strategies ofdeveloping countries, awareness of the roleof insurance lags behind that of bankingand capital markets. For these reasons, it isimportant to raise the visibility of this sectorand to clarify what unique regulatoryprovisions might be needed to enableinsurance market development alongsideother facets of financial deepening. Formany countries, a good starting pointwould be to include analysis andrecommendations specifically for insurancein financial sector assessments.
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1: Institutional Foundations for InsuranceMarket Development
The development of robust insurancemarkets generally requires many of thesame foundations as for banking andfinancial market deepening: reasonablemacroeconomic and political stability, clearproperty rights, enforceability of contracts,and safeguards against corruption. However,these are necessary but not sufficientconditions. Insurance market deepening alsodepends on the scale and growth of relatedmarkets, including sales of cars and otherconsumer durables, residential andcommercial mortgage markets, businessestablishments, disposable income, andcommercial and trade transactions, to namea few. Growth in these related markets iscritical in order for the nascent insuranceindustry to reach scale in developing sharedinfrastructure, underwriting capacity,statistical databases for actuarial purposes,and the associated skills.A variety of public goods are critical for jump starting and sustaining the growth ofdomestic insurance markets. These includethe collection and sharing of data on aconsistent basis, common supervisoryprinciples, for instance on reserves andsolvency, and consumer education.Recognizing the critical role of such publicgoods, several of the multinationaldevelopment banks, internationalassociations of regulators and supervisors aswell as private sector associations arealready active in providing technicalassistance on all of these dimensions.
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According to an in-depth survey of thefactors that have slowed the expansion ofinsurance markets in Latin America, theregion’s insurance professionals view thelack of sufficient education about insuranceas the greatest impediment to marketdevelopment. They also cited lack ofconfidence in the effectiveness of the judicial system and law enforcement’sfailure to collect information about theftsand automobile accidents as keyimpediments to market development.
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2: Insurance for Different Stages ofEconomic Development
Although there is broad agreement on theneed for adequate regulatory andsupervisory frameworks, there is somedebate on the content of these frameworks,
What is the role of insurance in economic development?
