A Boost To Economic Growth

Published Date: 02 Nov 2017

Although comparing with the proven banks’ role in economic growth, the role of life insurance is relatively less explored.  Definitely, life insurance provides various financial functions that affect significantly our economic activities. The relationship between life insurance and economic growth is very profound.

To start with, insurance in general is of great importance to all kinds of societies by making many economic activities possible in addition to its contributions to the economies from the following aspects: promoting financial stability, facilitating trade and commerce, mobilizing savings, enabling risk to be managed more efficiently, encouraging loss mitigation, fostering a more efficient capital allocation and  most importantly substituting for government security programs  throughout life and medical insurance. Indeed, life insurance is important worldwide. It is found in the most economically advanced economies and the least developed.

Life insurance companies contribute to the development of financial markets by serving as financial intermediaries between investors and economic agents that need financing: households, businesses and in some cases governments ,with features different from those of banks, with regard to the timeframe of investment in particular. In the some countries, life insurers have become the largest institutional investors and a key source of long-term finance, encouraging the development of capital markets.

It has been shown that there is about 1.728 per cent increase in economic growth given 1 per cent increase in life insurance density, which is very close to the enhancement impact of banking activities on economic growth (no more than 1.8 per cent given 1 per cent increase in bank credit)

While there may be some doubt as to the quantitative impact on savings of the development of life insurance, the qualitative impact is very clear:

On savings: Unlike many commercial banks, insurers have longer-term commitments and the stability of their cash flow provide ideal sources of term financing for governments and businesses.

On the development of financial markets: Reduction of the differential between short- and long-term interest rates (the rate curve is becoming flatter). This is prompting an improvement in the financial structure of business

Moreover, life insurance can serve shift the burden from government social programs to the private sector: regarding the growing aging-related financial difficulties of the social old-age pension systems, life insurers thus take an increasingly important role in relieving the cost of social pension schemes. They, thereby, can help governments respond more effectively to the fiscal pressures that will result from ageing populations and also help boost the broader economy. A number of arguments have been advanced to explain the above.

First, it’s a classic "win-win" situation for employees, employers, taxpayers, and local business owners. Indeed, when they receive their pension check, retirees spend it in their local economy. And the business where they make their purchases sees a boost in its profits. This means that they may be able to expand their business or even hire more workers.

Prefunding pensions can also serve important macroeconomic goals:

Raise national savings:  There was found evidence of a direct impact of pension reform on total savings and hence on economic growth. They estimate that approximately half of the increase in total savings between 1981 and 2001 was due to the pension reform.

International diversification: The development of pension funds also encourages savings by offering individuals and businesses in a country a way to better access output produced in foreign countries which may not be suffering the same demographic and economic shocks, raising national welfare.

Lastly, in developing countries, where financial systems are underdeveloped, prefunding pensions may contribute to economic growth by improving access to finance for productive activities. Pension funds and other institutional investors such as life companies can also help improve the operation of financial markets by making markets more liquid, efficient and transparent by for example, encouraging the modernization of market trading and engaging in shareholder activism. They can also act as a countervailing force to commercial banks and stimulate financial innovation. However, a high and sudden demand by pension funds for local assets could have a distorting impact, and therefore should be managed with care. While it is difficult to quantify such macroeconomic effects and isolate them from other factors, the few studies that have attempted to do so have found relatively large effects

To conclude, there is fairly strong evidence in favor of the hypothesis that life insurance development contributes to economic growth. This relationship is more significant for pension schemes than for other life insurance products. However, the positive impact that Life insurance activities have on economy, may vary across different countries .The result indicates that life insurance business, play a much more important function in developing economies than they do in developed countries