Health insurance

Given the lack of global information on insurance market development, USAID contracted Chemonics International and the International Insurance Foundation to assess 1) the link between strengthening the insurance industry and economic growth and development in developing countries, and 2) possible donor interventions that would support the development of insurance products in different types of countries, with what preconditions and for what level of investment.

LINKS BETWEEN INSURANCE DEVELOPMENT AND ECONOMIC GROWTH This report summarizes what is known regarding insurance market development and growth, as expressed in existing research by leading financial sector and development specialists. The report also considers the current state of insurance market technical assistance, and examines key relationships between insurance and economic growth indicators using an international insurance dataset.

The three key findings that arise from this analysis are: 1) countries are much more likely to experience sustained growth if their insurance markets develop well; 2) insurance market development is closely related to improved financial sector performance; and 3) insurance markets do not develop adequately without both public and private sector investment in their infrastructure. The research reviewed identifies the links between insurance, financial sector performance and growth in substantial detail, helping define the insurance – economic growth relationship and supporting the policy conclusions of this report.

The thrust of these links is that insurers encourage a greater efficiency and depth in the financial sector, by complementing, competing, and otherwise improving the services offered by other financial institutions. Some of the specific points made are summarized below: • Insurers measure and manage non-diversifiable risk faced by creditors and borrowers more efficiently than other financial institutions, facilitating the provision of credit.

• Because of their success in marketing contractual savings products and the nature of their liabilities, life insurers (and to some extent non-life insurers) can be an important source of long-term finance. • Insurance facilitates investment in infrastructure and high-risk/return activities, by generating sources of long-term finance, and helping measure and manage high-risk exposures. • By mobilizing substantial funds through contractual savings products, and investing them in bonds and stocks, insurers help stimulate the growth of debt and equity markets.

• As institutional investors, insurers pressure equity markets to adopt stronger corporate governance measures and greater transparency.

LINKS BETWEEN INSURANCE TECHNICAL ASSISTANCE AND GROWTH Despite the existence of substantial research linking insurance market development and economic growth, there is yet little data showing direct causality between technical assistance to the insurance 1 industry and growth.

The case for technical assistance is, however, quite compelling: both the role that insurance plays in economic growth and the need for insurance market technical assistance in emerging markets are clearly shown. This fact no doubt has much to do with the increasing attention paid by While data on this topic is scarce, a number of cases known to us, including India (see Box 4. 1), Mexico (see Box 5. 1) and Eastern European countries (see Box 6. 1), describe situations in which substantial insurance market technical assistance played a part in developing the insurance industry and increasing economic growth.

1 iii leading donor agencies to insurance market interventions in the last decade. Well-designed technical assistance to the insurance market as a means to more rapid development of the financial sector and increased economic growth is becoming an essential component of the widely recognized development framework.

STAGES OF INSURANCE MARKET DEVELOPMENT It is easier to understand how to strengthen insurance markets by first understanding their development cycle.

To perform well and grow, insurance markets require investment in infrastructure, which includes institutions, technical resources and capacity, as well as the existence of suitable economic, legal, and political environments. This paper identifies the internal building blocks of market infrastructure, as well as the external environmental factors, that are commonly decisive during each of the four stages of insurance market development: 1) dormant; 2) early growth; 3) sustained growth; and 4) mature.

STRATEGIES FOR TECHNICAL ASSISTANCE To assist donor agencies and policymakers determine which countries might benefit most from insurance market intervention, this report provides a preliminary means to compare levels of insurance market over or under-development, and assess its consequences for the potential economic pay-off from insurance market technical assistance. The report also provides guidance on selecting the most relevant type of technical assistance for a particular country, based upon its stage of economic, political, and insurance market development.

The various types of insurance market technical assistance that are recommended include the following: • Conducting insurance sector assessments, ideally in conjunction with financial sector assessments to encourage synergies and cost savings. • Improving insurance regulation and supervision by encouraging the application of International Association of Insurance Supervisors’ core principles and other global best practice standards.

• Encouraging the collection and sharing of insurance data, possibly through public-private partnerships with the Insurance Services Office, the Insurance Data Management Association, and Standard and Poor’s, among others. • Building actuarial resources through the development of formal education and apprenticeships that emphasize experiential learning. • Supporting professional insurance education, by providing access to or developing a range of offthe-shelf training materials in a broad range of topics and adapting them to local environments, as well as supporting scholarships and exchanges.

• Educating markets and consumers on standards by facilitating exchanges of information, establishing a self-regulatory industry organization, and providing models of consumer education websites. • Encouraging ethical market discipline by disseminating adequate information (possibly through rating agencies) and ensuring proper incentives and enforcement. • Promoting institutional development in multiple ways, from developing actuarial databases and strengthening information systems to product development and marketing.

• Connecting regulators with the private sector by nurturing effective communication links between insurance supervisors and private sector executives. These donor agencies, which have been and are continuing to pay more attention to insurance market technical assistance, include The World Bank (and International Finance Corporation), Asian Development Bank, the Financial Services Volunteer Corps, Inter-American Development Bank, among others. 2 2 iv • Facilitating new insurance markets, especially for rural and low-income populations.

ADAPTING TECHNICAL ASSISTANCE STRATEGIES TO THE COUNTRY CONTEXT To help ensure technical assistance generates the greatest economic impact, strategies should be adapted to the local context. Below are additional factors to consider for fragile, stable/transitional and strategic states.

FRAGILE STATES The goal in fragile states is stabilization, reform and recovery. • Establish a sound legislative or regulatory foundation, to the extent it can be resilient to economic or political instability, to nurture a potential insurance market and to guard against financial crimes.

• Increase risk management awareness and planning at the national, provincial, and local government levels for eventualities, such as natural disasters, and for general safety concerns, such as fire or industrial accidents. • Encourage the establishment of the preconditions for insurance transactions, such as rule of law, property rights, property registries, and monetary stability, and support democracy and governance initiatives to enhance voice and accountability. • Design assistance in a way that minimizes conflict, for example, by taking into account Islamic principles


Donors can have the greatest impact in transitional states in the early and sustained growth stages of insurance market development. • Assess weaknesses and opportunities related to data collection, professional education, actuarial capacity and market conduct. • Provide technical assistance to prepare for the IMF/World Bank Financial Sector Assessment Program (FSAP) and to complete the International Association of Insurance Supervisors (IAIS) selfassessment. Follow up by helping insurance companies and supervisors implement global standards.

• Increase transparency and efficiency of the insurance industry to enhance the public’s perception of and confidence in insurance.

STRATEGIC STATES Additional technical assistance can be extended to strategic states, as more resources usually become available to them when they take on additional importance. However, any assistance should be based upon the type of state as described above, in line with the country’s level of insurance market development.

v II. INTRODUCTION Although insurance has become a widely used financial service since first introduced in ancient Greece, its benefits have yet to reach much of the developing world.

USAID contracted Chemonics International and the International Insurance Foundation to examine how, and to what extent, insurance sector technical assistance in developing countries could help build reliable and effective financial sectors and support growth. Specifically, this report assesses the link between strengthening the insurance industry and economic growth, as well as possible donor interventions that would support the development of insurance products and markets in different types of countries.

Section III of this report reviews studies by leading economists and researchers that link insurance with increased financial sector depth and efficiency. The findings from these studies suggest that when insurance markets have the necessary capacity and infrastructure to deliver their variety of services, synergies arise between insurance and other financial services that improve financial sector effectiveness and economic productivity. Sections IV and V describe the internal and external factors that have the most impact upon the development of an insurance market during its four stages of development.

The external factors include specific issues within the economic, legal and political environments, while the internal or industry-specific factors consist of the institutional development of the building blocks of the insurance sector. Tied to how varying economic and institutional environments within a country affect insurance market development is a menu of possible technical assistance interventions.

Section VI concludes with recommendations on how USAID can fashion effective insurance technical assistance strategies. This section begins by presenting a tool for estimating an economy’s insurance deficiencies and its potential to receive economic benefits from insurance market intervention.

Guidelines are also provided for assessing insurance market needs and identifying the most opportune types of intervention based upon a country’s economic, political, and insurance market stage of evolution. Finally, some suggestions are given regarding cost-effective delivery mechanisms for technical assistance.

1 III. INSURANCE, FINANCE AND ECONOMIC DEVELOPMENT The research reviewed in this report links insurance market development to financial sector effectiveness and economic growth.

Research on insurance markets is limited, compared to what is available on banks, partly because insurance market analysis involves considerable difficulties in data collection and comparability. Nevertheless, research on insurance and economic growth is gathering momentum as more reliable data becomes available.

INSURANCE DEVELOPMENT’S CONTRIBUTION TO ECONOMIC GROWTH A review of international cross-country data over the last 40 years reveals that insurance consumption is not only strongly correlated with economic output; its growth actually outpaces that of the economy.

The data also shows us that the growth of insurance consumption (measured as insurance penetration or total premiums as a percentage of GDP) generally follows what is referred to as an “S-Curve”: it is slower at lower levels of development, accelerates as the insurance market and the economy expand, and then slows down again as the market matures. A similar pattern is seen with the growth of life insurance consumption worldwide. Figure 3. 1 illustrates the S-Curve relationship between GDP and non-life insurance growth.

The vertical dotted lines are approximate delineations of the four stages of development that most insurance markets go through:, dormant, early growth, sustained growth and mature. These stages have consequences for technical assistance, which are explained in Sections IV and VI and Annex C. The scatterplot portrays changes in insurance and economic development over time, as well as across countries. This general relationship is reviewed in Swiss Re (2004), Erbas and Sayers (2005), and Outreville (1996). Figure 3. 1: The S Curve of Insurance Market Development

Increasing Insurance Penetration Vs. Economic Growth 6 0 Non-Life Premium as % of GDP 2 4 1000 10000 Real GDP per capita in constant 1995 USD Yearly Data for 59 Countries from 1960 – 2000. Source: Swiss Re & World Bank 100000 2 Property-liability insurance can be used to cover a variety of risks facing the economy’s infrastructure (such as fire, flood, mechanical failure, and the loss of income from business interruption). However, the use of these coverages to protect the infrastructure is largely dependent upon the existence of efficient and capable insurance markets.

The statistics reflected in Figure 3. 1 demonstrate that economies which have had greater access to insurance coverages have over time experienced more growth. This relationship between insurance use and growth dates back to the early days of industrialization of many of today’s leading economies. Great Britain, which played a large part in contributing to the development of modern insurance market know-how and practices, turned to various forms of insurance early on its it economic development. Figure 3.

2 plots the total sums of fire insurance (in British pounds) against the index of industrial production in Great Britain between 1790 and 1862. During this period, Britain’s industrial production and its demand for insurance coverage to protect its physical assets and productive capacity increased almost in tandem. This relationship between business expansion and fire insurance consumption (by creditors and investors who wished to protect their ownership interests in industrial infrastructure) reflects the persistent demand for property-liability insurance that is generally seen during economic expansions worldwide.

Researchers have looked at insurance markets in different countries and over different time periods, applying econometric techniques to separate and control for the effects of many known factors in growth, as well as to identify the probable causal direction between these factors and growth. Many of these researchers have attempted to answer the question: does insurance contribute to growth, or is it simply a by-product of economic growth? These studies have sought not only to understand whether insurance makes an important contribution, but also if this contribution can be measured empirically.

This report collected and reviewed relevant research on this topic, the results of which are summarized below. Studies testing the causal relationship have found evidence that insurance market development is a 3 supply-leading phenomenon. While the number of studies carried out to date is limited, being greatly constrained by the lack of available insurance data, the few existing studies present a number of strong arguments, backed up by rigorous and methodological data analysis, advancing the conclusion that insurance is an agent, and not just a by-product, of growth.

Using Granger causality tests, Soo (1996) found that life insurance contributed to the productivity and economic growth of the United States 4 over a 30-year period. His study concluded that much of life insurance’s impact on growth was likely due to the huge contribution that life insurance made to U. S. financial intermediation and investment over this period. A follow-up study by Kugler and Ofoghi (2005), using Granger causality tests with disaggregated measures of specific classes of life and non-life insurance in the United Kingdom, found that eight out of nine classes of insurance showed evidence of causing economic growth in the UK.

The results implied that stronger causal relationships between insurance and growth could be found across countries if the bias introduced by using aggregated measures of insurance were avoided. In a larger, multiple-country study, using a different econometric technique, Webb, Skipper and Grace (2002) found that both banking and life insurance penetration were robustly indicative of increased productivity (as measured by increase in growth rate of real GDP per capita) in 55 countries over the 5 period from 1980 to 1996.

Patrick (1966) noted that the correlation between financial activity and economic growth could be either supply-driven, where a greater supply of financial sector capacity and activity drives economic growth, or demand-following , where greater financial activity and capacity merely follow economic growth because there is a greater demand for it as the economy grows. 4 While causality in the strict scientific sense of “A causes

B” generally does not apply in the sphere of economic events due to inability to control conditions in a laboratory sense, econometricians have developed techniques that can suggest the likelihood that there may be a causal relationship between events. One such technique uses time series analysis with what is referred to as “Granger causality tests. ” Granger causality analysis essentially identifies a variable “x” as causing variable “y” if taking into account past variables of “x” makes possible better prediction of “y.

” 5 Results from this study are shown in table A in Annex A. 3 3 FIGURE 3. 2: CORRELATION BETWEEN FIRE INSURANCE AND GROWTH Fire Insurance and the Growth of Industrial Production 1000 Great Britain: 1790 – 1860 200 1790 Millions of Pounds 400 600 800 1810 Year 1830 Source: L. T. Little (1937) 1850 Index Industrial Production Sums Insured Against Fire The studies reviewed in this section included variables to control for other influences on growth, as well as econometric techniques to account for the likely impacts of exogenous factors and reverse causality.

Their results provide solid econometric support for the premise that economies that experience more growth do so in part because they have access to efficient and effective insurance products. INSURANCE’S ROLE IN FINANCIAL SECTOR DEVELOPMENT. The depth and efficiency of a country’s financial sector largely determine how well its economy allocates resources. Wide agreement has been reached regarding the importance of a strong financial sector to economic growth.

Greater financial depth (i. e.greater variety and availability of financial services and instruments) advances economic growth by providing economic agents more 7 opportunities to save, invest, and borrow. Financial efficiency is a measure of how cost effectively these economic agents operate. Greater financial depth and efficiency translate into increased levels of financial intermediation, investment, and productive resource allocation. The mechanisms through which insurance works to stimulate economic growth revolve around the role insurance plays in deepening and improving the efficiency of the financial sector.

Studies show that insurance influences financial activity in the following ways: • Insurers measure and manage non-diversifiable risk faced by creditors and borrowers more efficiently than other financial institutions, facilitating the provision of credit. 6 6 By financial sector development, we are referring to financial and capital market development, including the major indicators of financial sector depth and efficiency, as well as capital market liquidity and transparency.

Contractual savings institutions are institutions such as life insurers and pension funds that collect savings from individuals on a contractual basis, as do life insurers and pension funds, allowing customers to plan for their future. These institutions are often institutional investors as well, and as such, channel large amounts of funds into the capital markets and other investments. 7 A common measure of financial depth across countries and over time is the ratio of currency to narrow money (M1) or the ratio of broad money (M2) to nominal GDP.

This measure somewhat crudely attempts to measure how well the financial sector caters to savers and how well it serves borrowers who want to raise capital for real long-term investment. 4 • Insurers generate price signals for risk that enables the economy to allocate its resources more efficiently among activities. • Insurers often offer more competitive and long-term contractual savings vehicles than other financial institutions. • Because of their success in marketing contractual savings products and the nature of their liabilities, life insurers (and to some extent non-life insurers) can be an important source of long-term finance.

• Insurance facilitates investment in infrastructure and high-risk/return activities, by generating sources of long-term finance, and helping measure and manage high-risk exposures. • By mobilizing substantial funds through contractual savings products, and investing them in bonds and stocks, insurers help stimulate the growth of debt and equity markets. • As institutional investors, insurers pressure equity markets to adopt stronger corporate governance measures and greater transparency.

The amount of lending by financial institutions to the private sector is one of the best indicators of the efficiency of a country’s financial system, as there will be a greater demand and supply of credit when financial institutions can measure, manage, and price risks better and when borrowers, lenders, and investors can transact with lower costs. Figure 3. 3 shows that for 59 developed and developing countries from 1960 to 2000, property liability insurance premiums strongly correlated with financial sector efficiency, as measured by credit extended to the private sector.

INSURANCE CONTRIBUTES TO AND IMPROVES THE EFFICIENCY OF CREDIT IN VARIOUS WAYS Insurance markets contribute to investment in infrastructure and high-risk/return activities by providing price signals regarding project risks, offering insurance coverage against undiversifiable risks, and generating long-term funds through collecting premiums that can be invested in long-term projects. Uncertainty affects entrepreneurship, investment, and social progress, threatening to curtail 8 growth if it is not well managed.

Banks, investment companies, pension funds, and capital markets combine their resources with insurance companies to accumulate information, consolidate and diversify risks, and manage this uncertainty. Insurance coverages implicitly measure and price risks, thus providing signals regarding the project risks. When risks cannot be managed, or when they are not adequately mitigated through risk management and safety measures, insurance coverages will change, signaling the nature of these underlying risks to potential investors.

These price signals and provision of coverage help reduce the transaction costs of investors and borrowers, as they clarify the nature and price of these underlying undiversifiable risks. Hence, it is not surprising that insurance is generally a necessary precondition in many mortgage finance markets and large-scale industrial investments.

INSURANCE COMPANIES, ESPECIALLY LIFE INSURERS, FACILITATE LARGE AMOUNTS OF CAPITAL ACCUMULATION By offering products with various combinations of life insurance and savings benefits, life insurers add 9 financial depth to an economy, simultaneously encouraging long-term savings.

The benefit of longterm funds to emerging market investment and productivity has been pointed out by various researchers. For our purposes, the difference between the term risk and uncertainty may be defined as follows: Uncertainty connotes a state of mind characterized by doubt, whereas risk refers to an exposure to potential loss, which may be measurable. 9 South Africa, Japan, South Korea, Taiwan, Singapore, Hong Kong, and the United Kingdom have had high rates of life insurance consumption for many years, which has turned life insurance companies into major investors in the economies of these countries.

In OECD countries, insurers’ assets comprised between 30 and 38% of total financial assets of institutional investors (pension funds, insurance companies, investment companies and others) during the period 1980 to 2000.

8 5 FIGURE 3. 3: CORRELATION BETWEEN NON-LIFE INSURANCE AND CREDIT Increasing Non-life Insurance Vs. Credit to Private Sector 5 0 0 Non-life Premium as % of GDP 1 2 3 4 50 100 150 Domestic Credit to the Private Sector as % of GDP Yearly Data for 59 Countries from 1960 – 2000. Source: Swiss Re & World Bank

The World Bank Development Report (1994, p. 107) highlights the fact that the growth in life insurance assets provides a scarce, but highly valuable commodity in developing countries—long-term finance—saying that “Contractual savings institutions, such as pension funds and life insurance companies, are particularly suited to making long-term investments. These institutions levy fixed premiums, have steady and predictable cash inflows, and incur long-term liabilities, making them ideal suppliers of long-term finance for infrastructure projects.

” World Bank researchers Musalem, Impavido, and Tressel (2001) studied the relationships among life insurance companies, pension funds, and banks in 34 countries and found that the development of life insurance companies and pension funds is associated with more efficient banking systems. Their explanation was that life insurers and pension funds, as contractual savings institutions, compete with banks. In response to the competition, banks concentrate on their comparative advantage, their superior ability to monitor firms, and provide short-term loans, thus increasing the efficiency of the financial sector.

LIFE INSURANCE ALSO CONTRIBUTES TO CAPITAL MARKET DEVELOPMENT Musalem and Impavido (2000) examined the growth of life insurers and pension funds across 34 countries over a 15-year period and found that the rapid growth of these contractual savings institutions partly explain the rapid growth of stock markets. Another World Bank study, conducted by Vittas (1998) also concludes that insurance companies and pension funds can provide a strong stimulus to the development of securities markets.

This relationship occurs because life insurers and pension funds can accumulate large amounts of savings in countries, which, in turn, are invested in businesses through equities and bonds. The result is that as life insurers grow, they channel large amounts of medium- to long-term funds through capital markets, deepening the country’s financial sector.

AS INSTITUTIONAL INVESTORS, LIFE INSURERS EXERT A POSITIVE IMPACT UPON THE TRANSPARENCY AND LIQUIDITY OF EQUITY MARKETS Vittas (1998) describes the important role that life insurers have had in enhancing corporate governance by requiring greater information disclosure and in stimulating financial innovation and modernizing capital markets, mostly in mid-level developing to developed countries.

The 1989 World 6 Development Report suggests that “Because pension and insurance institutions are likely to be relatively large and therefore able to afford professional management, these managers can play a role in 10 monitoring and control of the firms in which they invest. ” Better managed investments in turn improve the efficiency of the financial sector. INSURANCE AND FINANCIAL SECTOR DEVELOPMENT ARE MUTUALLY SUPPORTIVE The economic benefits produced by a strong insurance market, through its effect on financial sector efficiency and depth, are identified within the study by Webb, Skipper, and Grace (2002).

Using 16 years of data from 55 countries, this study finds that when higher levels of banking and insurance activity coexist, countries are more likely to have higher levels of economic growth. The finding is particularly noteworthy in that it shows that higher economic growth can not be explained as well by the individual development of banking or insurance markets as it can by the joint development of these 11 markets. To conclude, a substantial and growing body of evidence suggests that robust and efficient insurance markets improve an economy’s ability to organize and allocate its resources.

The research shows that insurance adds financial sector depth and efficiency, leveraging its strong role as an institutional investor and offering important services for which it has a comparative advantage, such as managing and pooling risks not diversifiable through capital markets, providing information and price signals to the market regarding such risks, and generating long-term funds for investment in infrastructure and other capital improvement projects. 10 11 World Development Report, World Bank, 1989, p. 108. Table A in Annex A presents the results of the simultaneous equations estimation of this study.

7 IV. STAGES OF INSURANCE MARKET DEVELOPMENT Insurance markets generally get larger relative to the economy during periods of economic growth. The rate at which this happens seems to be slower in very low- and high-income countries, and faster in low- to middle-income countries. For this reason, economists speak of an S-shaped curve when describing the growth of insurance alongside the growth of GDP. As can be seen in Figure 4. 1, insurance penetration appears to rise slowly, then more rapidly, then more slowly again, as GDP per capita increases.

Insurance market growth rates seem to vary according to the state of the enabling environment, which includes economic, legal, and political factors, as well the existence of the necessary internal building blocks of insurance markets, such as institutional infrastructure, technical resources and capacity. Table 4. 1 below identifies the environmental factors and the internal building blocks that seem to influence each of the four stages of insurance market development: 1) dormant, 2) early growth, 3) sustained growth, and 4) mature. The categorizations in Table 4. 1 are not mutually exclusive.

In reality, countries often fall in between categories. For example, Indonesia may be a fragile country due to its current political instability, but it has had an established insurance industry for many years, with some of the building blocks in place commonly found in more stable countries.

TABLE 4. 1: DECISIVE FACTORS PER STAGE OF INSURANCE DEVELOPMENT Influential Factors of Insurance Market Development Insurance Stage Type of State • • • • • • • • • • • • • • • • Stable / Upper Income External Economic/Legal/Political Preconditions Political stability Property rights Freedom of enterprise Voice & accountability Legal framework Contract enforcement Income Scale Economic stability Market restrictions Income Scale Savings rate Financial sector Enforcement, judicial efficiency/transparency Tax incentives Industry-specific Insurance Building Blocks.

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