What is insurance?

Insurance, in law and economics, is a form of risk management primarily used to hedge against
the risk of a contingent loss. Insurance is defined as the equitable transfer of the risk of a loss,
from one entity to another, in exchange for a premium, and can be thought of as a guaranteed and
known small loss to prevent a large, possibly devastating loss. An insurer is a company selling
the insurance; an insured or policyholder is the person or entity buying the insurance. The
insurance rate is a factor used to determine the amount to be charged for a certain amount of
insurance coverage, called the premium.
 
What is economics?
the branch of social science that deals with the production and distribution and consumption of
goods and services and their management or
Economics is the social science that studies the production, distribution, and consumption of
goods and services. The term economics comes from the Ancient Greek οἰκονομία (oikonomia,
"management of a household, administration") from οἶκος (oikos, "house") + νόμος (nomos,
"custom" or "law"), hence "rules of the house(hold)"
 
Developed, developing and under developed economy:
Economy is defined as a household or family and issues like financials aspect related to it.
Economy can be a developing economy, developed economy or under developed economy. The
economy and business of any country go hand in hand. The market forces are responsible for
regulating prices in an economy. The financial positions of any economy and fluctuations in the
rate of interests of loans are also governed by the forces of demand and supply of money market.
 
Underdeveloped Economy:
An economy is called under developed economy when it has not utilized its resources to the full
extent.
 
Developed Economy:
An economy is developed when it has known how to make optimum utilization of the resources.
 
Developing Economy:
Any economy is developing when it has just realizing how to make proper and full use of
resources. Business of an economy gets affected by financial market. It can be defined as the
market in which financial assets are created. Financial markets include money market, capital
market and credit market.
What is a Service?
 
The term “services” covers a broad range of activities that is difficult to encapsulate in a single
definition. Services are activities that produce value by providing solutions to customers’
problems. The service sector includes everything from transportation, to legal advice, to custom
software development and management consulting. In some cases, it is not easy to separate
services from the goods with which they are associated, such as an extended warranty purchased
with a consumer electronic device or the rental of an automobile. Services can also be embedded
in a manufacturing process, as manufacturers procure inputs, such as inventory management and
logistics services, from service providers, rather than perform these functions themselves.
 
Services are essential for the efficient operation of an economy, facilitating commercial
transactions and enabling the production and delivery of goods and other services. In
developed countries, the service sector employs far more people and creates many more new
jobs than the manufacturing sector. Services are a crucial component of innovation and
production in a host of manufacturing industries and agriculture. They can build infrastructure,
hone competitiveness, ignite technological development, increase productivity and expand trade
capacity. Research has shown that economies with more efficient service sectors enjoy higher
productivity and growth. The sectors accounting for the greatest share of trade in services
include transportation, travel, and some business sectors, such as banking, insurance, computer
and related services, and professional services.
 
Gross Domestic Product: Services represent over two-thirds of world GDP. In the 55 high-
income countries3 identified by the World Bank, services accounted for 72% of GDP in 2003, up
significantly from 56% in 1971.4 In contrast, industry, made up of manufacturing, mining,
construction and utilities, accounted for only 26% of GDP, while agriculture represented only
2% of these economies.
 

 
The following chart shows how the service sector has expanded its share of GDP since 1970
across countries at all levels of development. In all cases, from the highest developed countries
to the lowest developing countries group, the service sector already represents the largest sector
of the economy.
 
 
 
Employment: In high-income countries, the share of employment in both manufacturing and
agriculture has declined steadily over the last 50 years, as labor has increasingly shifted to
services. The share of workers employed in services is now over 70% in most developed
countries. In OECD countries, most employment growth over the last decade was due to
services, and in particular, business services.
 
Globally, agriculture still employs the largest share of the workforce, but the service sector is
close behind and is expected to surpass agriculture in total worldwide employment in the near
future. Since 1995, the share of worldwide employment in agriculture has fallen from 44% to
40% in 2005, while services have increased from 35% to 39% of total employment. During the
same period, worldwide employment in industry was relatively flat at about 21%. Industry
employment in developed countries has fallen from 29% in 1995 to 25% in 2005, but this is still
more than in the world as a whole.
 
Although employment historically has moved from agriculture, first to industry and then to
services, as countries have climbed the development ladder, many workers are now moving
directly from agriculture to services. In fact, since 1995, the share of employment in services has
increased in all regions of the world except for the Middle East and North Africa.
.
 
Contributions of Insurance to Growth and Development
Insurance serves a number of valuable economic functions that are largely distinct from other
types of financial intermediaries. In order to highlight specifically the unique attributes of
insurance, it is worth focusing on those services that are not provided by other financial services
providers, excluding for instance the contractual savings features of whole or universal life
products.
∙       The indemnification and risk pooling properties of insurance facilitate commercial
transactions and the provision of credit by mitigating losses as well as the measurement
and management of non diversifiable risk more generally.
∙       Typically insurance contracts involve small periodic payments in return for
protection against uncertain, but potentially severe losses. Among other things, this
income smoothing effect helps to avoid excessive and costly bankruptcies and facilitates
lending to businesses.
∙       Most fundamentally, the availability of insurance enables risk averse individuals and
entrepreneurs to undertake higher risk, higher return activities than they would do in the
absence of insurance, promoting higher productivity and growth.
∙       The management of risk is a fundamental aspect of entrepreneurial activity.
Entrepreneurs manage the risk of accidental loss by weighing the costs and benefits of
each alternative. In a structured risk management process, this involves:       
(1)identifying the exposures to accidental loss;                                                                 (2)
evaluating alternative techniques for treating each loss exposure;                               (3)
choosing the best alternative; and                                                                                              (4)
monitoring the results to refine the choices. Those who do not apply a structured process
still make decisions about risk, although sometimes by default rather than design. The
scope of an economy’s insurance market affects both the range of available alternatives
and the quality of information to support decisions.
∙       Insurers also contribute specialized expertise in the identification and measurement
of risk. This expertise enables them to accept carefully specified risks at lower prices than
non-specialists. They also have an incentive to collect and analyze information about loss
exposures, since the more precisely they measure the cost of risk, the more they can
expand. As a result, the insurance market generates price signals to the entire economy,
 helping to allocate resources to more productive uses.
∙       Insurers also have an incentive to control losses, which is a significant social benefit.
By offering discounts for seat belts, smoke detectors, or other measures that reduce the
frequency or severity of losses, they lower their eventual claims costs, in the process
saving lives and reducing injuries.
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
ROLE OF INSURANCE IN DEVELOPED AND
DEVELOPING ECONOMIES
 
Insurance is also a process of financial intermediation because the production cycle for insurance
is reversed. Payment is made before the service is provided and therefore insurance companies
built up reserves which are commitments with respect to injured parties. To measure the
contribution of the insurance companies to the financing of national economy, it would suffice to
compare the increase in technical reserves or provision with the economy’s financial
requirements.
 
What role does insurance play in economic development?
Considerable attention has been devoted to evaluating the relationship between economic growth
and financial market deepening. Most of what is learned relates to banking systems and
securities markets – with insurance receiving only a passing mention. Yet, while insurance,
banking, and securities markets are closely related, insurance fulfills somewhat different
economic functions than do other financial services, and in turn requires particular conditions to
flourish and to make a full economic contribution. In the past few years, several interesting lines
of research have begun to map the specific contributions of insurance to the economic growth
process as well as to the well-being of the poor. The evidence suggests that insurance contributes
materially to economic growth by improving the investment climate and promoting a more
efficient mix of activities than would be undertaken in the absence of risk management
instruments. This contribution is magnified by the complementary development of banking and
other financial systems. Empirical studies suggest that nonlife insurance contributes to growth in
countries at many different levels of development. Life insurance makes a substantial
contribution to growth mostly in wealthier countries, since life insurance is typically a smaller
part of the total insurance market in low income countries. The relationship between per capita
income levels and insurance penetration is also strong in the reverse direction – with rising
income a strong driver of life insurance coverage. However, it is difficult to disentangle whether
lower insurance consumption at lower income levels reflects reduced demand for life insurance
products or constraints on the supply side associated with weak regulatory and supervisory
environments and high costs of insurance provision.
Even if the data did not support a strong causal role for insurance as an engine of overall
aggregate growth, there might be a strong case for insuring the poor on social welfare grounds
that those at or below the poverty line are particularly vulnerable to catastrophic shocks to
income and consumption. And indeed, it appears that the gap between the potential social value
of insurance and the transactions costs of provision might be unusually wide for the poorest
segment of society, which explains the growing interest in microinsurance on the part of non
governmental organizations and philanthropic foundations, some of whom are partnering with
commercial providers.
 
 
The ratio of total premium written to the gross domestic product of a country is a measure is the
most commonly used to evaluate the importance of insurance to the economy.
 
 ➢       ROLE OF INSURANCE INDUSTRY IN CREATING AWARENESS: 
                                                                                                                             The major reason for low
penetration of insurance in developing countries’ Gross domestic product is basically the lack of
insurance awareness as a viable support arm for all commercial activities. In less developed
countries like Pakistan, srilanka India and Bangladesh the proportion of people buying
insurance is very low compared to developed world. They have less knowledge about
importance of buying insurance. Moreover, in Islamic countries such as Pakistan there is a
general perception that insurance is un Islamic and haram so they are reluctant to buy
insurance. Insurance companies are creating awareness  in these regards among people to buy
insurance and the benefits which can be gained by them if they purchase insurance. They are
doing this by using media, newspaper and publishing magazines. 

nROLE OF INSURANCE IN GENERATING LONG TERM FUNDS FOR INFRASTRUCTURE:

                                             For GDP to grow at 8 to 10%, qualitative improvement in
infrastructure is essential. The insurance industry also provides crucial financial intermediary
services, transferring funds from the insured to capital investment, critical for continued
economic expansion and growth, simultaneously generating long-term funds for infrastructure
development.

ROLE OF INSURANCE IN MOBILIZING SAVING AND INVESTMENT

 
In a modern economic and financial system the insurance sector plays main role for mobilizing
long term savings and investing them profitably in the capital market. Developing countries are
more consumption oriented than developed countries; they are not in a habit of saving. In
developing countries insurance can play a key role in mobilizing savings and allocating them
into productive assets. World Bank has identified life insurance as a sector whose development
could help the country mobilize public savings and allocate them into productive assets.
Insurance is the only sector which garners long term savings in the developing countries like
India and Pakistan. While encouraging savings habit it also provides a safety net to both
enterprises and Individuals. They offer more than the return on savings in the shape of life-cover
to the investors.
Premium funds that are not immediately needed, lent to businesses, people or to make real assets
like buildings etc. It also serves as an institutional investor for both capital and money market
instruments. Insurers can make or break new investments as if they decline to insure then Banks
will refuse the necessary loans. In 1996 the level of investment by the French insurance industry
was 40.4 percent of GDP, Italy 12.4 percent, Switzerland 75.5 percent, and the U.K. 91.4
percent.

➢       ROLE OF INSURANCE IN AGRICULTURE SECTOR:

                                                                                                       Developing counties rely heavily on
agriculture and it has main contribution in the gross domestic product of developing countries.
Agricultural insurance is widely available for large producers in industrialized countries. Small
producers in developing countries want it mainly to cover loss of crops, livestock, plantations
and farm equipment. Challenges for insurers include the high cost of distribution, the high costs
of loss assessment and claims handling, and difficulty in controlling fraud and moral hazard.

Index insurance:

index insurance is being proposed as a solution to the problems of property insurance,

especially for

drought in the agricultural sector and catastrophic risks such as floods, earthquakes, and
typhoons. For

a holder of an index policy, payments do not depend on his or her individual losses but on an
objective

index such as rainfall level or earthquake magnitude. Once an index is calibrated and correlates
well with

actual losses, underwriting and claims verification costs for the insurer are minimal and moral
hazard and

fraud are virtually eliminated. Index insurance or parametric products appear to be promising
solutions for some of the challenges of agricultural insurance, particularly weather-related risks
in most developing and developed countries.

➢       POTENTIAL ROLE OF INSURANCE IN MANAGING CATASTROPHIC RISKS:

                                                                                                                                              Insurance
plays a role in allowing communities to recover from the disastrous financial
consequences of natural catastrophes (Earthquakes, Tsunamis, and Tropical
Storms). Droughts, floods and other natural disasters lead to severe income losses for rural
people, especially farmers and poor people. Given their limited ability to offset these losses,
many rural people suffer extreme hardship, lose assets and default on their debts in disaster
years. Premiums are collected from many that reflect individual risk to pay for the catastrophic
losses of a few. Now SEVERE WEATHER damage is growing much faster than other claims. Over
the past 30 years global severe weather insurance claims have increased 20 fold. In developing
countries where there are less measures and the consequences of disasters are severe
insurance provide protection. There should be enormous potential for natural disaster and
weather insurance to improve the performance of lower income economies, which tend to be
more vulnerable to high volatility in incomes due to commodity price fluctuations and natural
disasters due to poor building codes and infrastructure. Current investments in new products
and innovations in weather and natural disaster insurance should be followed closely, as it is
anticipated that climate change will exacerbate the incidence of weather patterns and natural
disasters in many poor areas. In recent years, the World Bank and other donors have been
involved in experiments in countries such as Turkey and Mexico that provide earthquake risk
insurance financed through a combination of reinsurance and the capital markets. In areas of
Asia and Africa, there is growing interest in weather derivatives to insure against weather-
associated  agricultural losses. These are designed to sidestep the traditional incentive (moral
hazard) problems associated with crop insurance by using independent measurements of
weather outcomes such as rainfall rather than crop yields.
➢    
➢       ROLE OF POLITICAL RISK INSURANCE (PRI):
                                                                                  POLITICAL RISK INSURANCE (PRI)  is a tool for
businesses to mitigate and manage risks arising from the adverse actions - or inactions - of
governments. As a risk mitigation tool, PRI helps provide a more stable environment for
investments into developing countries, and to unlock better access to finance. The political risk
insurance industry helps multinational enterprises and lenders mitigate risk through insurance
against adverse government actions or war, civil strife, and terrorism.

➢       ROLE IN EXPANDING BUSINESS:

                                                                       Keeping in mind the insurance coverage, large amount
of money would available for expansion of businesses in developing countries which enhance
economic activities in the country, increase in exports, setting up new industries and so on.
Insurers can stop existing businesses from expanding as if they decline to insure then Banks will
refuse the necessary loans. Most businesses have to rely on Bank finance for their development
and Banks oblige them to insure their exposures.

➢       ROLE OF SOCIAL SECURITY:

                                                                 Social security is defined in the European Union as social
insurance and social assistance arrangements that protect the population against various
economic risks.

Social insurance denotes publicly provided or mandated contributory programs that cover
workers and their dependents against major life risks—essentially unemployment, health risks,
and old age. Insurance complements state social insurance programmes, especially in the area
of pension, disability and health care financing.

Social assistance refers to noncontributory transfer programs that are means tested and
targeted in some way to the poor or those vulnerable to poverty and shocks.

In developed countries, social security covers workers and their dependents against old age,
unemployment, health, and other risks. In developing countries, formal-sector workers have
access to social insurance, and the very poor have some access to social assistance and health
services, but large population groups are not covered. Much smaller weight is given to social
insurance programs among poorer countries, particularly those in East Asia.

'social' health insurance (SHI) in developing countries. SHI aims at protecting all population
groups against financial risks due to illness
 ➢        ROLE OF DEPOSIT INSURANCE:
                                                                      Insurance plays a role in providing deposit insurance
system in developing and developed countries. Deposit insurance systems are largely
established to protect the banking system against possible bank "runs" (unrestrained demand
for cash by savers) that can cripple the financial intermediation process, disrupt the payments
system, and have severe macroeconomic effects. These systems also protect small depositors
from losses in the event of bank failures and give the nation a formal and consistent mechanism
for resolving failing bank situations. Developing countries with deposit insurance include
Colombia (since 1985), Kenya (1985), Nigeria (1989), and Yugoslavia (1985). Brazil and Bolivia
are now in the process of establishing such a system. At present, almost all the major
developed countries, including France, the Federal Republic of Germany, Japan, the United
Kingdom, and the United States have deposit insurance schemes.

➢       ROLE OF PILOT PROJECTS:

                                                             Pilot project offers program that are tailored according to the
need of the country. A diversity of products is currently offered in pilot projects by many of the
large insurance companies in developed countries. Products for pilot projects in developing
countries are being tested.

In developing countries like Pakistan, Orangi Pilot Project (OPP) as an NGO began work in
Orangi in 1980. Orangi situated in the periphery of Karachi is a Katchi Abadi with a population
of 1.4 million. On the success of its five basic programs of low cost sanitation, housing, health,
education and credit for micro enterprise, in 1988 OPP was upgraded into three autonomous
institutions.

∙       OPP-Research and Training Institute (RTI) manages the low cost sanitation, housing,
education, and research and training programs.
∙       OPP-Orangi Charitable Trust (OCT) manages the micro enterprise credit program.
∙       OPP-Karachi Health and Social Development Association (KHASDA) manages the
health program.
Each institution has its separate board of directors and mobilizes its own funds. The approach
at the OPP is to encourage and strengthen community initiatives (with social, technical
guidance and credit for micro enterprise) and evolve partnerships with the government for
development based on local resource.

Another Example is China Life Insurance Company covered 700,000 lives in such a pilot in one
region and The People’s Insurance Company (Group) of China Limited (PICC), the biggest
market Participant aims at covering 900,000 lives before 2012.

➢       ROLE OF TERRORISM COVERAGE:

                                                                    Insurance is providing terrorism coverage in
developing countries such as Pakistan, India and Srilanka etc. Almost from last one decade,
Pakistan is being a prime victim of terrorism and has born huge losses of lives and
infrastructure. Insurance indemnified people, businesses and organizations so that they can
again maintain their position and contribute to economy.

       September 11 2001 sent a shock wave through the insurance industry worldwide. Views
have had to adjust on two things critical to the business of insurance: first, assessments of the
probability of occurrence of a catastrophic terrorist event; and second, assessments of the
probable scale of financial damage that might be inflicted by an act of terror.

➢       ROLE IN GENERATING EMPLOYMENT:

                                                                                   Insurance plays an important role in generating
employment in developing and developed countries.

Insurance sector of developing country Pakistan provides direct or indirect jobs to over 8000
people around the country. However, many other businesses are directly associated with
insurance activity such as surveyors, loss adjusters etc. Upon continuous progress of insurance
industry, more jobs are created regularly. similar is the case of employment generation of
insurance in India, srilanka and other developing countries.

UK Insurance Industry employs more than 350,000 persons which is a third of all financial
services jobs and accounts for almost 20 percent of investments in the stock market as well as
being a major invisible trade earner. So you see insurance is also a vehicle for job creation and a
way to reduce unemployment in society particularly as half of these jobs are for support roles
such as secretarial, word processing, bookkeeping and similar clerical tasks.

➢       ROLE IN PAYING TAXES:

                                                           Insurance companies also pay large amount to the government
in terms of taxes and fees etc.

Role of health insurance:

As with the wealthier economies, the
development of health insurance markets in
developing economies depends on the
composition of health delivery providers –
whether private or public – and the
government’s involvement in health
insurance provision. However, there is a
strong tendency in poorer economies for
households to bear responsibility for paying
a much higher proportion of overall health
costs out of pocket than in richer
economies, which leads to underinvestment
in health services (particularly on the
preventive side) and vulnerability to healthrelated
consumption shocks. Thus, a strong
case can be made for improving health
outcomes in poor countries through a varied
combination of public and private insurance
provision depending on the institutional
setting. Indeed, countries such as Mexico
and Colombia have undertaken interesting
reforms in this area in recent years, and this
is likely to be an area of strong growth.

Role of insurance for small scale enterpenures:

The economic contribution of small
enterprises to middle- and high-income
economies is well-known. However, in many
poor economies, start-ups and small-scale
enterprise fall short of their potential due to
a variety of barriers, including access to
capital. As attention to these barriers grows,
it is critical to put insurance high on the list.
While the risk appetite of large corporations
can be debated, small scale entrepreneurs
whose household wealth is tied up in their business enterprises are undoubtedly
preoccupied with managing risk. In the
absence of risk management tools provided
by formal insurance, there will be a tendency
to under invest in higher risk, higher return
activities, thus diminishing the potential
contribution of the critical small and medium
sized enterprise sector to employment,
investment, and growth overall.
In sum, extending accessible insurance
products to poor households and small
scale entrepreneurs should be a core part of
the agenda of democratizing access to
financial assets. When successful programs
are taken to scale, it will not only add
measurably to social welfare but also hold
the promise of generating a more
productive and higher growth mix of
activities and investments – with a payoff
perhaps greater than micro-credit.