Role of Insurance in Economic Development - Insurance Business and Market, Principles of Insurance B Com Notes | EduRev

Principles of Insurance

Created by: Arshit Thakur

B Com : Role of Insurance in Economic Development - Insurance Business and Market, Principles of Insurance B Com Notes | EduRev

The document Role of Insurance in Economic Development - Insurance Business and Market, Principles of Insurance B Com Notes | EduRev is a part of the B Com Course Principles of Insurance.
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The Role of Insurance to Economic Development

Economic development carries risk. When business owners decide whether to add a new storefront in a gentrifying area of town or serve a niche audience that hasn’t yet been targeted by their products, they weigh the potential profits against the risk of failure. The availability of insurance helps development primarily by allowing businesses to mitigate that danger, providing encouragement for them to expand their operations.

 

Risk Mitigation

The primary way insurance helps economic development is via risk management. Entrepreneurs and business owners can control their exposure via insurance policies, buying protection against crime, damages, liability lawsuits or natural disasters that could otherwise prove catastrophic. Without insurance, for example, it would be difficult to develop beachfront property in an area at risk of hurricane, because a bad storm could wipe away an investment instantly. Insurance removes that danger from the equation, thus making development more palatable.

 

Incentivizing Business Development

Governments can expand the availability of insurance beyond what the private sector would ordinarily offer by offering additional protections against loss. For example, a public-private partnership spearheaded by the federal government offered insurance that encouraged investments in areas that faced the threat of terrorism after the September 11 attacks. In areas where insurance companies might otherwise be skittish about covering, such as a crime-ridden part of town, government policies and incentives can help provide that protection.

 

Financial Effects

Insurance can help encourage investment by promoting financial stability and mobilizing savings. The concentration of income from customers purchasing life insurance policies, for example, provides capital that can be invested elsewhere in the economy by the company for greater returns. Individuals know that FDIC insurance means their bank deposits are safe, thus encouraging them to place money into financial institutions that can then use their funds to make new loans.

 

Safety Net

Personal and social insurance policies also can help economic development by helping workers stay healthy, keeping them afloat between jobs and getting them ready for a more appropriate assignment. With health insurance, for example, workers are encouraged to see doctors, get treatment for injuries or illnesses and avoid the burden that a catastrophic medical emergency might otherwise have on their finances. Unemployment and workers’ compensation coverage allows people to survive a temporary job loss and stay solvent while they look for work, keeping them available for those looking to hire new workers to develop their business.

 

Role of Insurance Companies in Economic Development of India

 

1. Saving and Insurance

Saving involves refraining from present consumption. The investment can take place only when there are savings. The relationship between. saving, investment and growth of GDP can be explained as:

G = S / K. Where G – Rate of GDP growth, S – Saving Ratio and K – Capital output ratio.

Insurance companies lead to economic development by mobilizing savings and investing them into productive activities. Indian insurance companies are able to mobilize long-term savings to support economic growth and also facilitate economic development by providing insurance cover to a large segment of our people as well as to business enterprise throughout India.


2. Capital Formation and Insurance

Capital formation maybe defined as increase in capital stock of the country consisting of plant, equipment, machinery, tools, building, means of transport, communication, etc. The process of capital formation envisages three essential steps. These are:

a. Real saving: Mobilization of saving through financial and non-financial intermediaries to be placed at the disposal of investor.

b. The act of investment: The contribution of insurance companies in the process of capital formation appears at all these stages. Insurance services act as a tool to mobilize saving, function as financial intermediary and at times also indulge in direct investment. Also govt. has made regulations under which every insurer carrying on business of life insurance shall invest 25% of funds in Govt. securities and not less than 15% in infrastructure and social sector.

The importance of Indian insurance industry is gauged by the fact that annual amount of investible funds of LIC and GIC and its subsidiaries amounted to over Rs. 20,000 crore and Rs. 10,000 crore are invested in nation building activities, housing and other infrastructural areas.

c. Increased Employment: Prior to the liberalization of insurance sector in India, the opportunities for employment were limited with the LIC of India as sole employer. While some of the professionals left the country looking for opportunities elsewhere, those who remained, worked within the confines and constraints of public sector monopoly. This has further constrained the opportunities for exposure to the development in rest of the world. Liberalization and the opening up of sector to private players has now created a vast opportunity for employment.


3. Obligation to Rural and Social Sector

In India, the insurance companies are required to fulfill their obligation towards rural and social sector. For this, Life insurers are required to have 5%, 7%, 10%, 12%, 15% of total policies in first five years respectively in rural sector. Like wise General Insurers are required to have 2% 3% and 5% thereafter of total gross premium income written in first five financial years respectively in rural sector.


4. Insurance as financial intermediary

Financial intermediaries perform the function of channelizing saving into domestic investment. They facilitate efficient allocation of capital resources, which in turn improve productivity and economic efficiency which result in reduced capital output ratio. The insurance companies perform extremely useful function in economy as financial intermediaries. These are as follows:

a. Reduction in transaction cost: Insurers help in reducing transaction cost in economy by collecting funds from policyholders and investing the same in different projects scattered over different regions. It is a specialized and time consuming job.

b. Creating liability: The policyholders, in case of loss, are not required to wait for a long period for the amount of claim. It improves their liquidity.

c. Facilitates Economies of scale in Investment: Insurers are in the position of financing large projects, railways power projects, etc. These large projects create economies of scale, facilitate technological innovation and specialization and thus promote economic efficiency and productivity.


5. Promotes Trade and Commerce

The increase in GDP is positively correlated to growth of trade and commerce in economy. Whether it is production of goods and services, domestic or international trade or venture capital projects, insurance dominates everywhere. Even banks demand insurance cover of assets while granting loans for purchase of assets. Thus insurance covers, promotes specialization and flexibility in the economic system that play contributory role in healthy and smooth growth of trade and commerce.


6. Facilitates efficient capital allocation

Insurance provides cover to large number of firms, enterprises and businesses and also deploy their funds in number of investment projects. The vast pool of knowledge and expertise so gained enable them to distinguish between productive and high return projects. Therefore, they promote efficient and productive allocation of capital resources, which in turn lead to increased productivity and efficiency in the system.


7. Encouraging Financial Stability and Reducing Anxiety

Insurer promotes financial stability in economy by insuring the risks and losses of individuals, firm and organizations. Because of uninsured large losses, firm may not be able to compensate for it leading to its insolvency which may cause loss of employment, revenue to supplier & Govt., loss of products to customer, etc. Moreover, it relieves the tensions and anxiety of individuals by securing the loss of their lives and assets.


8. Reducing Burden on Govt. Exchequer

Insurance companies, particularly life insurers provide a variety of insurance products covering needs of children, women and aged etc under social security network and thereby reduce the burden on Govt. exchequer in providing these services. This Govt., saves expenditure on these items and amount can be utilized for more productive projects. To conclude, we can say that insurance companies play an important role in economic development of country.

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