Economics and Business of Insurance - Term Paper Example

Economics and Business of Insurance Contents Market failure in a mixed economy 3 Productivity in the UK 3 UK fiscal policy 4 UK current account deficit 5 The function of the UK insurance industry 5 The value of the insurance industry 6 The failure of long-term stability in insurance pricing 7 The operation of insurance companies 7 Works Cited 9 Name of the Student Name of the Professor Name of the Course Date Economics and Business of Insurance Market failure in a mixed economy Mixed economies have both private sector where resources are allocated by the market forces; as well as public sector where resources are assigned by the government. The economy of United Kingdom is an example of mixed economy. There can be instances of market failure even in a mixed economy, leading to inefficient distribution of resources. Critics of mixed economy argue that government intervention can ensue uneconomical decision making, primarily influenced by short-term factors. The labour market in London is a good example, where forces of supply and demand do not operate as per the economic theory. The minimum wage law formulated by the government in London sets the wage above that dictated by market forces. This results in employers hiring few labourers than what they would have employed without the prefixed minimum wage. Examples abound in hotels, restaurants and catering outlets marked by high number of vacancies (Munday 60). Another point that has been identified by Toporowski is that the city politics in U.K. has often led to inefficient resource allocation, thereby resulting in a sub-optimal path of capital accumulation and industrial development (Toporowski 143). Productivity in the UK According to Economic and Research Council Report 2004-2005, productivity performance of U.K. is not very impressive. U.K. has been haunted by productivity gap for a long time, compared to other countries of the European Union. A number of reasons have been upheld by the Council, which are considered as probable reasons for this less productive nature. They are investment and innovation failure; poor labour relations; over-regulation of business; and lack of entrepreneurship. These factors have kept productivity of the labour low; which in turn has adversely impacted growth of the nation. The problem of productivity gap can be divided into three stages of time; the first phase occurred in 1945, the second in 1973 and the final one in 1990s. This productivity gap exists in the present scenario. The comparison with other European Nations had revealed that in countries like, France and Germany, the capital invested per worker is higher than in U.K. The labourers in these countries also possess higher level of skills compared to U.K. The works of Stephen Broadberry and Mary O’Mahony suggest that long-run stable investments in physical and human capital are necessary for productivity growth. Labour productivity can be hugely boosted if these areas are worked on properly. This report also highlights a host of factors that can contribute to productivity growth, namely enhancing competition and innovation both in public and private sector; improvement in skills of labour; management practices; and outsourcing and technology transfer. If the country can develop these areas, then productivity growth is likely to improve (Economic and Social Research Council, “The UK’s Productivity Gap”). UK fiscal policy The government of United Kingdom has been trying to boost the economy ever since the financial crisis through unconventional fiscal policies. The UK economy is slowly beginning to recover after experiencing one of the worst financial crises. The private consumption and housing investment are on a rise, but business investment and net trade investment are falling. It had been observed that productivity and real earnings growth performance has not been quite robust, but consumer confidence and credit conditions have improved to some extent. The volatility of productivity growth is concerning the analysts. The public sector net borrowing of the government has performed better than the forecasted value; and the revenue of the government is expected to improve through better performance of corporation tax and stamp duty. The fiscal policies undertaken by the government are anticipated to improve the insurance business and contributions from the national insurance are likely to improve in the future (Economic Secretary, “Office for Budget Responsibility: Economic and fiscal outlook”). The primary policy of the fiscal policy is to stimulate aggregate growth of the economy through government spending, taxation and borrowing. The government uses the tool of direct taxation to raise revenue from the insurance business. Current estimates had shown that the insurance industry is one of the largest contributors to the government receipts and hence, have a huge potential to stimulate future growth. The insurance industry has a commendable role to play in boosting confidence of the investors as well as in context of the future growth. UK current account deficit The current account deficit of the U.K. has been one of the worst in the past two decades. The current account deficit comprises trade balance, cash transfers and earnings on foreign investments inside and overseas. Recent estimates have shown that the current account deficits have been widening in the country. The chief reason that has been pointed out for the weak performance of current account deficit is poor performance of the export sector. The declining investment from abroad has also been largely responsible for inadequate performance in the current account deficit. The current account is not only related to trade of the country, but is also related to international transactions in services, income and current transfer. The importance of current account for economic development of a country is that it helps to estimate the position of the country in the world. A negative current account deficit shows that the country is spending more in abroad transactions and receiving less; or in other words, it is a net-debtor to the rest of the world. Insurance services are considered as a part of International trade in services. The insurance business is also related to current transfers of the government, including insurance premium of the government and claims on the non-life insurance companies (“Balance of payment statistics”). A high deficit in current account also implies a sluggish recovery for the economy. The recovery status of the country depends to a large extent on weak overseas growth. This implies that the economy is currently unstable. The function of the UK insurance industry One of the biggest functions of the insurance industry in the market is that it can play a huge part to rebuild trust of the stakeholders. This can increase the amount of investment in the country. Apart from economical good, one of the most pivotal functions of the insurance industry is that it increases investment opportunities of individuals. As primary function of the insurance industry is to protect individuals from unfavourable events, insurance indirectly increases the risk appetite of individuals. Insurance business diversifies risks of the entrepreneurs, which in turn increases attractiveness of business. Insurance may not be able to eliminate the market risk of entrepreneurs, but is definitely able to insure material integrity of the investment goods. It can also improve health of the entrepreneur. The entrepreneur feels more confident if his business is insured; this in turn allows him to venture overseas. Insurance business is also able to put a price on the amount of risk borne by an individual. The insurance premium acts as a price signal for risk profile of the individual seeking insurance. With help of the accurate price, the insured can take more efficient decisions in various aspects of life. For example, if the insurance premium is very high, then the individual can change his behaviour for the good, such as, quit smoking to avoid risks of lung cancer (Hardwick and Guirguis, “The UK Insurance Industry-Structure and Performance”). The value of the insurance industry The insurance industry of United Kingdom has a great relevance for the economy of the country, given that it is the largest industry in U.K. and third largest in the world, according to Association of British Insurers (ABI) report. The contribution of this industry is one of the most important determinants of economic strength of the nation. As has been noted earlier, this industry is one of the major contributors to tax receipts of the government. The stakeholders of the insurance industry ranges not only from the government and political parties of U.K. to regulators and but also from consumer groups to the media. The main agenda of this industry is to provide best quality products and services to consumers and emerge as one of the top players globally. The business is a major exporter of its services and around 30% of its net premium comes from abroad. Majority of the households are related directly to the insurance business. There are a variety of services offered by the industry, ranging from the insurance of motor vehicles to that of the mortgage. In order for a country to become financially resilient, the ABI makes sure that every individual in the country is financially stable and constantly works with the government to achieve this perspective. These facts from the insurance sector indicate that the latter has a very dominant role in shaping long-term sustainable economic growth of the country (Association of British Insurers, “UK Insurance Key Facts”). The tax receipts can particularly help to improve the government revenue as well as facilitate long-term sustainable development. The failure of long-term stability in insurance pricing As insurance business is primarily based on risk-taking ability of individuals, there are chances of failure of the insurance business, if managed inadequately. There are a variety of reasons that can lead to failure of the insurance business. This case study singles out the case of insurance under pricing or reserving, which can prove to be a major reason of failure of the insurance business. It has been noticed that several U.K. based life insurers faced an increasing demand for reserving needs at beginning of the millennium. The primary reason that has been attributed for the same was the dual problem of under pricing of guarantees embedded in the products and overuse of equities to back the liabilities of the policy. The life-insurance company that could not survive the crisis and had crashed was Equitable Life. Although reasons for failure of this company were specific to it, the sector as a whole had suffered for a prolonged period owing to this problem (Standards and Poor Ratings Services, “Ratings Direct”). This issue had also created problems for motor vehicle insurance in the 1960s. This period was marked by the entry of a number of small, undercapitalized firms that had charged low premiums to compete with established insurers. As a result of this, under pricing, eleven motor vehicle industries had failed in 60s, given that this kind of a strategy is not sustainable in the long-run. The charging of low premiums had made these companies default and they were unable to cover claims (Borscheid and Haueter 549). The operation of insurance companies As insurance sector is one of the largest industries in U.K., its effective operation is one of the most important objectives of the country. This industry is highly regulated, given that it is essential for safety of the insurers. The Financial Services Authority is the chief regulator here and always ensures that insurance companies are run by competent management. If the firms are in any type of financial troubles, then this authority intervenes. It has been observed that even though there are a large number of companies in the market, yet this industry is characterized by a high degree of market concentration. The degree of competition is very high in this industry. This fact coupled with other attributes like, presence of asymmetric information and differentiated products, implies that the market structure of insurance industry is complex. In order to function efficiently in markets, smaller companies have to secure niche markets and their growth will depend largely on strategic mergers and acquisitions with the larger firms. According to the performance indicator report of top insurance companies in the United Kingdom, profitability of this industry has improved in 2012. As per new regulations of the FCA, chartered status between the insurers and the brokers has become mandatory. The insurer distribution programs of the U.K. insurance industry are also plagued with inconsistency and complexity. The choice of brokers is becoming important as they do not ensure equal expertise and professionalism (Hardwick and Guirguis, “The UK Insurance Industry-Structure and Performance”). Works Cited Association of British Insurers. “UK Insurance Key Facts.” Association of British Insurers, 2012. PDF File. Web. 3 Mar. 2014. “Balance of payment statistics.” Eurostat. European Commission, 2014. Web. 3 Mar. 2014. Borscheid, Peter and Niels Viggo Haueter. World Insurance: The Evolution of a Global Risk Network. Oxford: Oxford University Press, 2012. Print. Economic and Social Research Council. “The UK’s Productivity Gap.” Economic and Social Research Council, 2004. PDF File. Web. 3 Mar. 2014. Economic Secretary. “Office for Budget Responsibility: Economic and fiscal outlook.” Crown Copywright, 2013. PDF File. Web. 3 Mar. 2014. Hardwick, Philip and Michel Guirguis. “The UK Insurance Industry-Structure and Performance.” Melat, n.d. PDF File. Web. 3 Mar. 2014. Munday, Stephen C. R. Markets and Market Failure. Norfolk: Heinemann, 2000. Print. Standards and Poor Ratings Services. “Ratings Direct.” Standard & Poors Financial Services, 2013. PDF File. Web. 3 Mar. 2014. Toporowski, Jan. Political Economy and the New Capitalism: Essays in Honour of Sam Aaronovitch. London: Routledge, 2002. Print. Read More