The Economic Impact of Insurance - Essay Example

The Economic Impact of Insurance in the United Kingdom Insurance is one of the most beneficial financial services to be developed by mankind in reducing risk. When in operation as intended, Kunreuther, Pauly and McMorrow observe that it should provide financial protection to individuals and organizations and at the same time make profits for investors.1 Uncertainty is what creates both the demand and supply of insurance. Thus, insurance operates on the principle that the insurer shoulders the risk of the insured in exchange for premium payments, noted to be considerably less than the value of the insured item as documented by Gosdin.2 A well established insurance company should collect premiums from its customers and invest such that the returns from such investment and the total sum of the calculated premiums enables it to pay its customers’ claims when they arise and still make profits. Insurance is therefore a critical player for a stable economy. The United Kingdom has a farfetched history of insurance. As documented by Birds, this could be traced back to the sixteenth century when London merchants adopted previous practices of the Italian merchants.3 Currently, the Association of British Insurers [ABI] ranks the UK insurance industry as the largest in Europe and third globally.4 Furthermore, of the total European Union premium income, 22% could be attributed to the UK insurance industry. The widespread appreciation of insurance in the country that has seen about 90% of the 26.4 million households in the UK have at least one insurance cover, an indication of the importance of the 1 Kunreuther, Pauly, & McMorrow, Insurance and Behavioural Economics, p.13 2 Gosdin, James L., Title Insurance, p.3 3 Birds, John, Insurance Law in the United Kingdom, p.19 4 Association of British Insurers. UK Insurance, p.1 industry to livelihoods in the country. This has made the industry a crucial player in the economy of the country’s economy. Economic Security Insurance provides comprehensive coverage for UK firms directly hence ensuring their financial soundness. Feetham notes that this is particularly important for small organisations that have limited access to financial markets making them vulnerable to adversities in the market.5 In case of such eventualities, UK insurance companies have been keen to compensate the insured firms and ensure that such firms do not discontinue from business. In 2012, the UK insurance industry paid out £12.5 million worth of claims every day for property claims, £3.4 million of which were commercial and £9.1 million were domestic. Some other £1.19 billion were paid out as commercial and domestic claims combined resulting from storm damage and flooding. Even after these payments, the industry still made underwriting profit of £242 million as noted by ABI.6 Thus, insurance plays a critical factor in curbing the going concern of business in the UK economy. Massive amounts of contingency funds would be required to be set aside to protect firms from uncertainties in the market. This is particularly true for large companies which according to Seog would have resorted to self-insurance.7 The insurance industry shoulders such burdens from these organisations, setting free the money that would have been used for such purposes. 5 Feetham, Nigel A Guide to Insurance, p.55 6 ABI, UK Insurance, p.4 7 Seog, S. Hun, The Economics of Risk and Insurance, p. 23 Mankiw argues that such funds would then be pumped into the economy and boost economic activities in return.8 Indeed, both individuals and organisations in UK appreciate this postulate thus the insurance industry has a major role to safeguard numerous livelihoods and businesses in the country. As indicated by ABI, 20.2 million, 19.6 million, 17 million and 3.6 million of the 26.4 million households in the UK have household contents insurance, motor insurance, building insurance and mortgage protection respectively.9 Furthermore, some other 1.7 million households have medical insurance. Such covers ensure that firms and families do not lock their money in readiness for emergencies but allows such money to be used in building the country’s economy. Employment The insurance industry in UK provides massive job opportunities directly and indirectly. The economy has about 976 firms registered to sell general insurance and some other 285 registered to sell long term insurance as documented by Smart.10 These firms directly provide employment to many citizens of the UK who would have probably had no jobs. Currently, ABI documents 320,000 people directly employed by the UK’s insurance industry.11 This is a substantial contribution to the labour market by UK insurance industry, bearing in mind the statistics by Organization for Economic Cooperation and Development [OECD] indicating that this accounts for about 33% of all the jobs in the financial services.12 8 Mankiw, N. Gregory, Principles of Economics, p. 23 9 ABI, UK Insurance, p.6 10 Smart, N. Gregory, “Insurance.” 11 ABI, UK Insurance, p.1 12 OECD. “Global Insurance Market Trends” Smart observes that the industry employs twice the number employed in water supply, gas and electricity sectors combined.13 Therefore, the industry directly employs a considerable portion of the UK population. Indirectly, the industry contributes to numerous employment sources to insurance brokers and agents who do business with the companies. It also offers employment to reinsurers and insurance regulation officers in the UK government as documented by Cimmins and Venard.14 The support services in conducting insurance business like infrastructure and stationery among many others also provide job opportunities to many more citizens. Other than employment provision, the UK insurance industry plays a crucial role in sustaining incomes for those in employment. By offering employment protection insurance, Kugler and Ofoghi observe that the industry ensures that the people of UK have sustainable sources of income such that in case of any unforeseen eventualities causing such income sources to be cut, the insurance firm keeps paying the insured for some time.15 In 2012, 2.8 million of such products were issued out making a total of 29 million such policies in force. Indeed, ABI documents payments worth £36.1 million in 2012 for such persons.16 This reduces the burden of social welfare for the government to cater for the unemployed. 13 Smart, “Insurance” 14 Cimmins, J. David., Venard, Bertrand (eds.), Handbook of International Insurance, p.66 15 Kugler, Maurice., Ofoghi, Reza. “Does Insurance Promote Economic Growth?” 16 ABI, UK Insurance, p.12 Foreign Earnings Export business is critical in ensuring that a country maintains its balance of payment. As countries seek to gain competitive advantage over their rival economies, they seek to foster export earnings. The UK insurance industry being the largest in Europe and among the top in the world has customers from all over the world having much confidence in it. This encourages a majority of them to insure with UK insurance companies, earning the UK economy foreign income as noted by Kugler and Ofoghi.17 There is also income coming from UK insurance subsidiaries from abroad that make returns to their parent companies as observed by Finkelstein and Poterba.18 The industry has 26% of its premium income generated from overseas business. Though amounting to a total of $311 billion, third after the US and Japan in 2012, it still was a significant injection into the UK economy according to ABI.19 Thus, the UK insurance industry enjoys global goodwill that earns its economy massive foreign income. Investment The UK insurers provide numerous investment vehicles in the economy. As noted by Kjoseviski, investment is a critical role of insurance companies in ensuring that it generates income from the collected revenue to enable it make claims settlements when they are due.20 17 Kugler, Ofoghi, “Does Insurance Promote Economic Growth?” 18 Finkelstein, Amy., Poterba, James., ‘Adverse Selection in Insurance Markets’ 79 19 ABI, UK Insurance, p.4 20 Kjoseviski, Jordan, ‘Impact of Insurance on Economic Growth’ 35 The UK insurance industry manages about £1.8 trillion worth of investments which ABI approximates to be 25% of the total net worth of the country.21 The industry has been steadily growing the portfolio of its investments since 2002 at £1 trillion and offers a myriad of investment solutions. The public sector debt securities grew from 10% in 2002 to 17% in 2012. Of the current investment portfolio, there are also 18% of private sector debt securities. The industry also considerably invests in UK and overseas equity, unit trusts and property. Such investments provide its customers with confidence in the ability of such firms to pay their claims when they are due. Government Income The UK government significantly sources its income from its insurance industry. Dickson observes that insurance companies are major players in financing government budgets.22 The major way this occurs is through payment of corporate tax and insurance premium tax. Ericson, Doyle and Barry observe that additionally, the government gets financing from insurance companies when they buy government bonds and securities.23 The UK insurance industry contributes significantly to the government’s income through taxation. In the 2011/2011 taxation year, the industry contributed income from taxes worth £10.4 billion, constituting about 1.9% of the total tax income for the government as given by ABI.24 21 ABI, UK Insurance, p.1 22 Dickson, D. C. M., Insurance Risk and Ruin, p.23 23 Ericson, Richard V., Doyle, Aaron, & Barry, Dean, Insurance as Governance, p.22 24 ABI, UK Insurance, p.3 Of this taxation income, £3.2 billion was a result of income tax on annuities and employment income, £2.7 billion from corporation tax and Insurance Premium Tax generating £1.6 billion. The industry has also been a key participant in buying government bonds and securities when they are floated. This makes the industry not just a financier of government’s budget but also a significant player in controlling inflation in the country. Conclusion The UK insurance is a significant player in Europe and indeed, in the world. It is the confidence that it bestows upon customers drawn from all over the world that makes the industry an economic asset to the government. It provides economic security to individuals and organisations to ensure continuity even after being hit by unanticipated eventualities. The industry also directly and indirectly provides employment to UK citizens, and further protects the income of the insured. Through the premium payment from foreign markets, the industry provides foreign earnings to the government together with massive income from investments. Therefore, the UK insurance is a critical player in the economic well being of the UK government and its people. Reference List Association of British Insurers. UK Insurance: Key Facts 2013 (London: ABI, 2013). (www.abi.org.uk) Birds, John, Insurance Law in the United Kingdom (New York: Wolters Kluwer, 2010) Cimmins, J. David., Venard, Bertrand (eds.), Handbook of International Insurance: Between Global Dynamics and Local Contingencies (New York: Springer, 2007) Dickson, D. C. M., Insurance Risk and Ruin (Cambridge: Cambridge University Press, 2005) Ericson, Richard V., Doyle, Aaron, & Barry, Dean, Insurance as Governance (London: University of Toronto Press, 2003) Feetham, Nigel., A Guide to Insurance: Combining Governance, Compliance and Regulation (London: Spiramus Press, 2012) Finkelstein, Amy., Poterba, James., ‘Adverse Selection in Insurance Markets: Policyholder Evidence from the U.K. Annuity Market’, Journal of Political Economy, 112:1, 2004, 183 - 205 Gosdin, James L., Title Insurance: A Comprehensive Overview, 3rd Ed. (Chicago: American Bar Association, 2007) Kjoseviski, Jordan, ‘Impact of Insurance on Economic Growth: The case of Republic of Macedonia’, European Journal of Business and Economics, 4, 2011, 34 – 39 Kugler, Maurice., Ofoghi, Reza. “Does Insurance Promote Economic Growth? Evidence from the UK.” (2005). http://repec.org/mmfc05/paper8.pdf (accessed April 6, 2014). Kunreuther, Howard C., Pauly, Mark V., & McMorrow, Stacey, Insurance and Behavioural Economics: Improving Decisions in the Most Misunderstood Industry, (Cambridge: Cambridge University Press, 2013) Mankiw, N. Gregory, Principles of Economics, 5th Ed. (Mason: South-Western Cengage Learning, 2009) Organization for Economic Cooperation and Development. “Global Insurance Market Trends.” (November 2011). http://www.oecd.org/daf/fin/insurance/49108065.pdf (accessed April 6 2014). Seog, S. Hun, The Economics of Risk and Insurance (West Sussex: John Wiley & Sons, 2010) Smart, Phil. “Insurance.” KPMG (2014). http://www.kpmg.com/uk/en/industry/financialservices/insurance/pages/default.aspx (accessed April 6 2014). Read More