# **1. Introduction**

The benefits of a well-functioning insurance sector to households, firms and the public sector are widely acknowledged (Lester, 2014; Bennett et al., 2018; Mall, 2017; Camargo, Chamberlain and Coetze, 2017; Hagmayr et al., 2007; Webb, 2006). By reducing the risk to which humans and their activities are exposed, insurance prevents adversity from leading to immiseration, and reduces the related anxiety. Related, it allows putting to better use buffer capital stocks that individuals saved up in case of unlikely but devastating hardships. Insurance also allows economic actors to engage in activities that promise greater expected returns but are subject to uncertainty, and it allows them to access financing, be it small-scale farmers, multinational conglomerates or governments. Insurance quantifies risk and incentivizes informed risk reduction, as risk-taking individuals such as smokers and aggressive automobile drivers, for example, face higher insurance prices and thus increased incentives to modify their behavior leading to fewer road traffic accidents and less smoking. Insurance also creates markets by increasing the supply of organ donors for individuals that need organ transplants. Without insurance there would be too few individuals that could afford the health care costs making the market too thin. More generally, insurance plays an important role of financial intermediation by mobilizing and pooling capital and making it available efficiently and at scale, often for the long durations required by infrastructure projects (Levine and Zervos, 1996 and 1998; Arestis and Demetriades, 1997). As institutional investors, insurers can contribute to good governance of their investees, and hence to positive business confidence. Even where insurers play a minor role in accumulating the pension assets that aging populations increasingly require, annuities offered by insurance companies are the only hedge there is against the longevity risk.

Given these benefits, why do we observe such low levels of insurance in some countries? The median of worldwide Insurance Penetration, defined as a country’s insurance premium as percentage of GDP, was under 2% in 2016,<sup>1</sup> but this masks the fact that national differences are huge, ranging from close to 20% at one end of the spectrum to 0.06% at the other. Media coverage of every natural disaster highlights the often large difference between the economic and the insured losses, a gap that has been widening over the last decades.<sup>2</sup> The same is true for shortfalls in pension levels compared to living standards that citizens expect around the world.

The early literature on finance and growth, started by the work of Goldsmith (1969), McKinnon (1973), and Shaw (1973), notes that it is difficult to establish “with confidence the direction of the causal mechanism, i.e., of deciding whether financial factors were responsible for the acceleration of economic development or whether financial development reflected economic growth whose mainsprings must be sought elsewhere” (Goldsmith, 1969 pg. 48). Jung (1986) provides postwar econometric evidence for a group of 56 countries that causality (in the Granger sense) runs in either and both ways.

Greenwood and Jovanovic (1990) develop a model that highlights how financial intermediation and growth are inextricably linked in accordance with the Goldsmith-McKinnon-Shaw view on economic development. Financial intermediation promotes growth because it allows a higher rate of return to be earned on capital, and growth in turn provides the means to implement costly financial structures.

> 1 Source: AXCO Insurance Information Services global statistics.

> 2 Edwards (2012) presented a methodology to quantify this so-called insurance protection gap for non-life insurance, and found that 17 of the 42 countries they analyzed are underinsured, with the gap adding to 168bn USD.

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