# **2. Literature Review**

Many of the recent studies documenting the relationship between insurance penetration and economic growth (e.g. Wardand and Zurbruegg, 2000) neglect the direction of causality. A set of studies suggest that the development of an insurance sector is a necessary pre-condition for economic growth. They maintain that development of the insurance sector may induce higher economic growth by facilitating savings in the form of financial assets, thereby promoting capital formation and hence, promoting economic growth (see, for example, Alhassan and Fiador, 2014; Lee et al., 2013; Haiss and Sumegi, 2008; Lee, 2011 and 2012; Ward and Zurbruegg, 2000; and Webb et al., 2002). Another set of studies suggest in contrast that the development of the insurance sector only plays a minor role in economic growth, and that the development of the insurance sector is merely an outcome or result of economic growth in the real side of the economy. As an economy grows, the argument goes, additional insurance coverage may emerge in the market in response to a higher demand for financial services (e.g. Catalan et al., 2000; Pan and Wei, 2012; and Ward and Zurbruegg 2000). Yet another line of thought suggests that economic growth and development of the insurance sector can complement and reinforce each other, making development of the insurance sector and real economic growth mutually causal. The argument in favor of this bidirectional causality is that development of the insurance sector is indispensable to economic growth, as economic growth inevitably requires a developed insurance market. This is the core idea in Greenwood and Jovanovic’s (1990) model and empirically this has been tested by Beck and Webb (2003), Nejad and Kermani (2012), and Pradhan et al. (2016). Finally, one last set of papers argues that development of the insurance sector and economic growth are independent from each other (Pan and Wei, 2012).

From the point of view of an individual, several factors may drive demand for insurance. These include utility maximization and risk aversion (Yaari 1965; and Hakansson, 1969), income and wealth, subjective discount factors, insurance premium rates (Outreville, 1985), human capital endowment (Szpiro and Outreville, 1988), and religion (Browne and Kim, 1993). These theories usually assume perfect capital markets, intergenerational distribution of income in the presence of population growth, and universal access to savings products. Despite the perhaps limited applicability of these theories to developing countries, Outreville (1990, 1996) tries to identify the link between an economy's financial development and insurance market development. Using insurance premium income data from 48 developing countries compiled by UNCTAD, Outreville (1996) sets up an empirical model of life insurance demand that depends on GDP per capita, anticipated inflation, real interest rates, and life expectancy at birth as a proxy for the price of insurance. Demand for insurance also depends on whether the market is monopolistic, whether foreign insurance companies are present, and on the level of financial development.<sup>3</sup> He finds an income elasticity of insurance demand that is positive and provides regression coefficients for a number of other explanatory variables, which are not straightforward to generalize given the limited amount of insurance premium data available.

Outreville’s results are similar to those of Browne and Kim (1993) who conclude saying that “As more data become available, an analysis of insurance consumption in a wider sample of countries would likely lead to a greater understanding of insurance demand. Further, a time series study of demand could potentially lead to a greater knowledge of the growth and maturation of insurance markets.” In addition, empirical and theoretical evidence suggests that the role of insurance in the economy may be varied across countries. Beenstock, Dickinson, and Khajuria (1986) and Browne and Kim (1993) found that the role of the state in providing insurance services was a determinant of the demand for life insurance, 3 Measured by the ratio of quasi-money (M2-M1) to the broad definition of money (M2).

5