What Is the Economic Function of Insurance?

by Team Insurepedia
Function of Insurance in Economy

The Economic Functions of Insurance

The origins of insurance as a practice and business are not clear. It is not quite clear when the practice first started. However, what is certain is that informal risk sharing has most probably been around with human beings for hundreds, if not thousands of years.

However, the development of modern insurance business and practice is much more recent.  It is known to have started in the 16th century. But it has really become a mass financial market and organized business over the past 100 years of so.

Today, the insurance is a vast global business. The global insurance market was worth just under five trillion U.S. dollars as of 2020, but this looks set to increase substantially in the coming years.

Life premiums account for $2490 billion, general insurance premiums the remaining $1779 billion.

Insurance premiums therefore account for approximately 7% of the world gross domestic product.

Insurance penetration refers to how developed the insurance sector is in a country, and is the ratio of annual total insurance premiums to the gross domestic product. The vast majority of European countries had an insurance penetration of under ten percent in 2020.

So, What is the Function of Insurance?

The primate function of insurance is frequently stated to be to act as a risk transfer mechanism.  However, it is widely agreed that insurance does have secondary economic functions.

Secondary Economic Functions of Insurance

There are several economic Functions of insurance:

Below are a few:

1. Economic Stimulation through security
2. Availability of Finance
3. Business Promotion
4. Business Continuity
5. Reduction of Tax burden
6. Source of Investments
7. Loss Reduction
8. Promoting Savings

Let us get some little details about each

Stimulation via Security
The security that an insurance policy gives, is very significant in economic terms.  This sense of security provides means that funds that would have had to be retained to meet possible losses can be released.

In the case of individuals, the same sense of security provided by insurance means increased consumer spending providing stimulus to the economy.

Industry and comes is free to undertake greater investment in the business hopefully increasing both profitability and employment.

In addition, insurance facilitates such investment by increasing the likelihood that it will be successful as additional assets purchased can be insured.

Further, it reduces the risks faced by external investors (such as shareholders) and this in turn, promotes investment. 

All these, is what is meant when people refer to an insurance policy as providing peace of mind.

Availability of Finance
Associated with stimulation via security above, is the role of insurance in providing security for bank lending. Loans are frequently secured on physical assets (most commonly in the case of domestic mortgages).

Such assets only represent good security if they continue to exist in an undamaged state. The insurance of the asset means that it is fairly certain that the asset will continue to secure the loan. This leads to  greater willingness, on the part of the banking institutions to lend.

Business Promotion
By covering some of the risks associated with business contracts and business loses, insurance makes business more likely to enter into such contracts, and explore more possibilities.

This confidence leads to a greater level of business activity. Examples would include marine insurance covering good in transit between buyers and sellers, and liability insurance covering the consequences of errors.

Business Continuity
By providing finance in the event of catastrophe, the level of business failure is reduced, with the obvious benefits in terms of increased tax revenues and reduce unemployment.

Reduced Tax Burden

Insurance provides a source of financial compensation for private individuals who would otherwise turn to the state for assistance.

This would include 2 scenarios, either the individual directly insures their assets or earning potential or where liability insurance provides a guarantee of compensation the vent of injury that might otherwise not be forthcoming.

Note that this has a cost, the insurance premium. A benefit to society only arises if the insurance industry is able to handle the loss more efficiently than government.

Source of Investments
As well as stimulating investment, the insurance industry controls vast funds. These funds provide an additional source of finance for industrial development and government borrowing.

Loss Reduction
The insurance industry has a vested interest in accident /fire prevention and is a major source of research funding in this area as well as providing a natural forum for discussion and dissemination.

Promoting Savings
Many insurance policies are in fact saving schemes. For example, many people fund pensions via insurance companies. Some life insurance contracts also are particularly or mainly savings based. Up to the appoint the accrual of savings could be viewed as being beneficial to the economy. 

This provides financial stability for individual s, reducing dependency on the state benefits.  Taken to extremes, however, excessive savings could lead to recession as firms struggle to sell their products to consumers spending and hence demands falls.

To Conclude About the Function of Insurance

In summary, the function of insurance in the economy goes far beyond mere protection against losses. It provides the foundation for economic stability, facilitates risk management, fosters innovation, and supports financial intermediation.

By enabling individuals, businesses, and governments to mitigate risks and pursue opportunities, insurance becomes an integral component of a robust and thriving economy. Recognizing the vital role of insurance and ensuring its accessibility and effectiveness is crucial for building resilient and prosperous societies.

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