The effects of insurance beyond the financial dimension

As we saw in the preceding sections, insurance plays an important role in the financial domain. However, its impact beyond the purely financial and on economic growth is as relevant to a modern economy. Insurance, when it is provided, gives independence to people and increases their capacity of self-reliance.

The ability to cope with adverse effects, which are often unexpected and might occur at the least opportune moment, is strengthened.

This creates a very strong impact on future development because it enables people to become and stay active as they do not have to worry about all possible adverse effects that a certain activity might entail.

While there is a direct economic effect through the financial protection of assets, there is also an additional consequence: peace of mind. People tend to behave differently and we suppose more positively when they know that certain risks are taken care of.

This is a psychological rather than a financial effect accompanying the purchase of insurance. The counterargument here is the existence of moral hazard, where individual behaviour becomes more risky due to an existing insurance coverage.

It is difficult to assess the exact impact of both the effects, a positive one that reduces risky behaviour and a negative one that would encourage it. Insurance companies have found ways of dealing with the problem of moral hazard by implementing mechanisms that protect the insurance scheme from undue exploitation and bad risks.

Once people are insured, they become members of a solidarity group that goes far beyond their own circles. In the past, a family or village, maybe an extended family or a network of little villages could work together to share certain risks and compensate those that suffered from ill fortune.

However, the scope of a risk-sharing group was usually limited, if not by geographic realities then by the impossibility to knowand understand the risk exposure of an unknown partner.

Through insurance, however, the risk-sharing group can be extended and people who participate in it need not know everybody else in the group as they delegate the task of organising the group to an expert, the insurer.

Consequently, the group can take on a whole new extension where risks can be pulled from different parts of the world and even from different risks and different lines of businesses.

The resulting risk pool is organised ex ante, that is, before a disaster happens, to support the others when and if it happens regardless of the formal ties that participation in the scheme might or might not share beyond taking part in the scheme.

This is an important mechanism that would not exist at such a sophisticated level without insurance. Insurance companies are information providers, knowledge carriers and training centres for economies with highly complex products that need a lot of financial and non-financial knowledge: a fire insurer needs to know about building codes and materials, a flood insurer about geographic feature and meteorological conditions, a health insurer about medicine and pharmacology, etc.

This bundling of superior knowledge has a positive effect on and is of a significant value for the development of economies and of societies.

Firstly, insurers need well-formed experts in risk matters who work for them and so they have an interest in the education and formation of an experienced workforce.

Through their work and the specialists needed to run their business, better understanding about risk issues is introduced into a society.

Secondly, they create more knowledge about risk management, risk assessment and understanding vulnerabilities on the side of their potential customers, consulting for example about risk exposures and prevention, mitigation strategies and possible solutions.

The sale of an insurance product is closely tied to a risk assessment exercise by the insurer, which is usually shared with the prospective client.

This introduction and spreading of knowledge and understanding is valuable not just for the insurance markets, but for the general development of the economy because risk assessment, risk management, prevention mechanisms, etc., are very much a precondition of and a driver for sustained growth.

And its absence can be disastrous for many undertakings. It is interesting to note the high correlation between the existence of insurance in certain markets and the profusion of preventive measures.

This apparently not only affects those parts of the economy where insurance is active but also in a more general way as certain risk management practices spread and are more widely adopted. Even legislators seem to react to this mechanism because more sophisticated legislation tends to appear in tandem with a more sophisticated insurance market.

While this conclusion is merely based on observation, it would be interesting to obtain research results that could substantiate this view. Insurance not only affects ex ante behaviour such as more efficient prevention, but also ex post behaviour.

The information and knowledge that exist through insurance allow, for example, speedier reconstruction after natural or man-made disasters.

Knowing that the affected parties have insurance policies that cover an event and ensure enough funds to sustain rebuilding efforts, the work on a disaster site becomes more attractive or even possible in the first place.

Larry Silverstein, the owner of the World Trade Centre in NewYork that was destroyed in the attacks of 11 September 2001, made a very clear case for reconstruction. He said that the availability of the insurance payout was directly linked to his reconstruction effort.

But it is not only the payout that has an effect. Already the understanding by all parties that a risk is covered leads to positive results.

Let us consider another example: After a hurricane, if it is known that homeowners have the money to pay for new roofs, the construction companies will be standing at the ready in order to provide the services because they knowthat they are going to be paid eventually.

This means that the existence of an insurance scheme creates another reservoir of activities, of services that are ready to step in, in case of a disaster. They would not be available as a backup if people lost everything due to a disaster and did not have the opportunity to rebuild.

The existence of an insurance market fosters an industry around it: offers for preventive measures and services, damage assessments, legal advice and assistance, claims handling services, relief and reconstruction mechanisms, etc.

These services are not only available to insureds but benefit the whole economy. They also create jobs, much like the insurance industry does, a very large employer in most developed economies.

Work in the insurance industry is quality work, as insurance jobs are highskilled modern services workplaces with low absenteeism and few accidents. They are well-paying jobs for a large number of persons with varied backgrounds.

Insurance also has a very positive interaction with the public domain because major incidents could result more easily in large disruptions and even in civil unrest in the absence of mechanisms to compensate the affected population.

The aforementioned 11 September attacks caused economic losses to the city of NewYork in the order of 100 billion USD, as calculated by McKinsey.

The insurance payout is estimated by Swiss Re and Munich Re to be around 30 billion USD, a significant share of it in the form of life insurance payments to distressed families who lost their prime income earner or in the form of business interruption policies which guaranteed continuing income despite the loss of a key source of revenue for shop owners.

It is only too obvious that these payouts helped mitigate the effects of the disaster on the general population.

As the New York experience showed, after large disasters, the insurance infrastructure allows for easy piggybacking of additional initiatives like impact assessment and information sharing, public disaster information and relief centres, and the channelling of humanitarian help, etc.

The disaster relief centre, created by the Insurance Information Institute in NewYork grouped and coordinated 25 different organizations, all with the aim of helping to cope with the aftermath of the terrible event.

The counterexample to this positive post-catastrophe scenario could to a certain extent be the aftermath of Hurricane Katrina that struck NewOrleans in September 2005.

The storm and the floods that followed not only took hundreds of lives but they also destroyed the livelihood of many people and families who had no protection in the form of insurance.

Additionally, the insurance infrastructure in the state of Louisiana was much inferior to that of the state of New York in 2001.

The violence and looting that took place in the days after the hurricane were linked by some media commentators, at least in part, to the fact that very fewof the poorer families could expect insurance payouts to help them with reconstructing their lives.

As we can easily observe, the existence of insurance and the protection and prevention schemes that go with it have a noticeable impact on public life. People will generally not accept the same lax attitude towards risk management of governments if they are fully aware of the consequences.

The nuclear debates in the 1970s took a different turn when the high risks associated with this technology became more apparent and publicly known.

Insurers and their business partners also provide a lot of the knowledge concerning climate change and natural disasters like storms and earthquakes. Through their work the public risk debates are different, usually more informed but also intense, and they often play a direct role in stimulating less risky behaviour.

Safety campaigns like ‘‘Safe driving’’ or ‘‘Safety at Work’’ are very positive as they reduce fatalities and accidents. In France, the recent nationwide safe driving campaign was supported in a major fashion by the FFSA, the French insurers’ association.

It reduced road fatalities by about a quarter in the space of less than one year! Insurers are sometimes considered as very boring because they want people to buckle up in their car and they do not want them to go bungee jumping.

People can still decide not to buckle up but at least they are aware of the dangers and that sort of behaviour is becoming less acceptable and less common. The possibility to associate insurance premium directly with the risk exposure, especially where individual behaviour plays a major part, is a powerful tool.

The awareness about insurance premia going up because of risky behaviour is not lost on the cost conscious consumer – with a generally positive result for the economy at large.

Location: Indonesia