1.
Introduction
Insurance in its simplest form
is familiar to everyone as they know at their daily lives in the form of medical
insurance, accidental insurance, buildings insurance, life insurance and more
recently disaster insurance. Insurance, in economics and
finance, is a form of risk management primarily used to hedge against
the risk of a contingent loss. Thus, insurance is defined as the planned
transfer of unforeseeable and unwanted risk of a loss, from one entity to
another. In this regard, insurance has been introduced to safeguard the
interest of people from uncertainty by providing certainty of payment at a
given contingency.
Basically, such transfer of
risk is possible in exchange for a premium, which is commonly taken as a
guaranteed and known small loss to prevent a large, unpredictable and possibly
devastating loss. Insurance, thus, may be known as a co-operative device of
distributing losses, falling on an individual or a family or an entity over a
large number of participants, each bearing a nominal expenditure and feeling
secure against heavy loss.
2.
The Business Model
In insurance business, each policy
owner (individual or entity) pays a premium to transfer 'catastrophic risks' to
an insurer (insurance company). The insurer, in due course, calculates the
premiums based on the probability of risks using sophisticated algorithms and
statistical tools which vary across companies and types of insurance. This
is done in such a way that on an average the insurer makes a profit, even
though it will have to pay out some claims. The principle is based
upon the insurer spreading its risk over many different clients, some of them
will sustain losses and make claims, but most of them will not.
3.
Role of Insurance
Insurance industry consists of
such financial institutions which help protect from a variety of perils. Not
only in Nepal rather throughout the world, insurance industry has evolved as an
important sector of the financial system side by side the banking industry. The
major roles that an insurance industry plays in an economy are briefed below:
3.1
Economic Role
For the economy of any country
insurance plays key role, which are of two folds: 1) provides a strong safeguard
in protecting loss of live and damage of properties; and 2) develops a system
to accumulate adequate funds for investment and capital formation. A sound
and healthy insurance sector is, thus, a necessary condition for smooth
functioning of economy and achieving sustainable and inclusive growth in the
long-run.
Non-life insurance such as
health, crops, livestock and fire insurance enable households to obtain a
higher income and improve the livelihood by satisfying the desire of security
and providing indemnity to the possible loss. In the meantime, industrial, transport,
any kind of third party liability and property insurance promote
entrepreneurial activities and commerce motivating the private investors for
taking additional risks.
Life insurance not only promotes
the quality of life but also facilitates development of capital markets and the
financial sector as a whole by generating additional sources of funds and help
meet the demand for long-term financing. Insurance against premature death or
disability in part substitute governmental social security spending and safes
governmental resources for other essential social purposes. Consequently,
insurance should not be seen as a luxury good, but as a necessary condition for
sustainable economic growth in any country.
In short, the economy and
society as a whole benefit from the certainty insurance brings through the
following ways:
· Efficiently
protecting the public through innovative risk management techniques.
· Freeing
up businesses and professionals from everyday risks and encouraging innovation
and competition.
· Relieving
the burden from the state and providing comfort to individuals by providing
safe, effective and affordable pension savings, protection and diversified
products that convert pension savings into retirement income.
3.2
Social Role
Insurance companies also
perform a redistribution of income, a great social role in reducing poverty and
inequality. The collected premium eventually got distributed among the
stakeholders: the policy holders; agents; surveyors; employees; and equity
holders. The redistribution of money either in terms of claims or in other
benefits may take place anywhere from a few months to many decades.
Because of this delay between
collecting and paying out funds, insurance companies invest their funds to
bring extra revenues. Such investments help business and government to finance
their operations and generate profits from those investments. In
this sense, though insurance is considered as a commercial product, both for individuals
and for corporate customers, they clearly serve a wider social purpose.
Insurance helps oil the engine of the economy, for example in underwriting
trade through trade credit. It also provides peace of mind to the public
through collective insurance for a host of perils including flood, fire, and
health.
4.
Importance of Insurance in Nepal
Insurance benefits society by
allowing individuals to share the risks faced by many people. It also serves
many other important economic and societal functions. Insurance also provides
the capital that the developing countries need to make large volume of
investment to accelerate the overall economic development. The efficient
insurance markets are an essential for the transition countries like Nepal to
achieve integration into the global economy and sustainable as well as strong
economic growth. In this connection, insurance can play an active role for
economic development of Nepal in the following ways:
4.1
Risk Transfer
One of insurance's key roles
is safeguarding the financial health of small and medium-sized enterprises. In
addition to the protection provided by social security systems, private
insurance cover is crucial for people to insure themselves against inability to
work, set aside money for retirement or protect themselves against the loss of
their assets. This is where insurance comes in as a key component in ensuring
the healthy development of small and medium-sized enterprises - a fact which is
of paramount importance to a country's economic stability.
A vibrant insurance sector is
also important in encouraging domestic production, innovation and trade.
Insurance reduces the investment risk faced by companies and the state. This is
especially important in emerging markets, as a shortage of capital is one of
the major disincentives to investment. By reducing investment risk, insurance
can also encourage companies to think more long-term and increase their risk
tolerance.
4.2
Information Dissemination
Insurance plays an additional
role in the economy: that of providing information. The level of insurance
premiums provides an indication of existing risks and of how probable it is
that a loss will occur. This helps companies make a comparison of the
risk/return profiles of projects, thereby ensuring that the available resources
are put to the best possible use.
This is highly important in
the country (Nepal) having infrastructure gap and striving for graduating from
LDC status to status of developing country. To infrastructure investments: if
it weren't for insurance, a lot of infrastructure projects - such as power
plants, railways or airports would not have been financially feasible.
Insurance companies also offer consultancy services, advising on how to improve
safety standards and a product's quality.
4.3
Capital Market Development
As institutional investors,
insurance companies contribute to the development as well as functioning of
capital market. Insurance companies receive premiums and set them aside as provisions
for the payment of future claims. They proceed to invest them in the capital
market, which gives them the status of major investors. Insurance has, thus,
become a significant economic force in most industrialized countries. Insurance
market activities may contribute to economic growth; both as financial
intermediary and indemnification by allowing different risks to be managed more
efficiently; and by mobilizing domestic savings.
5. Reflection
of Nepal
Insurance industry is one
component of the overall financial system of Nepal. According to the current
national income accounting system of Nepal, income generated/value added from
this sector has been included in the tertiary sector, which falls under
non-agriculture sector of the economy.
According to the latest data for 2018,
the tertiary sector has been contributing 7.61% to total GDP, while the
contribution of non-agriculture sector as a whole to total GDP is around 71.79
%. From the fiscal year 2001/02 onward,
the tertiary (service) sector of Nepal has been growing by an annual average
growth rate of around 5 % and the share of this sector to total GDP of Nepal
has recorded 50.66 %. Although the annual growth rate of tertiary sector has
been fluctuating, the share to total GDP has been increasing gradually reaching
around 58 % in 2018 from 45 % in 2002. This is presented in the figure 3 below.
It is shown by the figures
that the development of insurance industry of Nepal has gained momentum after
2001 which may be due to increasing economic literacy and resulted risk
avoiding awareness among the people supported by the growing middle-class
households. During the review period, there has been a gradual increase in
various fields of insurance industry, such as, insurers (life and non-life
insurance companies), insured people (insurance service buyers), insurance
agents, and surveyors, on the one hand, and the collection of insurance fees
have also increased on the other hand.
Investment flow from the
insurance sector, contribution to the national economy, and direct and indirect
employment opportunities, has also increased. This has been clearly indicated
by the higher growth rates of insurance premium collection than the growth of
tertiary GDP. In the meantime, the share of insurance premium to tertiary GDP
has increased by almost three-fold during the review period whereas, the share
of tertiary GDP to total GDP has grown marginally in comparison to the
insurance premium.
6. Observations
Despite such remarkable
development, insurance service however, is yet to reach the people of remote
and rural areas and the low-income groups. The quality of services, now being
available to the general public should be improved to meet the international
standards. In such a situation, the following observations have been made:
·
The quality of insurance services has to be enhanced according to the
international standard. Non-life insurance has to be developed as a powerful
mechanism of managing the possible exposure to financial losses that occur due
to social and natural risks as an instrument of capital formation.
·
People of remote and rural communities, low-income groups, and the society
as a whole have to be ensured that the standard of insurance service is
available with respect to the national need, including those of remote and
rural communities and low-income groups.
·
Problems of the insurance sector have to be addressed so as to meet the international
standards and national needs. Appropriate systems have to be developed to
upgrade service delivery as per the needs and purchasing capacity of people.
·
Service delivery mechanism and channels have to be refined and extended to
new areas. Public awareness efforts have to be focused to the rural areas.
·
Existing provisions of law have to be revised to incorporate legal
provisions as appropriate to the policy requirements reforms taken place in the
overall socio-economic landscape of the country.
·
Necessary actions to be taken to fill gap of skilled human resources needed
for further improvement of the insurance business. The regulatory mechanism and
operational modalities have to be reformed in line with the international
standards as per the national needs and capacity.
7. The
End Note
From a macro-economic point of
view, the insurance market could help to mobilize national savings and narrow
the investment gap of developing economies. In emerging markets, domestic
savings have not been fully mobilized despite huge funding needs arising from
infrastructure projects. Insurance companies as important long-term
institutional investors, therefore functioning as financial intermediaries,
contribute to bringing together savers and borrowers. Life insurance, in
particular, can make savings available – although life insurers are themselves
dependent on a functioning capital market if they are to measure up to their
role in the area of risk transfer.
Employees buy insurance to
cover their work-related injuries and health problems. Business also insures
their property, including technology used in production, against damage and
theft. Because, it makes business operations safer, insurance encourages
business to make economic transactions, which benefits the economy of
countries. Thus, a strong and healthy insurance industry is of utmost
importance for all groups and sectors of the economy. Nepali economy cannot be
an exception and insurance industry can play pivotal role in mobilizing idle
resources that in turn converted into investment, capital formation,
industrialization, employment generation and promoting the economic growth.
Published in Insurance News and Views of Insurance Board of Nepal 2019 May
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