Introduction. Does Insurance Promote Economic Growth? Evidence from BRICS Countries

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1 Does Insurance Promote Economic Growth? Evidence from BRICS Countries Introduction Over the years insurance sector has witnessed significant growth worldwide and India is no exception to this phenomenon. According to the finance-growth nexus theory, financial development (through financial intermediaries) promotes economic growth (Levine 1997). Among financial intermediaries, the insurance companies play an important role as they are the main risk management tool for companies and individuals. Literature shows three schools of thought on the nature of relationship between insurance and economic growth. The first school of thought postulates that insurance leads to economic growth, the second school of thought says that economic growth leads to development of insurance sector (Patric 1966). The third school of thought suggests bidirectional relationship between insurance development and economic growth [Hariss and Sumeigi, 2008]. Studies like Boon (2005), Arena (2008), webb et al (2002), Akinlo (2013), Nejad and Kermani (2012), Umar and Ahmad 92015) found Unidirectional causality running from insurance development to economic growth, while Oke (2012), Ching, Kogid and Furuoka (2010) reported the Unidirectional causality from economic growth to insurance development. Studies by Kugler and Ofoghi (2005), Akinlo (2012), Su Chi Wei (2012), Verma (2013), Umar (2015), Pradhan (2015) found evidence of bidirectional relationship between insurance and economic growth. Understanding the fact that insurance not only facilitates the economic transactions through risk transfers and indemnation but also provide financial intermediation. Keeping this in mind the main objective of the study is to examine the relationship between insurance development and economic growth in BRICS countreis for the period and thus fill the gap in the literature. The paper is organized in four sections. Section 2 gives theoretical approach to finance and economic growth. Section 3 provides the review of literature of the empirical studies on

2 relationship between insurance and economic growth. Data and methodology is presented in section 4. The last section gives the summary and conclusion. 2. Theoritical Approach to Finance and Economic Growth Finance is developing very rapidly. This has been due to many factors, including, globalization, liberalization, deregulation, and the financial innovations. According to the finance-growth nexus theory financial development promotes economic growth through channels of marginal productivity of capital, efficiency of channeling saving to investment, saving rate and technological innovation (Levine, 1997). Many theories and have shown that countries with better-developed financial systems enjoy faster, more stable and long-term growth. Well-developed financial intermediaries and financial markets have a significant positive impact on higher long-run growth. Financial development contributes to an increase in the efficiency of the use of savings through investments, which in turn would favour economic growth. Economic growth is the result of various factors. There are two main approaches: classical and neo-classical theory (supply-side factors long-term analysis); Keynesian theory (demand factors an analysis of growth in the business cycle short- and medium-term analysis). The assumption of the relative isolation of the markets, according to which what happens to the money market does not influence the goods market, derives from the classical idea of an economy. According to classical theory, finance is neutral to the real economy. According to Walras theory of general equilibrium, financial intermediaries can neither contribute to the acceleration nor to the slowdown of the growth-rate of an economy. There is no need for functioned intermediation in hypothetical ideal environments such as those in the models of Arrow and Debreu. 1 J. Schumpeter 2 said that a well-functioning financial system plays an essential role in promoting economic development. He argued that the services provided by financial intermediaries mobilizing savings, evaluating projects, managing risks are essential for economic 1 D.D. Hester, On the theory of financial intermediation, De conomist 142(2) (1994): R. King and R. Levine, Finance and growth: Schumpeter might be right, The Quarterly Journal of conomics 8 (1993): 717.

3 development.1 R. Merton,said that... in the absence of financial systems... technical progress will not have significant and substantial impact on economic development and growth. 3 Several economists opined that finance is a relatively unimportant factor in economic development. Recent literature emphasizes the role of financial intermediaries in improving the allocation of resources. Authors like Greenwood and Jovanovic, and also King and Levine, have developed financial models in which financial sector services contribute to economic growth. 4 Financial development is measured by factors such as size, depth, access, efficiency and the stability of a financial system, including its markets, intermediaries, range of assets, institutions and regulations.32 One of the components of this index is insurance development, measured by the following indicators: (1) Life and Non-life insurance penetration insurance premium per capita; (2) Real growth of direct insurance premiums, (3) Life and Non-life insurance density relative insurance premiums to GDP (4) Relative value added by insurance to GDP, which measures the contribution of the insurance sector in the development of GDP. Table 1. Selected data from the ranking of countries in terms of financial development between Specification rank rank rank rank rank rank Brazil Russia India China South Africa Source: World Economic Forum financial Develpement Reports World Economic forums first Financial Develops Report was published in The analysis of the financial development summary in Table 1 gives important insights, firstly of all the BRICS nations China is the most financially developed as we can see from table 1 from 2008 to South Africa moved from 25 th rank to 28 th rank in India moves from 31 st rank to 40 th rank 3 P. Haiss and K. Sumegi, The Relationship of Insurance and Economic Growth A Theoretical and Empirical Analysis, (paper presented at the 2006 EcoMod Conference, Hong Kong, June 28 30, 2006): J.F. Outreville, Financial development, human capital and political stability, UNCTAD Discussion Papers 142 (1999): 2.

4 because of the lower levels of financial sector liberalization. In 2008 the world was amidst of financial crisis that posed one of the greatest threats to the world economies. The growth and stability of emerging market economies has been the bright spot. But these economies in turn were dependent on their financial system. The role of financial sector in economic growth has become a major topic of empirical research in the last few years and the work of R. King and R. Levine has elaborated this. With the use of Granger causality test for a number of time series, Watchel and Rousseau confirmed that relationship exists between financial development and economic growth. A large number of empirical studies have shown that financial development has an important impact on growth. Many studies have given the relationship between development of the banking sector and economic growth. Although insurance companies are growing in the importance in financial intermediation but they have not received much attention as not more work is there in this area. Among financial intermediaries, insurance companies play an important role in the functioning of financial systems. They are the main risk management tool for companies and individuals. Since insurance companies act as financial intermediaries it connects their function with economic growth. Therefore, according to the theory, the insurance sector is one of the factors contributing to the longterm economic growth. The importance of the insurance industry in the economics of a country was already studied as early as in 1964, at the first UNCTAD conference: a robustly national insurance and reinsurance sector represents an essential feature of a proper economic system, contributing to economic growth and fostering high employment. 5 Insurance development is a part of financial development. In this study we accept the definition of insurance development (as analogous to financial development) as a long-term process of growth and improvement of the insurance market, institutions and instruments (qualitative changes), oriented to increase the effectiveness of their operations and increase the volume of insurance transactions (quantitative changes). 6 5 M. Kugler and R. Ofoghi, Does Insurance Promote Economic Growth? Evidence form the UK, (2005): 1, www. repec.org 6 J.Kulawik

5 This study discusses possible contributions of insurance development to economic growth, based on the theories of financial intermediation and growth. The aim of the study is to examine the relationship between insurance and economic growth occurring because of the interdependencies of development of finance and insurance, and economic growth (finance-insurance-growth nexus theory). The main research hypothesis is as follows: insurance development does not have a positive effect on long-term economic growth. The study also examines the short term relationship by studying if insurance development granger causes economic growth and vice- versa. 3. Review of Literature Beenstock, Dickinson and Khajuria (1988) apply pooled time series and cross-section analysis on data, covering mainly 12 countries. They regress premiums for property liability insurance (PLI) onto gross national product (GNP), income and interest rate development. They find that premiums are correlated to interest rate and GNP; marginal propensity to insure (short- & long-run) rises with income per capita and is always higher in the long run. Beenstock et al (1988) argue that insurance consumption is not affected by economic cycles or cyclical income variations. Holsboer (1999) is concentrating on the recent changes in the external environment for insurance companies in Europe. He argues that the change of importance of insurance services in the economy is dependent on the growing amount of assets and the increasing competition between the financial sectors, but the author emphasis the prominent role in the services industry and denotes insurance sector development as a determinant for economic growth. D. Ward and R. Zurbruegg s (2000) work is considered the first study to examine the potential relationship between the growth in insurance activity and economic growth for nine OECD countries. They used the total number of written insurance premiums as the definition of insurance activities. Causality tests from vector auto regressions in levels show that insurance activity leads to economic growth only in Canada and Japan. In Italy there is a bidirectional relationship. For all other countries, including the United Kingdom, the USA, Austria and

6 Switzerland, there is no evidence of the interaction. Ward and Zurbruegg conclude that the causal relationships between insurance and economic growth might vary across countries due to the influence of different country-specific factors, including cultural, regulatory and legal ones 7. Beck & Webb (2002) apply a cross-country and a time-series analysis for the relation between life insurance penetration, density, and percentage in private savings and in force to GDP as the dependent variables and GDP, real interest rate, inflation volatility and others the explanatory figures. Strong evidence was found for GDP, old dependency ratio, inflation and banking sector development. Webb, Grace and Skipper (2002) examine banks, life and non-life insurers. In particular, they examined how banks and insurers contribute to economic growth individually and together. Their findings indicate that financial intermediaries are significant and synergy exists between banks and insurers. Furthermore, results show that a combination of banking and one insurance type has the strongest impact on growth. Conclusions indicate a supply-leading causality link 8. Das, Davies and Podpiera (2003) in the model they proposed identified contagious functions and properties of insurances. They further develop new financial soundness indicators for insurance companies by joining their experiences gained under the Financial Sector Assessment Program31 (FSAP) and from a review of recent failures in the sector. M. Kugler and R. Ofoghi (2005) examined the long-term relationship between the size of the insurance market and economic growth in the United Kingdom. Using Johansen s cointegration tests, they found a long-term relationship between the development in the size of an insurance market and the economic growth. The results show that for most cases there is a bilateral longterm relationship between the development of the size of an insurance market and economic growth 9. He concludes that causality runs in both directions. 7 D. Ward and R. Zurbruegg, Does Insurance Promote Economic Growth? Evidence from OECD. Countries, The Journal of Risk and Insurance 4 (2000). 8 I. Webb, M. F Grace and H. Skipper, The Effect of Banking and Insurance on the Growth of Capital and Output, Center for Risk Management and Insurance Working Paper 02 1 (2002). 9 M. Kugler and R. Ofoghi, Does Insurance Promote.

7 Peter and Kjell (2006) worked on the relationship of insurance and economic growth, a theoretical and empirical analysis which was presented as a paper at the 2006 ECoMOd conference in Hong Kong. They applied a cross country panel data analysis using annual insurance premium data from 29 European countries over the 1992 to 2004 period. They found a weak evidence for a growth-supporting role of life insurance and explain this with similarities to recent bank and stock sector findings M. Arena (2008) provides a systematic assessment of the impact of insurance market activity (life and non-life insurance) on economic growth. Both life and non-life insurance premiums have a positive and significant causal effect on economic growth, but life insurance is, according to Granger, the cause of economic growth in high-income countries. The impact of the development of non-life insurance was confirmed in both developing and developed countries, it is greater in developed countries than in developing ones 10. Conclusions regarding a causality link show that it is supply leading, both in life and non-life sectors. Life insurance is more important for high-income countries. P. Haiss and K. Sumegi (2006) examine whether insurance influences economic growth and if it influences how it does. They developed a modified production function to empirically investigate the endogenous insurance-growth model. Their research produced mixed results. Their results show no evidence of a correlation between aggregate insurance premium income and GDP growth. However, strong evidence of the impact of life insurance on economic growth has been found 11. In another study, P. Haiss and K. Sumegi (2008) investigated both the impact of insurance investments and premiums of life and non-life segments on GDP growth in Europe. Their findings emphasise the impact of the real interest rate and the level of economic development for the insurance-growth-nexus. They argued that the insurance sector needs to be paid more attention in financial sector analysis and macroeconomic policy. They concluded that it is a 10 Marco Arena, Does Insurance Market Activity Promote economic Growth? A Cross-Country Study for Industrialized and Developing Countries, (The World Bank 2006) 11 P. Haiss and K. Sumegi, The Relationship of Insurance and Economic Growth A Theoretical and Empirical Analysis, (paper presented at the EcoMod conference, Hong Kong, 2006).

8 supply leading causality link. Life insurance is more important for high-income countries and non-life is more important for emerging EU countries 12. K. Ortyński and T. H. Bednarczyk (2010) studied the relationship in Poland. Their results show that there is a positive and statistically important relationship between the development of the insurance market and economic growth in Poland. A strong relationship was observed between the development of the non-life insurance market and the value of the real GDP 13. T. H. Bednarczyk (2012) examined in her work the long-term relationship between insurance development and economic growth in Poland. Insurance development is measured by the growth-rate of insurance density and the economic growth by the GDP per capita. Three different insurance variables were used life insurance premium per capita, non-life insurance premium per capita, and total insurance premium per capita. Econometrics tests were used for cointegration and Granger causality. The estimation method used the Ordinary Least Square (OLS) for time series, with data on a quarterly basis. Using Johansen s cointegration tests and the Engle-Granger procedure, the author finds a long-term relationship between insurance development and economic growth. Both methods gave similar results. There was no causality proven by the Granger causality test.conclusions regarding a causality link: no significant causality links in Poland 14. The strength of the link between the insurance sector and economic growth, however, is not static. As the relationship between bank and capital market finance and economic growth varies with the level of economic development, so does the insurance-growth nexus. The potentiality of growth contribution is much higher than in developing countries where the insurance sector hardly reaches the same importance and evolutionary stage. 12 P. Haiss and K. Sumegi, The Relationship Between Insurance and Economic Growth in Europe A Theoretical and Empirical Analysis, vol. 35 of mpirica 4 (2008). 13 K. Ortyński, Ubezpieczenia a wzrost gospodarczy w Polsce, in Globalizcja i integracja regionalna a wzrost gospodarczy, ed. S. I. Bukowski, (Warszawa: CeDeWu, 2010), T. H. Bednarczyk, Wpływ działalności sektora ubezpieczeniowego nawzrost gospodarczy, (Lublin: Wydawnictwo UMCS, 2012).

9 4. Insurance Development and Economic Growth: Data and Methodology In the present study five BRICS countries i.e., Brazil, Russia, India, China and South Africa are chosen. The Life insurance penetration, Non- Life insurance Penetration and total insurance penetration are variables taken for insurance development and GDPP (GDP per capita) is taken for the economic growth. Therefore time series of five countries for the time period from 1990-to 2014 is considered for four variables. The time period for the study is from 1990 to The data was tested grouped into panel data thus combining time series and Cross section data. The data was tested with Panel Unit Root test. Panel Unit roots are performed to check whether the series is stationary or not.[series means - each variable data]. Panel Unit roots are done and not time series unit roots. Time Series Unit roots don t give BLUE estimates, they give inconsistent and biased estimate. Hence Panel Unit Roots are done. Stationarity means Mean and Variance is consistent over a period of time. Levin, Lin and Chu (2002) and Im, Pesaran and Shin (2003) are the two panel unit root tests are adopted and these two tests have alternative hypothesis. In the Levin, Lin and Chu (2002) test it is assumed that the autoregressive coefficient (which indicates whether or not unit roots are presents) is homogeneous. Despite the assumption of homogeneous of autoregressive coefficient, the Levin, Lin and Chu (2002) test made provision for making heterogeneity through the allowing of fixed effects and country-specific time trends. In the Im, Pesaran and Shin (2003) test, ADF test or regression for each individual country s will be clearly stated and specified. The overall t-test statistics are also given by ADF. Panel Unit Root Tests performed are i)levin, Lin, Chu t-statistic test ii) Im, Pesaran and Shin w- statistic test. The above tests were performed at 95% confidence level or level. If P < 0.05, then the null hypothesis is rejected. If P>0.05 the alternate hypothesis is accepted. The Null Hypothesis for Panel Unit Root - Series is having unit root. Unit roots should also be checked for (variables) series which are also having linear trend. Two tests are performed for each variable. They are i) Panel Unit Roots: - individual effects and ii) Panel unit roots with individual effects and linear trend.

10 Mostly in econometric series data appear to be in trend, to safeguard against this trended data is taken. If individual effects and linear trend give the same results then estimate in good and efficient. Basic requirement for Panel Co-integration is that all the series should be stationery at their first difference. Since it is confirmed that all the series are stationery at their first difference, panel cointegration can be conducted. Co-integration would mean that the series are moving together. H 0 : There is no cointegration between insurance development and economic growth. H 1 : Cointegration exists between insurance development and economic growth. The null hypothesis if P < α is rejected and alternate Hypothesis is accepted. Four cointegration tests were conducgted, out of which majority count is taken. Pedroni Co-integration were conducted which have the following tests: 1. Panel v statistic 2. Panel rho statistic 3. Panel PP statistic (Phillip Perron) 4. Panel ADF statistic (Augmented Dickey Fuller) 5. Group rho statistic 6. Group PP statistic 7. Group ADF statistic Mostly in econometric series data appear to be in trend, to safeguard against this trended data is taken. If individual effects and linear trend give the same results then estimate is considered to be good and efficient.

11 Results and Findings: Table 2 Unit Root Tests At level After first difference Variable/ Test Levin, Lin & Im, Pesaran and Levin, Lin & Im, Pesaran and Chu t* Shin W-stat Chu t* Shin W-stat GDPP (0.9995) (1.000) (0.0000)* (0.0005)* Life Insurance penetration ( ) (0.7582) (0.000)* (0.0002)* Total Insurance (0.2906) (0.7764) (0.000)* (0.0001)* penetration Non-Life Insurance (0.3679) (0.8539) (0.0000)* (0.0000)* *indicate the rejection of null hypothesis at 1% significance level. Probability values are presented in parenthesis. The order of integration is tested by using Levin, Lin & Chu (2002) and Im Pesaran and Shin (2003) unit root tests in panel framework. Both the test statistics accepted the null hypothesis of non-stationarity and confirming that these series are non-stationary at level. The test statistics for the first differenced series is rejecting the null hypothesis of non-stationarity at 1% significance level, since test statistic values are more than respective critical values. Both the series are found to be stationary after first difference hence, it can be concluded that these variables are following I(1) process. Since, both the variables are found to be integrated of order one, cointegration can be carried out to examine the long run equilibrium relationship between insurance development and economic growth. Pedroni s Cointegration (2004) test can be employed to understand the long run equilibrium relationship in the panel framework. The panel Cointegration test results are presented in the following table 3.

12 Table 3 Panel Cointegration Name of Statistic Statistic Value Probability Weighted Probability statistic Panel v-statistic Panel rho-statistic Panel PP-statistic Panel ADF-Statistic Group rho-statistic Group PP-Statistic Group-ADF-Statistic Pedroni s panel cointegration results found long run association between economic growth and insurance sector development. Thus, it shows the relationship between insurance development and economic growth of an economy. The results show that as the economy grows the insurance market (both life and non-life) also grows. Finding long run equilibrium necessitates understanding the causal relation between economic growth and insurance sector growth. Table 4 Granger Causality Test Null Hypothesis F- Statistic Prob. Life insurance penetration does not Granger Cause GDP per capita growth GDP per capita growth does not Granger Cause Life insurance penetration * Total insurance penetration does not Granger Cause GDP per capita growth GDP percapita growth does not Granger Cause Total insurance penetration * Non-Life insurance penetration does not Granger Cause GDP per capita growth GDP per capita growth does not Granger Cause Non-Life insurance penetration * *rejecting the null hypothesis at 1% level of significance.

13 To estimate the causal relation between the development of insurance sector and economic growth Grange Causality test (1987) has been employed and the results are presented in the table 4. The tests accepts the null hypothesis and prove that development in the life insurance, non-life insurance and total insurance does not granger cause the economic growth. The test results reject the null hypothesis and suggest that the GDP per capita growth causes life insurance penetration, total insurance growth and non-life insurance growth. The causality test results suggest that there exists a unidirectional relation between Economic growth and Insurance sector development. It also shows that there is no relation between insurance development and Economic Growth. Conclusion In this study we conducted an empirical investigation into the causality relationship between insurance development and economic growth in BRICS countries for the period Panel unit root and cointegration tests were conducted and also conducted panel causality tests so that we can obtain reliable and efficient results. The result shows that there is stable long-run relationship between insurance development and economic growth. Regarding the results of the panel causality tests, we found a uni-directional causal relationship between economic growth and insurance development for all BRICS countries of the panel. This result is consistence with Taiwo Akinlo (2012) that found uni-directional relationship between economic growth and insurance development and is also a confirmation of Outreville (2011) statement that insurance development is very important for the economic development, as it makes long-term investments available for economic growth, and also concurrently reinforcing the risk-taking abilities. References Akinlo, T. and Apanisile, O. (2014), Insurance Development and Economic Growth in Sub- Saharan Africa: A Panel Data Analysis Modern Economy, 2014, 5, ( 5, Arena, M. (2006), Does Insurance Market Activities Promote Economic Growth? A Cross- Country study of Industrialized and Developing Countries. World Bank Policy Research Paper 4098, Pp 1-3.

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