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Insurance and its relevance to global economy

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“The trade of insurance gives great security to the fortunes of private people, and by dividing among a great many that loss which would ruin an individual, makes it fall light and easy upon the whole society. In order to give this security, however, it is necessary that the insurers should have a very large capital.” (Wealth of Nations by Adam Smith, Scottish Economist – 1776).

The history of insurance traces the development of the modern business of insurance. Insurance is the oldest method of transferring risk, and is deemed to be one of the oldest in the field of economics. The first activities like insurance appeared nearly 4000 years ago and is as old as the historical society.

The so-called “bottomry” contracts were known to merchants of Babylon as early as 4000–3000BC. Bottomry was also practiced by the Hindus in 600 BC and was well understood in ancient Greece as early as the 4th century BCE.

[Bottomry, referring to the ship’s bottom or keel, is a maritime transaction, where the owner of a vessel borrows money and uses the ship itself as collateral. If the money with interest is not paid at the time appointed at the ship’s safe return or if the ship sinks, the owner forfeits the ship itself to the creditor.

While insurance can be traced back thousands of years, it is only in the last half century that we have come to a comprehensive and deep understanding of this most vital, yet complex, economic institution. To really understand insurance, it takes a deep knowledge of the subtleties of risk and probability, of how rational (and not so rational) people behave when faced with risk; of how insurance companies can be structured to cope with risk; of how governments can effectively intercede when insurance markets fail to deliver

Whether in the past periods or in the modern period the main goal of insurance is protecting health and assets of the people. Insurance is the main element in the operation of sophisticated national economies throughout the world today. Insurance stimulates business activities to operate in a cost-effective manner, by managing risks which associated with business activities are assumed by third parties. As we know, risks and bad accidents can happen always in life. These risks affect people badly and negatively every time. But insurance protects people from these risks. We can say that insurance is a measure, which people take in advance to risks which can happen every time and at any time.

The importance of insurance, like other financial institutions such as banking and the stock market, is vital for the sustainable economic growth of any country. The risk is inherent in every human activity ranging from social life to economic activities. The huge contribution of insurance to the economy as a whole, promotes a greater sense of security, peace of mind, reduction in anxiety and fear among individuals, businesses and governments.

The insurance industry is part of the services sector and is deemed to be a secondary branch of economic activity. Its effect is essentially indirect and intangible, because it deals with consequences of economic activity that would occur if insurance did not exist. Insurance serves production and consumption, international and interpersonal trade, payment and credit transactions, as well as the conservation of existing and creation of new wealth. However, the insurance industry has developed differently across industrialized countries due to differences in regulatory legislations by various regimes.

To individuals, insurance purchase enables an individual to sustain continuous consumption of his property in the case of theft or damage or due to other endangerments and perils.

With regard to corporate institutions, insurance enables businesses to operate in a cost-effective manner by providing risk transfer mechanisms.

To the Government, on the other hand, expenditure on damages caused by natural disasters such as fire, flood and other natural disasters is reduced, if not eliminated, with the help of insurance.

In developed countries, insurance has become a vital part of the economy and they make it a point to insure all assets with reputed insurance companies. Insurance lets people as well as businesses protect themselves against certain potential losses and financial hardship at a reasonable acceptable rate. In modern times there are certain specialized insurances which play great roles in the economy of countries.

The importance of the insurance-growth nexus is growing due to the increasing share of the insurance sector in the aggregate financial sector in almost every emerging and mature market economy.

The main intention of this article is to add to the understanding of the role of the insurance sector in the finance-growth nexus – whether and how insurance influences economic growth. The rationale behind this notion is twofold: on the one hand, the importance of the insurance sector within total financial intermediation has risen over time, including the magnitude and intensity of links between insurance, banking and capital markets. Thus the likely impact of insurance on the economy, consequently, increases.

The literature on finance and growth does not, however, pay sufficient attention to the important and rising role played by non-banking financial intermediaries such as insurance companies. While the actuarial processes for insurance have been in continuous development, it really took till the second half of the twentieth century for a modern theory of insurance economics to emerge. This laid out a model of an optimal insurance contract between risk-averse consumers and an insurance company capable of diversification.

In this ever growing field of enquiry, in which rational consumers and rational insurers come together in a mutually beneficial trade of risk, it deepened the understanding of how people come to share risk in an insurance market, and the natural frictions that occur (particularly the conflicting incentives of the policyholders and insurers); there was growing dissatisfaction with a theory that ignored the quirkiness of actual behavior; in real life people might not be quite so rational and raised questions like: “How would insurance market work in a world of limited rationality”?

Modern financial theory has another set of fascinating implications for those interested in insurance. Uncertainty is at the heart of insurance. This is already manifested in our limited knowledge about observable past events. All our activities depend on uncertain and unknown circumstances beyond the control of a single individual. Unambiguous, deterministic cause-effect relationships are replaced by ambiguity in the perception of the economic environment. With respect to the future, uncertainty looms still larger. Insurance is, however, of particular importance for risks with negative consequences.

What does “risk” mean in insurance parlance?

Usually risk is understood to mean as the danger of incurring a loss. This danger can materialize in different ways in a disaster-stricken community, ranging from complete loss, impairment or reduction of value of an asset, to the disruption of business, to the loss of a limb or even loss of life.

What is meant by the colloquial use of the word – “insurance”?

The pertinent literature gives various definitions of insurance. Problems arise because the term originates from business practices.

Individuals seek to protect themselves against irregular but probabilistic shocks impinging on their assets “health”, “wealth”, and “wisdom” by employing one or several tools of risk management, mainly by purchasing insurance. Therefore, the importance of insurance presumably increases with growth in the value of these assets. In step with the growth in general wealth, the concentration of assets has also increased, leading to so-called catastrophic risks.

It will expose us to modern financial theories such as asset pricing theory and option theory and, in doing so, will expose us to such exotic financial instruments as catastrophe bonds. It will take us deep into public policy and the welfare state and into the challenges of operating universal health insurance programs; and it will face us with the challenges of a world where new and unpredicted risks are appearing and for which normal insurance mechanisms may not function; where such catastrophes are either triggered by human failure as a result of man-made disasters; or by nature (natural disasters).

Disasters with the largest financial consequences fall into the category of natural disasters. We have also witnessed that the more recent disasters are also the more severe ones. This gives rise to the conjecture that increasingly, natural disasters are in fact man-made, caused notably by environmental pollution through Carbon-dioxide – GreenHouse Gases, causing global warming, and the latest Coronavirus – Covid -19 pandemic, pushing mankind into a state of extreme, irremediable, ruin and misfortune.

These challenges will lead to the expectation that the demand for insurance will tend to increase in the future. To achieve this, the industry has to be prepared for the unexpected and to be able to timely respond to the challenges laid before them; insurers and reinsurers must know and follow the trends and dynamics that characterises the global insurance and reinsurance industry.

ZULKIFLI NAZIM

[The writer counts over 50 years in the insurance industry and is an Associate of the Chartered Insurance Institute [London] and also holds the title of Chartered Insurance Practitioner; as well as an Associate of the Insurance Institute of India.]

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Opinion

Agriculture Dept. in a slumber

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The Department of Agriculture has been in a slumber for many years. Governments talk about developing agriculture in this country, but nothing happens. I am talking through experience. For the last several years I have been trying to obtain assistance from the department to fertilize my small coconut land and tea plantation, but with no success. In Galle my property is located about one km from the Highway on the Akuressa Road. I spoke to the officers through my cultivator at Walahanduwa and Labuduwa but the stock response is “SORRY the Government has not issued!” Do these officers ever visit these places ? ” NO”.

About two years ago I had to buy from a private trader to fertilize my coconut plants and part of my tea plantation. My profit is almost “NIL”. Due to lack of fertilizer the coconut crop dropped from five hundred nuts to 150/ nuts this month. Besides this, my buyer bought the coconuts @ of Rs 50/ per nut, whilst in Colombo I pay Rs 90/ per nut. Even, in my tea plantation there is a drop in the quantity of green leaf, as I have not fertilized it! Here too I am at the mercy of the buyer and have to accept whatever price he offers as there is no guaranteed price.

In my property I decided to plant cinnamon as it grows well along my fence , but the Agriculture Department told me that I will have to go to Matara to obtain plants, which is 28 miles from my place in Kalahe. Their attitude is very negative.

If one watches the Sinhala news on TV, it is quite evident that the Agriculture Department does nothing to encourage the cultivator in terms of providing fertilizer, advice against pests or even methods in improving the crop. Officers are warming their seats in the offices and never conduct field visits.

There is also no supervision or management by the Department. If from the head office they conduct surprise checks and visits, they will realise the exact situation. My visits to the branches indicated they are very poorly equipped in terms of furniture and equipment. It was found that they are poorly maintained and the premises, with broken furniture and unclean toilets, have never been swept or colour washed. A clear indication that none of the management teams from the head offices ever visit. The approaches to their offices are in a terrible state. Why cannot the management get these officers to provide a programme for the month, and get them to report on facts and figures, with acknowledgement from the growers being obtained with their comments; thus ensuring that the reports are genuine, and there must be sudden visits by the head office to these sites to check and supervise them. The department must adopt appropriate measures by giving proper directions to ensure that the cultivator/grower benefits from the department”. The Public are their Servants today.

The Vision of the Coconut Research Institute is to be the centre of excellence in coconut research technology, development and technology transfer in the region.

Its Mission – General knowledge and technology through excellence in research , towards increasing production & profitability of coconuts.

Its Mandate – 1. Maintain seed gardens.

2. Train advisory and extension workers to assist the coconut industry, guide & advise coconut industry on all matters of technical nature.

It is sad to say these so-called “Visions & Missions” are only on paper. Even the Mandate they talk about is also confined to paper! At grass root level “Nothing” happens.

There is no purpose in having any research and having great experts at the CRI, what matters is do the public benefit from them? It Is an Emphatic No!

No new seedlings are available. There is neither fertilizer nor expert advice. The Southern Province growers are completely neglected, as the so called institutions consist of incompetent and lazy officials who do not care about government or CRI policy. These CRI experts must not confine themselves to their offices; they must visit these places without giving them notice if they want to see what is happening.

 

NIHAL De ALWIS

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Opinion

Presidential words as orders

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At present two presidential inquiry commissions are working on – Easter Sunday Attack and Political Victimization. Many people come before these two commissions and mention many things that have been said/ordered by the former President, Prime Minister and various officials. It would be exceedingly difficult or impossible to check the veracity of those statements.

Now, incumbent President Gotabaya Rajapaksa asks/orders (or in a way threatens) government officials to take his spoken words as legitimate circulars. One day those officers too would have to come before various commissions and judicial courts, to justify the tasks they carried out on verbal orders by a President (may be solely to save themselves from being punished), and then who would be there to safeguard them?

A RATNAYAKE

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Opinion

‘Amude’ also tried in Parliament

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There has been furor on the dress code of NC Leader Athaullah who came to the parliament in a decent Afghan-style dress. I could remember in the years of yore, our friendly Dahanayake from my former electorate Galle, tried to come to the Parliament in an Amude, but cannot remember what followed. He tried to enter the Parliament in Amude (Span Cloth worn by farmers) to protest against the imposition by Mrs Bandaranaike in 1964 of a ration of two yards of textiles per month per person, at a time of grave shortage of foreign exchange.

 When Gandhi came to the British Parliament many decades ago – MPs referred to him as “Naked Pakir walking down the British parliament steps”, as he was dressed in 3/4th trouser style cloth for the down portion, and top part of the body was naked, except for a thin shawl draped over the body exposing parts of his chest. Also in the recent past an ex-president was attired in Modi Dress ( I am not sure if he came to the parliament) for the top part (similar to the top part of Afghan dress) and no one in the government like MP Marikkar or Harin Fernando protested.

Is the so-called Kapatiya Dress in white only admissible in parliament? What about full suits worn by brown sahibs / ex-Royal politicians – this is also a British dress; so why make a big fuss about an Afghan style decent dress. Kandyans are not protesting when down south bride grooms wear the Nilame style dress, which is trending these days?

 

SUMITH DE SILVA

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