Financial development and volatility of growth rates: Cross-country evidence on the link between insurance market activity and the volatility of GDP per capita growth rate

Abstract

PURPOSE OF THE STUDY The purpose of the study is to examine the relationship between insurance market activity and the volatility of the GDP per capita growth rate. We investigate whether insurance market activity has an effect on the volatility of GDP per capita growth rate and whether the effect of insurance market development on economic growth volatility follows a hump-shaped pattern, i.e. a shape of an inverse parabola. The role of the insurance sector has grown in importance. In addition to becoming quantitatively more important as a part of the general development of financial institutions, insurance has also become qualitatively more important due to the increase of risks and uncertainties in most societies. While there have been studies conducted on the financial development and macroeconomic volatility, the insurance sector has not received much attention in this respect. We fill this gap by reviewing theory and empirical evidence and suggest channels of influence.

DATA We use measures of insurance penetration, i.e. insurance premiums in relation to GDP, as proxies for insurance market development for a set of 74 countries over the period from 1980 to 2007. We will control for variables, e.g. the country size in terms of population, the inflation and exchange rate volatility and government consumption.

RESULTS Findings of the study show a negative and significant relationship between insurance market activity and GDP per capita growth volatility suggesting that the proxies used for insurance market activity have a causal effect on economic growth volatility. We find no evidence suggesting that the relationship would be hump-shaped. Moreover, the results for the non-linear effect suggest that the effect of insurance market activity is negative in all cases, i.e. total, non-life and life insurance. According to our study, it might be beneficial for governments and economies to encourage the use of insurance policies and help households and companies in risk management.