1

FACTORS AFFECTING DEMAND OF LIFE INSURANCE IN

DEVELOPING COUNTRIES

Naveed Abbad

Roll Number: 15200

Supervisor: MS. AYESHA REHAN

Introduction

Insurance became an indispensible product for contemporary era. Insurance is one of the best

options for risk management. By purchasing insurance, the individuals can transfer their risk to a

third party-insurance company. Insurance not only plays a significant role in commercial and

industrial enterprises but in individual’s life as well. The premiums that are reserved by the

company can be used in later years for investment purposes in securities which are again used for

the development of the economy.

Insurance plays three important roles a) risk transferring, b) intermediation, and c)

indemnification of losses. The role of life insurance is considered to be associated with

intermediary. Pathania (2012) Sates that the growth rate of an economy is directly affected by the

health of the people in a country. The good health status of the people of an economy leads to

better overall productivity and also the national development. Government should make efforts

in making people aware about the insurance policies in the country.

Normally insurance can be categories into two classes a) life and b) non-life insurance, however,

some researchers claimed that re-insurance is a separate class of insurance while others believe

that it either fall under life or non-life based on policy type. Life insurance is an insurance

coverage that pays out the amount insured to the insurer or to the nominated beneficiaries upon

certain events such as death the individual who is insured with the insurance plan. This insurance

plan is also used for the retirement plans and for investing purpose. The purpose of this insurance

at times is solely to provide others who will be left behind after your death. There are many

different types of insurance that are being introduced almost universally for safe and rigorous

health of the people and also to reduce the risks involved in different business. Health insurance

is usually known as medical insurance protects individuals and their families when they face
severe health issues. Paying a premium to the insurance company helps the individuals in

unexpected health related expenses. Originally when health insurance was introduced it was

designed to cover all the catastrophic health related expenses but gradually with the passing it

includes more precautionary care (Rejda & McNamara 2013).

Disability insurance is also known disability insurance. It offers income protection to the

individuals in case of a mishap if they become disabled for a long period of time or if they

cannot work for that particular period of time. Only the employees who have paid federal

insurance contribution act tax for a specific amount of time are eligible to receive the social

security disability insurance. It is a type of insurance that protects individuals when some other

party claims that you have wronged them in some way. Generally this insurance pays the medical

bills or a specific compensation in the case when the other party proves that you have been

negligent or have not acted cautiously.

Fire insurance is an insurance coverage that compensates the insured for the loss or

damage that has been caused by fire to a certain insured property or building. It is a contract of

indemnity which means that the insurer cannot claim the amount above than the value of the

property that has been destroyed in fire or the amount of the insurance policy, whichever is lower

in value. Marine insurance is a type of insurance that is given by the insurance company to

indemnify the owner of a ship or cargo against risks that are incidental related to marine

adventures. This type of insurance also protects the owner in case of the lost freight due on the

cargo. Marine insurance that covers the loss of the cargo by storm or other natural disasters is

known as cargo insurance. Apart from these types of insurance there are other insurances

available such as burglary insurance, Moor vehicle insurance fidelity insurance etc.
 Although many studies has been carried to explore factors that affect the demand for

insurance specially in developed countries but only few of such studies explored the said factors

for developing countries. The purpose of this paper is to identify the factors that affect the

demand of the insurance in less developed country like Pakistan.

Problem Statement

All of these insurances are used by the individuals to protect them against certain risks. There are

different determinants of the demand of the insurance in different companies as researched

earlier by many authors. Studies have found numerous variables that affect the purchase of the

life insurance products. There have been many researches which conflicts with the previous

finding of the researchers. The huge number of studies leaves the readers in a confusion what are

actual determinants of the purchase of insurance policy. Results of different studies can be

contradictory but the actual factors can be determined by comparing their results.

Apart from contradictory results, researchers like Beenstock, Dickinson, and khajuria (1986)

specifically focused 10 OECD countries to explore demand factors of life insurance for 1970 to

1981. On the other hand, Browne and Kim (1993) and Outreville (1996) have done their

researches on developing countries. Later Beck and Webb (2003) have done studies on both the

developed and developing countries. But the framework that they used didn’t really identify the

determinants of the insurance in the OECD countries.

This study will mainly focus on the determinant of the life insurance in less developed countries.

It is also intended to find out that how different researches has applied to find different variables

that affect the demand of the life insurance policy among individuals. This study will contribute

more in the researches to contemplate life insurance consumption in developing countries taking
into consideration the income, life expectancy, social security expenditure, interest rate, inflation

rate all at once. This will provide a more comprehensive view of the importance of the insurance

among individuals and also the reasons that drives its need.

Research Questions:

1. Does disposable income affect demand of life insurance?

2. Does Real interest affect demand of life insurance?
3. Does Inflation affect demand of life insurance?
4. Does education level affect demand of life insurance?
5. Does dependency ratio affect demand of life insurance?
6. Does life expectancy affect demand of life insurance?
7. Does social security expenditure affect demand of life insurance?

Research Objectives

To study relationship between disposable income and demand of life insurance

To study relationship between real interest and demand of life insurance

To study relationship between inflation and demand of life insurance

To study relationship between education level and demand of life insurance

To study relationship between dependency ratio and demand of life insurance

To study relationship between life expectancy and demand of life insurance

To study relationship between social security expenditure and demand of life insurance

Literature review:

Kim and Browne, 1993 states that the service sector has grown substantially after the World War

2. There was a major growth of insurance worldwide afterwards. The insurance industry had a

very rapid average annual rate of growth of 25 % in the 1980s. His study has identified that the
demand of the insurance is usually affected by the dependency ratio, national income,

government spending on social security, Inflation rate. He found that the countries with a stable

and developed economy have more insurance consumption than others.

Truett (1990) A comparative study of Mexico and United States on the demand of the life

insurance used regression analysis for its findings. The study concluded that age, education, the

level of income of individuals has a positive relation with insurance consumption. The income

elasticity of demand for life insurance is higher in Mexico as compared to the United States.

Zietz (2003) concludes that even though there are many studies available on the determinants of

the demand of the life insurance but still are still many areas that need to be highlighted. Many

literatures on insurance have become outdated because of the change in the demographic factors,

technology and the economic factors. Also with the changing trend there is a need to focus on

product development and marketing issues.

Cooper and Schone, (1997) findings explain that there is a significant decrease in the

consumption of employment related insurance coverage. It states that falling take up rates has

increased the cost of insurance for the employees. Various factors have caused the falling take up

rates that includes the decline in the real income of the employees especially those employees

who are not willing to take insurance coverage, rising cost of insurance, Increasing amount of

premiums of health insurance and the medical aid expansion. The individuals with low wages

and those under the age of twenty five has comparatively faced more decline in the reach of

employment based insurance since 1987. Proposals should be made for improving the rate of at

which the insurance coverage will be easily accepted by employees just like subsidies.

Bakar (2012)Health insurance is basically health care financing. The study identified the factors

that influence the individuals to purchase private health insurance. Income level, age, gender,
race-religion education level; job sector, and risk were found to have the most impact in

consumption of insurance for a salaried person whereas for a non-salaried individual marital

status, education level, race religion and out-of-pocket health expenditures. The impact of the

price of insurance coverage was identified to be more significant for a salaried person than a

non-salaried person.

Bhat (2006) The study analyses the factors that affect the demand of the private health insurance

in a micro insurance scheme setting. They used Heckman two-stage estimation procedure for

their research. The results of this literature indicated Income and health expenditure as two of the

most significant determinants of the demand of the health coverage. Some other factors that

seemed to be affecting the demand positively included age, coverage of illness and awareness

about insurance, health care expenditure and number of children in a family. The amount of

health insurance purchase was considerably affected by the income of individuals.

Sehhat (2011) According to his literature the main purpose of the corporations for buying

property insurance is the high rate of bankruptcy and high operational risks. Higher operational

risk leads to a higher bankruptcy risk. For individuals the basic purpose of insurance is risk

aversion. Shareholder’s combination and tax incentive had no positive relationship with the

purchase of insurance policy. The insurance companies can develop more in the competitive

market by adopting more protective and persuasive policies relevant to different industries.

Donghui Li) The article analyzed the determinants of aggregate life insurance demand in

developed economies. Considering previous researches on it, the author found that Income and

all the socio economic factors plays a very major role in the demand for life insurance.

Specifically average life expectancy (lower probability of death) decreases the demand for
insurance whereas it increases with the dependency ratio. The effect of education level is positive

and social expenditure is derived to be negative with the demand of insurance.

Sargazi (2013) the study identified that the agricultural services insurance of crop is mainly

affected by the annual returns and experience of the farmers. As agriculture sector has to face

multiple types of risks such as climate, pests, diseases, production, price and fluctuations etc.,

these risks should be eliminated or at least decreased by stimulating investment in agricultural

insurance.
 Conceptual framework

Disposable
Income

Inflation

Life insurance
Life expectancy

Real Interest rate

Social security
expenditure

Level of
education

Dependency Ratio
From previous studies and literatures, data can be found about the some socio-economic

Characteristics and product market conditions that affect the demand of life insurance. The

factors include disposable income, life expectancy, and number of dependents, level of

education, social security expenditure, anticipated inflation and real interest rate.

Disposable income

Income is a very important variable in the models of demand insurance as it positively affects the

consumption of the Insurance(see Fortune, 1973; Campbell, 1980; Lewis, 1989). With the

increasing affordability of insurance products, a large amount of income results in greater loss of

utility after the income earner’s death for its dependents. With this impact the relationship

between income and insurance is positive and thus increases demand for insurance coverage.

According to Fitzgerald, (1987) the demand of insurance increases with the expected future

earnings of the husband and vice versa with the earnings of wife. Beenstock, Dickinson, and

Khajuria (1986), Truett and Truett (1990), Browne and Kim (1993), Outreville (1996), and Beck

and Webb (2003) also provides evidence of the positive relationship between life insurance

demand and income with the help of their research and literature work. Based on literature one

can say that

Disposable Incoem has significant relationship with life insurance demand in Pakistan

Life expectancy

The theoretical literature by Lewis (1989), in which the main purpose was to increase the

expected lifetime utility of the dependents, the consumption of life insurance is hypothesized to
increase with the probability of death of the wage earner. By considering this result it seems that

there is a negative relationship between the life expectancy and the consumption of insurance

coverage. Several other studies just like Browne and Kim(1993), Outreville (1996), and Beck

and Webb (2003) have tested this relationship but these indicated that life expectancy lacks the

statistical implication. Another argument in this was that as the life expectancy increases, the

price of life insurance decreases and thus it encourages its consumption. Based on literature one

can say that

Life expectancy has significant relationship with life insurance demand in Pakistan

Dependency Ratio

As the literature by Lewis (1989) defines that the demand for life insurance increases with the

expected value of the dependents’ lifetime consumption. So, that means number of the dependent

also increase with increase in the expected value. Henceforth there is greater need to protect the

dependents against the early death the wage earner. Campbell (1980) and Burnett and

Palmer (1984) argues that the major driving force of life insurance

consumption is to safeguard the dependents from facing the financial

constraints later. To test this relationship, the life dependency ratio is used,

which is defined as the ratio of dependents—under 15 and over 64—to the

working-age population aged between 15 and 64. According to Beenstock,

Dickinson, and Khajuria (1986) and Browne and Kim (1993), there is positive

relationship between the number of dependents and the life insurance

consumption. Beck and Webb (2003) argues that the dependency of aged
(above 64) hold more significance than the dependency of the young (below

15). Based on literature one can say that

Dependency ratio has significant relationship with life insurance demand in Pakistan

Level of Education

The positive relationship between the level of education and the demand for life insurance can be

viewed with two perspectives. Truett and Truett (1990) argues that when the level

of education raises among individuals then so is their concern about their

family dependents and the desire to attend their needs and raising their

standard of living. Browne and Kim (1993) are of the view that education

leads awareness among individuals about the uncertainty of dying any

moment and henceforth, explains the advantaged of insurance consumption.

Outreville (1996) also have the same thought about it as Browne and Kim

(1993). Based on literature one can say that

Educational level has significant and positive relationship with life insurance demand in

Pakistan

Social security expenditure

Social security expenditure seems to lower the demand of life insurance. Skipper and Klien

(2000) specifies that the schemes of social welfare programs tends to reduce the cost of

dependence for people. Following their work Lewis (1989) believes that social security

expenditure works just as a life insurance plan that reduces the need to buy any actual private

insurance. And also the social security expenditure is usually collected from the taxes which is
why there is reduced income with the individuals to purchase life insurance.Beenstock,

Dickinson, and Khajuria (1986) researched and have found out a negative relationship between

life insurance and social security expenditure among the developed countries. Based on literature

one can say that

Social Security Expenditure has significant but negative relationship with life insurance demand

in Pakistan

Inflation rate

The impact of inflation rate on life insurance demand is well documented by many authors.

Browne and Kim (1993) and Outreville (1996) has given empirical evidence about the negative

effect ofnflation on life insurance consumption. Fortune (1973) the rise in the inflation rate

makes life insurance less attractive the individuals and they do not move toward purchasing it.

Based on literature one can say that

Inflation has significant but negative relationship with life insurance demand in Pakistan

Real Interest Rates

Real interest rate as not been a topic of focus in the studies. Some examples on this includes that

Outreville (1996) found a correlation of the life insurance consumption with real interest to be

negative or insignificant. Browne and Kim (1993) completely ignores the impact of real interest

rate on inflation. According to some theoretical work there is a justification that the demand of

life insurance is increased due to high interest rates as the cost of insurance is decreased because

of that. On the other hand there are individuals who are more interested in the returns then the

insurance policies. Back and Webb (2003) seemed to find out a positive relationship between
them using the lending rates. However, the lending rate premiums are different in different

countries. Based on literature one can say that

Real interest rate has significant relationship with life insurance demand in Pakistan
Methodology

3.1.1 Data Sources

We used the secondary data in this study. The data of life expectancy, disposable income,

inflation, real interest rate, expenditure on social security, level of education, and dependency

ratio retrieved from various issues of Pakistan statistical bureau, World Bank, State Bank of

Pakistan, And Ministry of Finance’s websites from 2000 to 2013.

3.1.2 Measurements

LID= Life Insurance Demand

LE = Life Expectancy

RI = Real Interest

Inf = Inflation

DI = Disposable Income

Edu = Level of Education

SSE = Social Security Expenditure

DR = Dependency Ratio

above equation will be used to study the factors affecting demand of life insurance in Pakistan.

Ordinary least squared (OLS) test will be use to test hypotheses developed in chapter 2.
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