The Role of Insurance in an Economy

by Eric Novinson; Updated September 26, 2017
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Insurance provides the economic function of distributing risk. An individual pays a premium to an insurance company, which ensures him against a catastrophic event that has a large potential economic cost. Since the catastrophic event is usually rare, the insurance company receives a steady income, and the individual has protection against a loss that could otherwise result in bankruptcy, property foreclosure or other negative outcomes.

Large Projects

Insurance allows companies to construct large projects. For example, a microchip production factory may cost millions of dollars. The company that builds the microchip factory assumes a large risk, since the factory might burn down or collapse in an earthquake. With insurance on the factory, the company can build the factory and produce microchips. Large projects like this often have economies of scale, so they can produce goods more cheaply than small projects.

Vehicle Travel

Vehicle travel requires insurance. Drivers on the road can potentially cause large amounts of damage to other cars and trucks, and they may also harm other drivers or pedestrians. Insurance allows drivers to travel with protection against the risks of harming other individuals. Vehicle travel produces substantial economic benefits, since it allows trucks to deliver goods across a nation and allows workers to drive to their jobs.

Liquidity

Even if a company has enough money to protect itself against a catastrophe, insurance is still useful. A microchip production factory may have enough money to build a second factory if the first factory burns down. It can keep the money in the bank to protect itself from this event, or it can purchase insurance and use this money to build a second factory. Insurance frees capital for other investments.

Peace of Mind

Peace of mind is a psychological benefit of insurance. A person can lose everything she worked for her entire life due to a single disaster, and just the thought of this is stressful. According to Northwestern University, disability insurance helps medical students stop worrying about suffering costly injuries and concentrate instead on their medical coursework. Workers are more economically productive since they can focus on their jobs.

Group Discounts

Insurance provides services at a group discount. An employer who offers insurance plans often negotiates with the insurance company for a single policy that covers every worker. The family members of the workers may also be included. Purchasing products in bulk is often significantly cheaper than purchasing products individually.

About the Author

Eric Novinson has written articles on Daily Kos, his own blog and various other websites since 2006. He holds a Bachelor of Science in business administration from Humboldt State University.

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