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Advances in Social Sciences Research Journal – Vol. 8, No. 3
Publication Date: March 25, 2021

DOI:10.14738/assrj.83.9796.
Hafiz, U. A., Salleh, F., & Garba, M. (2021). A Theoretical Basis for Innovation, Institutions and Insurance Penetration Nexus. Advances in
Sciences Research Journal, 8(3) 61-72.
Social

A Theoretical Basis for Innovation, Institutions and Insurance
Penetration Nexus
Usman Ahmed Hafiz
Universiti Sultan Zainal Abidin, Terengganu- Malaysia
Abubakar Tafawa Balewa University, Bauchi –Nigeria

Dr. Fauzilah Salleh

Universiti Sultan Zainal Abidin, Terengganu- Malaysia

Murtala Garba
Universiti Sultan Zainal Abidin, Terengganu- Malaysia
Abubakar Tafawa Balewa University, Bauchi –Nigeria

ABSTRACT
Insurance is one of the systematic solutions to risk reduction available
in the modern world. Its contribution to socio-economic development
is difficult to overestimate, bearing in mind that the level of diversity
and inclusion of the sector explains the degree of financial progress of
a nation. This paper has a twofold objectives of ascertaining and
discussing an overview of theories that stimulate economic
performance from the angles of institutions and innovation. Keywords
were used to search literature repository with the aid of Harzing’s
publish or perish software. As a result of this process, the New
Institutional Economics (NIE) and Schumpeter’s theory of Innovation
found suitable to the objectives of the study. The paper concludes that
efficient institutions coupled with the emergence of the novel products
may likely promote trust and confidence in the market as well as
specific needs of the large majority unserved potential consumers.
Therefore, interaction between institutions and innovation could likely
trigger insurance uptake.

Keywords- Institutions, New Institutional Economies, Innovation,
Insurance, Penetration.

INTRODUCTION
Insurance is one of the systematic risk mitigation approaches available in the modern world. It
significantly contributes to nations' economic growth(Ying, 2020). The fact is that the rate of
insurance inclusion is among the factors that describe the country's financial development level
and, by extension, its level of economic growth. Fashagba (2018), describes insurance as a mutual
arrangement governing risk sharing by two or more individuals. This arrangement allows for the
shifting of adverse effects of the loss that the client would have suffered to the insurer to
guarantee zero risks (Salleh et al., 2018a). The role play by insurance and its allied product to the

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Advances in Social Sciences Research Journal (ASSRJ) Vol. 8, Issue 3, March-2021

nation's socio-economic development include paving the way for employment opportunities by
channelling domestic savings into productive investments (Fashagba, 2018) and stimulating
financial stability in the economy (Kumar et al., 2020). s indicates that in the absence of financial
intermediaries such as insurance in the economy, the market could witness severe economic loss
(Ul Din et al., 2017) and financial fragility.

In literature, the insurance penetration rate in the market reveals its contribution to economic
development. Kumar et al. (2020), describe insurance penetration as the gross annual premium of
insurance accrued or written in a nation measured as a portion of that nation's GDP. To Arych and
Darcy (2020), insurance penetration rate is an indicator that reveals the insurance industry rates
of growth in the economy. Ul Din et al. (2017) explored and made the concept more explicit,
describing the term as the total insurance premiums paid by the policyholders in a determined
period as a proportion of GDP. This article considers insurance penetration as a measure of the
inclusion rate of insurance in a given market. It reflects the yearly increase or decrease in the
number of people with any form of insurance policy in an economy. To sum it, extant descriptions
of insurance penetration were all geared to the direction of World Bank's conventional measure to
determine insurance development, which is the premiums' ratio to the GDP in a particular year for
a given country.

Consequently, technology advancement, soaring human interaction and increasing competition
among businesses have increased humans' susceptibility to risks (Yazid et al., 2017), such as
business interruption, property damage, health issues, climate, and cyber threats. However,
among the emerging nations and most notably countries from the Sub-Saharan African region, are
lagging concerning risk mitigation plans uptake, compared to countries from other continents
around the world. Buttressing this assertion, Kyerematen (2015) maintained that, except for
South Africa and Namibia, the uptake of insurance services in the countries that made up the
region is only about 5 per cent of their population. This circumstance is a matter of concern, given
the extent of vulnerability among a large number of uninsured individuals amid the growing
influence of insurance and takaful products as essential tools for minimizing risks adversity.

Against this background and coupled with the importance of insurance to economic development,
factors that stimulate or contract insurance need to be fully uncovered. Hence, the purpose of the
article is to explain some selected theories explaining innovation and institutions as well as their
potential application to the development of economic activity from the viewpoint of insurance.
The article is unique in the sense that to the knowledge of the authors no previous paper has
jointly discuss New Institutional Economics (NIE) and Schumpeter’s theory of Innovation in a
study.

Hence, this article will contribute to the existing literature by setting up a new frontier to examine
the institutional framework and innovation variables on insurance penetration. It will also give a
clear policy direction to policymaker concerning the advancement of the low insurance uptake
problem affecting emerging nations.

Accordingly, the remaining parts of the article are structured as follows. Section 2, presents
methodology. Section 3, discussed the theoretical overview, theories, criticisms, and application of
the selected theories on insurance. Section 4 concludes the article.
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Hafiz, U. A., Salleh, F., & Garba, M. (2021). A Theoretical Basis for Innovation, Institutions and Insurance Penetration Nexus. Advances in Social Sciences
Research Journal, 8(3) 61-72.

METHODOLOGY
This article has the objectives of ascertaining and discussing an overview of theories that
stimulate economic performance. New Institutional Economics and Schumpeter’s innovation
theories were found suitable to achieve these objectives. Their features and assumptions seem fit
to describe the effect of institutional components and innovation on economic activity
development. The article adopted the methodological approach of Rashid et al. (2018),where
Google Scholar, Crossref, Scopus and Web of Science websites were visited to sought literature
with the aid of Harzing’s publish or perish software. The searching process involves the use of
keywords, such as institutional factors, institutional drivers, innovation, and economic
development. Lastly, the narrative method was the approach used in the review of the extant
literature.

Theoretical Overview
Recent literature shows that insurance scholars around the world have shifted their focus to the
specific contemporary issues stimulating or inhibiting the development of national and global
insurance markets (Burma, 2018; Hong & Seog, 2018; Mnykh, 2017; Sholoiko, 2018). These issues
include, among others, institutional factors of the insurance market (Dragos et al., 2019),
information transparency in the insurance market (Lin & Huang, 2020; Porrini, 2017), the
development of modern branched infrastructure (Sholoiko, 2018), the presence of shadow
insurance (Koijen & Yogo, 2016), the interaction of insurance and banking institutions (Chang,
2018), the development of agricultural and environmental insurance (John et al., 2019), the
impact of various regulations on insurers' development (Gaganis et al., 2019), and development of
innovation in the insurance industry such as general and family takaful, flood takaful, micro
takaful and micro-insurance (Chen et al., 2020; Okonkwo & Okeke, 2019; Salleh et al., 2018b).

Previous studies have used theories and concepts to examine individuals’ decisions toward
insurance, including endowment effect, consumer theory, prospect theory, state-dependent utility,
and disappointment paradigm. However, this article centres on applying the new institutional
economics and Schumpeter's innovation theory on economic performance from the perspective of
the insurance industry.

The New Institutional Economics (NIE) Theory
The term "New Institutional Economics (NIE)" was initiated by Williamson in the 1970s to
differentiate the NIE from the "Old Institutional Economics (OIE)" founded by Common and
Veblen. However, Kherallah and Kirsten (2002) maintained that this latest economics thought has
its origin from two articles of Coase in 1937 and 1960, titled "The Nature of the Firm" and "The
Problem of Social Cost", respectively.

The OIE School claimed that institutions were critical variables in interpreting economic
behaviour, with a robust analytic process outside the neoclassical economics framework.
Contrarily, neoclassical economics disregard the function of institutions. Maintaining that growth
solely depends on the total population and savings rates (Faundez, 2016). However, the NIE, like
the OIE, recognises the importance of institutions in shaping economic performance (Arzenšek et
al., 2016).

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Advances in Social Sciences Research Journal (ASSRJ) Vol. 8, Issue 3, March-2021

The NIE thus argues that institutions are instrumental in enabling human economic
activity. Suggesting that transaction in the economy would likely be uneasy without a sound
institutional framework. In support of this point, studies have acknowledged that institutions are
indispensable to proper economic outcomes and are predisposed to analysis (Alsahlawi, 2018;
Kherallah & Kirsten, 2002; Matthews, 1986; Picot, 1997).

The word "Institution" has puzzling applications to different people. It may perhaps represent an
established organisation, a structure hosting an organisation, more, custom, practice and
regulation. Nonetheless, in the light of institutional economics, it is formal rules (system of politics,
laws, contracts, economies, organisations) as well as informal rules (standards, customs,
traditions, morals, religions) that promote or regulate anonymous relationships among
individuals or groups (Okwor, 2019). By increasing transaction's certainty (Bbale & Nnyanzi,
2016), mutual cooperation and economic development (North, 1990).

NIE is an integration of different philosophies or analytical from a spectrum of backgrounds in
the business, humanities and social sciences (Alston, 2008). It has two critical goals: explaining the
determinants of institutions and examining their effect on success and dissemination of economic
activities (Alston, 2008; Nabli & Nugent, 1989). Besides, the NIE theory has three essential
features in terms of the analytical process. First, economic activities are explained from the
perspective of transaction costs. Coarse, North and Williamson, believe that people cannot
rationally take the right decision in the face of transaction costs (Yongjian et al., 2005).
Asymmetric information and differences in mental capacity produce exchange costs or transaction
costs (Mamaril, 2019). However, costs minimisation requires institutions’ intervention (Yongjian
et al., 2005). Secondly, the NIE theory challenges the total rationality assumption of the
neoclassical philosophy. It argues that humans have limited conditions necessary to make
reasonable decisions, such as intellectual capability and full access to information. The theory
suggests that decisions rely on bounded rationality. Thirdly, NIE Theory describes institutions in
the context of individualism, rather than holism (Spithoven, 2019).The individualism approach
upholds that research requires studying an entity, and the entity existing in real life is the
individual (Bunge, 2000; Soares, 2018).

NIE Analytical Framework

Williamson (2000) had established four divisions of institutional explanatory framework.
However, the NIE primarily deals with the second and third levels.

First level Second level Third level Fourth level

Informal Institutional Appropriate Resource

institutions such environment and policy and allocation and
as culture, norm, rule of the game governance Employment
tradition, religion on property (price, inflation,
e.t.c rights income, e.t.c.)

Social theory Economic of Neoclassical Transaction cost

property rights economics economics
Fig. 1:Four-level model of institutional analysis (Williamson, 2000)

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Hafiz, U. A., Salleh, F., & Garba, M. (2021). A Theoretical Basis for Innovation, Institutions and Insurance Penetration Nexus. Advances in Social Sciences
Research Journal, 8(3) 61-72.

At the top level is the social embeddedness level. This level indicates the norms, customs, mores,
traditions and religion of the society. According to Okwor (2019), social status affects insurance
penetration in many ways. For example, religion has contributed to the slow pace of insurance
growth. Some religious faithful considers insurance as antagonism to God's ability to protect
human against misfortunes (Adetunji et al., 2018; Zelizer, 1979). According to Gennaioli et al.
(2020), trust is a social factor that influences how people participate in insurance and the
transaction process in totality. They reiterate that low confidence interferes with every
contracting process phase, creating transaction costs and setbacks insurance uptake. The
institutional environment is at the second level (L2). The structure here, informal constraints
(norms, customs, values, traditions and religion) and formal rules (constitutions, legislation,
property rights), were combined (Pereira & Lopes, 2018). The essence is to restrict excessiveness,
and to Williamson (2000), it reduces uncertainty by raising economic efficiency and guaranty
property rights. The third level (L3) locates governance through the organisations. The main
thrust of this level is to guarantee the execution of contracts and cut transaction costs. The stage
ensures that risks relating to contracts accomplishment are minimised, in addition to the
deployment of a practical regulatory framework that reduce the imperfections commonly inherent
with the third world market. Therefore, strengthening the governance structure will reduce
transaction costs and guarantees contract enforcement among society members (Okwor, 2019).
The fourth level (L4) is related to neoclassical economics that aims at maximisation of resources
allocation. Therefore, this level addresses the daily market behavior.

Criticism of the NIE Theory

A significant transition from traditional neoclassical analysis to NIE in the past two decades has
occurred in the research on the development of mainstream economics. Schneider and Nega
(2016), maintained that endorsement NIE could be informed from the manner stakeholders are
craving for greater institutional efficiency. However, some scholars have picked loopholes in the
NIE for example, Tamanaha (2015), and Castellano and García-Quero (2012). These authors
argued that the NIE's methodological approach had neglected causality link from development to
institutions. The NIE's conviction that economic development is a product of free market and
private property rights protection is naïve because some markets are highly regulated, and the
property rights may not likely spur growth.

Furthermore, the authors contended that econometric studies have suffered from wrong
indicators and different samples. Again, most indicators have their origins from organisations
inclined to the free market and Anglo-American institutions. The implication is that the
institutional component that will facilitate development, for instance, regulation, may not be
appropriate for the analysis of liberalised markets. Moreover, institutions are the product of
rational choice, which is replaceable with political action. Hence, the institutional standard ignores
the institutional diversities of the targets countries.

Innovation from Schumpeter's Perspective

Innovation was from the Latin term "innavatus", connoting making something new. It appears in
print in the early fifteenth century (Kaya, 2015). However, its more recent explanation is traced
back to Joseph Alois Schumpeter's works in the early 20th century, in which innovation was an
essential factor. Schumpeter further explains innovation, or "development," as "new
combinations" of unique or prevailing facts, tools, resources, and other factors (Schumpeter,
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Advances in Social Sciences Research Journal (ASSRJ) Vol. 8, Issue 3, March-2021

1934). Schumpeter postulates that through the advancement of fresh ideas, novelty or
modernisation, an entrepreneur can earn economic profits (Schumpeter, 1934).

Schumpeter argued that innovation is the driving force behind economic development; he also
identified five different strategies for implementing innovation (Malerba & McKelvey, 2020).
These strategies include the launching of new a product or new categories of an existing product,
the initiation of a different market frontier, exploration of various techniques of fabrication or sale
of goods, choosing a new supplier of production goods, and structural change of business like
maintaining or conceding of a monopolistic power (Zaleska & Kondraciuk, 2019).

Schumpeter assumes the presence of a purely competitive economy in a stationary state without
growth, savings, and uncertainty, among others. According to Sweezy (1943) this assumption
resulted in an economic system termed circular flow, which shows the effect of inadequate
economic change stimulants. The author adds that the interaction of innovation with other forces
in the economic cycle creates change, implying that the transformation's causal factor is
innovation.

The theory assumes that innovations by large corporations and individual entrepreneurs create
opportunities for new profits, the splendid profit margins would later erode due to the large influx
of imitators attracted by these profit margins.

Schumpeter maintained that innovation begets proceeds (Sledzik, 2013), competition increases
with more activities (Porter & Stern, 1999) and the process fast track economic momentum
(Qamruzzaman & Wei, 2018). Schumpeter further posits that innovation is a method of industrial
transformation, which cyclically modernises the structure of the financial system from within,
thereby destroys the old ineffective innovation, and incessantly creates a new one (Sledzik, 2013),
he labelled this repetitive procedure as “creative destruction”. Moreover, Schumpeter describes
the task of an entrepreneur. He maintained that innovation does not manifest alone. Instead, a
causative agent, the entrepreneur who organises business, introduces innovation, which increases
the demand for his products or service. This function will likely earn profit for him.

From the perspectives of finance and its allied field like insurance, the debate on financial
innovation and financial development has for sometimes persisted (Laeven et al., 2015). Scholars
like Schumpeter label innovation as a catalyst to economic growth (Fritsch, 2017), within the
sphere of financial agents (Qamruzzaman & Wei, 2018). However, the financial system is
considered as an endogenous variable, for this reason the contribution of innovative financial
assets to the economic development has been overlooked (Michalopoulos et al., 2009).
Nevertheless, financial innovation is a task of labour, funds, and knowledge that interact and
function in an environment shape by the institutions (Bara & Mudzingiri, 2016).

Criticism of Schumpeter's Theory of Innovation

Although Schumpeter's contribution to the theoretical discourse of innovation has been
recognised globally, some scholars have contrary views on his postulated theorem's suitability.
Rimmer (1961), argues that researchers from the emerging market considered the theory scarcely
relevant. For instance, an individual entrepreneur's assumption as the primary catalyst of

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Hafiz, U. A., Salleh, F., & Garba, M. (2021). A Theoretical Basis for Innovation, Institutions and Insurance Penetration Nexus. Advances in Social Sciences
Research Journal, 8(3) 61-72.

economic development does not hold water in these markets because innovation development
requires strong institutions and considerable corporations support.

The claim of cyclical modernisation of the economic structure by the wave of innovation is
insufficient due to the existence of other determinants of economic cycles such as oil price,
political volatility, agriculture, foreign direct investment, exchange rate, tourism, and financial
development, among other (Awokuse & Xie, 2015; Cortés-Jiménez et al., 2009; Mohammed, 2019;
Nguyen & Nguyen, 2007). Schumpeter has limited the functional scope of an entrepreneur to
innovation. However, an innovator is equally a rational and prudent risk-taker, a farsighted and
an opportunist; therefore, his functions embodied the appropriate company of the management
(Boutillier, 2019).

Application of NIE and Schumpeter’s theory of Innovation in Insurance
An institutional environment that maintains sound property rights, effective accountability, and a
reliable judicial system can impact positive economic growth (Agyemang et al., 2018). Williamson
(2000), states that a suitable political and legal environment coupled with excellence governance
reduce transaction costs in the market. However, Okwor (2019) points out that market failure
and imperfection are a pattern to most emerging markets due to high transaction costs. Literature
has established that NIE theory is appropriate to explain institutional components' effect on
economic activity development (Dragos et al., 2017). Therefore, insurance uptake is an aspect of
the overall economic activities influenced by the formal and informal elements rooted in the NIE
framework. The presence of a sound legal system encourages insurance inclusiveness (Gaganis et
al., 2019). They affirmed further that regulations relating to the agent responsibilities, structure,
conditions and rates of contracts are likely to boost trust among present and potential clients in
the industry. Trust does affect not only the extent to which people engage in trade but also the
entire structure of transactions; for example, it cuts disputes and changes the cost structure.
Similarly, confidence in the sector could trigger insurance uptakes and the overall penetration in
the economy by extension.

Deployment of innovative solutions in the financial institutions' activities, including the insurance
industry, was motivated by the need to deal with ever-increasing challenges facing the sector. The
potential market of insurance in the emerging economies desire range of novel insurance products
that could likely meet their population's specific need (Rajapathirana & Hui, 2017). The authors
asserted that traditionally insurance products were limited to fulfilling the generalise needs.

From the technological point of view, the spread of internet connectivity, computers, mobile
devices, and availability of application packages has deepened the influence of technology on the
financial sector of the economy like the insurance industry (Ostagar, 2018). Deployment of new
technology "InsurTech" will lead to the possibility of a new method of service provision, which
would result in efficient handling of big data, risk identification and mitigation.

Some attributes of innovation among the strata of approaches outlined by Schumpeter could be
applied in the context of insurance. The unveiling of a new product, for example, or modification
of the existing development, establishing a new market frontier, exploring new sales techniques,
and improving organisational structure, specific examples of insurance practices may be provided
for each of these innovative approaches.
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Advances in Social Sciences Research Journal (ASSRJ) Vol. 8, Issue 3, March-2021

In this respect, Takaful unequivocally fits into Schumpeter's prescribed strategies. Buttressing the
need for a novel insurance product that meet the peculiar needs, Salleh and Afthanorhan (2018)
pointed to the specific ground-breaking novel attribute of Takaful which is free from unethical
dealings. The speculative transaction, risky trading and usury were the reasons for the snubbed of
conventional insurance products by the majority of Muslims with solid religious
philosophy(Hassan et al., 2018)

Alternatively, Takaful provides novel risk management coverage to a large significant uninsured
Muslims population, promotes financial inclusion and reduces inequality in the economy. This
implies that Takaful products meet the economy's financial needs while complying with the
Islamic requirements (Salleh et al., 2018c). Similarly, it is worth noting that Takaful is not only to
Muslims, but it is compatible with the proponents of ethical products. Salman et al. (2019)
reported that other faiths correspondingly discourage unethical dealings. Moreover, Salleh et al.
(2018c) hinted that the evolving marketing strategies of Takaful could serve customer's different
needs.

CONCLUSION
This article has dual objectives of ascertaining and discussing an overview of theories that
stimulate economic performance from institutions and innovation angles. Two theories were
identified; these are the NIE and Schumpeter's theory of innovation. From the institutional
components perspective, the NIE theory states that formal and informal constraints could inhibit
or stimulate change in economic activity. For this reason, institutions matters and should be
subjected to the analytical process.

Schumpeter's approach claims that innovation is the turning point in the market by introducing a
new solution. However, the influx of imitators could result in a meagre positive impact on the
prevailing innovation. This development would encourage the emergence of an advance solution
to phase out the ineffective solution. This phenomenon is termed "creative disruption". This
indicates that without innovation, the market would be in saturation.

The article concludes that efficient institutions, coupled with the emergence of novel products,
may likely promote trust and confidence in the market as well as specific needs of the large
majority of unserved potential consumers. It is envisioned that the interaction of institutions and
innovation could trigger insurance uptake, which is an aspect of the overall economic activity.

Competing Interests
The authors affirmed that there were no conflicting interests.

Authors' Contribution
The authors substantially contributed to this article.

Funding Information
The authors obtained no particular grant from any funding entity from this study.



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Hafiz, U. A., Salleh, F., & Garba, M. (2021). A Theoretical Basis for Innovation, Institutions and Insurance Penetration Nexus. Advances in Social Sciences
Research Journal, 8(3) 61-72.

Data Availability Statement

Literature used were mostly from open-source journals, are therefore readily available. These
articles can equally be requested from the first author.

Disclaimer
Perceptions and opinions shared in this article are from the authors; therefore, they do not
represent their respective affiliated organisations.

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