Bank credit saw a year-on-year (yoy) increase of 7.76 percent, slightly lower than the 9.39 percent recorded in May 2023. Similarly, investment credit still grew at 9.60 percent yoy, compared with 12.69 percent the previous month. Third-Party Funds (DPK) witnessed 5.79 percent yoy growth, just slightly below the previous month's 6.55 percent, largely driven by deposits.

While the banking industry showed a relatively stable performance, the insurance sector faced significant challenges in 2023. It stood as the only financial sector experiencing negative growth, at 0.7 percent yoy, despite the country's overall gross domestic product (GDP) growth reaching 5.03 percent yoy.

From an industry perspective, notable disparities emerged between the life insurance and general insurance sectors. The life insurance industry experienced negative growth in gross premiums and claims, by 11 and 7 percent yoy, respectively. On the other hand, the general insurance sector demonstrated relatively positive growth in gross premiums at 7 percent yoy, but faced a larger increase in gross claims of 14 percent yoy.

We have identified two primary structural issues that are impeding the growth of Indonesia's insurance industry and contributing to a penetration rate of below 4 percent over the last five years. The first issue pertains to financial literacy. A survey conducted by the Financial Services Authority (OJK) in 2022 revealed a low level of financial literacy (31.7 percent) and inclusion (16.6 percent) within the industry.

A recent study conducted by the Indonesia Financial Group (IFG), which surveyed over 500 students, shed light on the understanding and ownership of financial instruments among young individuals and revealed striking findings. The survey corroborated those of the OJK’s figures. The majority of respondents were familiar with conventional products such as savings (97 percent), gold (61 percent) and investment options like stocks (67 percent), bonds (41 percent) and mutual funds (47 percent).        

However, only 37 percent of those surveyed were familiar with insurance policies. Moreover, the ownership pattern remained consistent, with most respondents possessing conventional products like savings (97 percent) and gold (19 percent), while only a mere 9 percent had insurance policies.

The lower rate of penetration is also attributable to its poor image and lack of public trust, stemming from instances of insolvent insurance companies failing to fulfill their claims commitments and experiencing significant losses due to investment governance failures. Some notable examples of such cases include Bumiputera, Jiwasraya, Kresna, Wanaartha Life and Asabri, where losses exceeded Rp 5 trillion (US$329 million) in each instance.

Similar problems have occurred in other developed countries and regions in the past. Europe, for instance, has witnessed 65 instances of insurance failure, largely due to underpricing, high operational costs, depreciation of investments and other operational challenges. However, in the majority of these cases, policyholders' rights were safeguarded through takeovers by other parties or assistance capital injection, as only 5 percent of companies managed to recover without external aid. Similarly, the United States also faced significant insurance failures in the life and health sectors until 2000, after which the number began to decrease.

Among the factors contributing to this significant improvement in the industry's image, the establishment of an insurance guarantee scheme (IGS) has played a key role. An IGS is designed to protect customers by providing compensation to policyholders or beneficiaries in the event of an insurance company's bankruptcy. Implementing an IGS not only ensures the sustainability and security of the insurance business but also aims to restore public confidence in the industry.

Notably, credit insurance stands out with the highest loss ratio among these three business lines, reaching 59 percent in the first quarter of 2023. The loss ratio, which represents insurance claims paid plus adjustment costs divided by total premium earned, has been consistently high for credit insurance over the past five years, necessitating closer attention to its performance. The link between banks and insurance lies in this relatively risky credit insurance.

In an effort to understand the relationship between the insurance and banking sectors, IFG Progress conducted a study utilizing Input-Output (IO) table data from 2010 and 2016, the most recent available data, encompassing details of 185 industries.

The research findings reveal a substantial level of interrelation and interdependence between both industries. During the period from 2010 to 2016, the insurance industry's contribution to the banking sector increased 4.2 times, while the banking industry's contribution to the insurance sector rose 2.7 times. This suggests a high degree of interconnectedness between the two industries, where the failure in the insurance sector could potentially lead to cascading impacts on the banking industry, and vice versa.

Indonesia is poised to embrace the implementation of Law No. 4/2023 (UUP2SK), which grants the Deposit Insurance Corporation (LPS) new mandates. The LPS, currently an institution that guarantees deposits and policies, will now play an active role in maintaining financial system stability, executing bank resolutions and overseeing the liquidation of insurance companies. This expanded mandate aims to address issues related to confidence and trust and mitigate potential systemic impacts in the insurance sector.

To sum this up, it is imperative to implement an IGS and address the challenges posed by low financial literacy and inclusion rates. Additionally, addressing the potential cascading impact due to interrelatedness between sectors is crucial.

By adopting these measures, we can create a more robust and resilient insurance market, instilling greater confidence and trust among consumers.

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Ibrahim Kholilul Rohman is senior research associate at IFG Progress and lecturer at SKSG University of Indonesia. Rosi Melati is research associate at IFG Progress. The views in this article are their own.