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Computer Assignment Topic: International Investment in Insurance Services in the US

Due Time: 18:00 pm, Lecture 12 Submission Format: Email you electronic version to Donghui@unsw.edu.au ***One hour delay will incur a reduction of 20% of your assignment mark!***

Maximum number of people allowed in one group is three. The assignment with the following group number is acceptable: one, two, or three. Recommended group number: 3. Required writing style: academically publishable paper (abstract, introduction, literature review, empirical testing and result analysis, conclusion, and references). Each of these components is ESSENTIAL for you to obtain a satisfactory mark in assignment. Required format of report: double line, maximum 20pages.

Abstract This paper analyzes and measures the significant components of foreign direct investment in insurance service in the United States. It is to demonstrate that the national income, the relative cost of capital, the relative wage rate, total trade in insurance services, the exchange rate, FDI in banking, source countries insurance market size and FDI in manufacturing are the major determinants of foreign investment in the insurance sector. The empirical results of this study show that the relatively higher cost of capital and the increase of FDI in manufacturing of the host countries contribute to the expansion of FDI in insurance sector while the high national income, the relative higher cost of capital, the relative higher wage rate, the increase of total trade in insurance services, the appreciate of the US dollar, the increase of FDI in banking and the larger of the source countries insurance market size reduce FDI in insurance sector.

1.

Introduction

Globalization, the integration of the global economy, is promoted by foreign direct investment (FDI).1 FDI refers to the net inflows of investment to acquire 10 percent or more of voting stock in a company located in a country other than that of the investor. The average annual growth rate of FDI has been high between 1987 and 1997 and this growth far exceeded that of merchandise exports and nominal GDP. There are several categories of FDI in the US.2 FDI in insurance services is the category that we are going to discuss in this paper.

According to WTO (1996), FDI occurs when an investor based in the home country acquires an asset in the host country with the intent to manage that asset. There are three main categories of FDI: 1). Equity capital (the value of the MNCs investment in shares of an enterprise in a foreign country). Ten per cent or more of the ordinary shares or voting power of an equity capital stake in an incorporated enterprise, or its equivalent in an unincorporated enterprise, is normally considered as a threshold for the control of assets. Mergers and acquisitions (M&A) and the creation of new facilities fall in this category. 2). Reinvested earnings (the MNCs share of affiliate earnings not distributed as dividends or remitted to the MNC). 3). Other capital (short or long-term borrowing and lending of funds between the MNC and the affiliate). 2 According to the US Department of Commerce, FDI in the US is defined as the ownership by a single foreign person (or an associated group of foreign persons) of at least 10% of the voting stock of an incorporated US business enterprise, or an equivalent interest in an unincorporated US business enterprise.

There have been a number of studies on FDI in general, manufacturing and banking in the past.3 Yamori (1998) analyzes the components affecting the location choice of Japanese multinational financial institutions. Moshirian (2001) examines the determinants of FDI in banking sector for the US, the UK and Germany. Moshirian (1997, 1999)4 is the only researcher who analyzed the factors of FDI in insurance services in the US. The US demand for insurance services, the relative rate of return, the exchange rate, the market size of the source countries insurance sector and the bilateral relations between the US and the source countries were factors that were analyzed and measured by Moshirian (1997) in his previous paper.

The purpose of this paper is to analyze and model the factors of FDI in insurance services in the US over the period from 1987 to 1998. This paper extends the previous study of FDI in insurance sector in the US by Moshirian (1997). This study updates Moshirians (1997) paper by focusing the period from 1987 to 1998 where his previous paper only covers the period from 1982 to 1992.

The remaining part of this paper will be structured as follows: Section 2 will propose a model of FDI in insurance services which will be used to describe why the determinants are chosen. Section 3 will explain the source of data used and the methodology in reaching the empirical results. Section 4 will detail the empirical findings. Section 5 will conclude.

2. A model of FDI in insurance services


The proposed model for FDI in insurance services in the US is as follows: IN = f (NI, RR, WG, TI, ER, BK, PR, MF)
3 4

(1)

For a review of the earlier literature, please refer to Moshirian (1997 and 2001). In the past, the only close available study, by Hultman and McGee (1988) has examined FDI in finance, insurance and real estate.

Where, IN = the stock of FDI in insurance services in the US. NI = national income of the US. RR = relative cost of capital between the US and the source countries. This is proxied by the government long-term bond corrected for corporate tax and inflation rates. The source countries cost of capital is the weighted average of the individual countrys cost. The weights are based on the individual countrys share of FDI in insurance services in the US. WG = relative wage rate between the US and the source countries. This is the proxy for cost of labor. The foreign wage rate is the weighted average of the individual countrys wage rate. The weights given to each country are based on that countrys share of FDI in insurance services in the US. TI = total trade in insurance services of the US. ER = exchange rate variability of US dollar, the exchange rate is the real effective exchange rate. BK = the stock of FDI in banking in the US. PR = source countries average insurance premiums. MF = the stock of FDI in manufacturing in the US.

The following brief explanations are provided for the use of the above factors in measuring the FDI in insurance services.

National income (NI) US GDP is used as NI in this project. 1) The relative cost of capital between the US and the source countries (RR)

It is hypothesized that the larger the difference between the US real long-term cost of capital vis--vis the source countries, the less will be the level of FDI in insurance services in the US. The measure for the relative cost of capital is as follows:

CC = (1-Tx) (B-i) RR= Ln (CCus / CCfr)

(2a) (2b)

Where, CCus and CCfr are cost of capital for the US and the source countries, respectively. RR is the relative cost of capital. Tx is the corporate tax rate, B is the long-term government bond yield and i is the actual inflation rate.

3) Relative wage rate of the US versus the source countries (WG) It is hypothesized that the higher the wage rate in the US relative to the source countries, the lower the FDI in insurance services in the US will be. The measure for the relative wage rates is as follows:

WG= Ln (WGus / WGfr)

(3)

Where, WGus and WGfr are wage rates for the US and the source countries, respectively, WG is the relative wage rates. It is hypothesized that the relative wage rate between the US and source countries has a negative impact on FDI in insurance services in the US.

4) Total trade in insurance services (TI) Moshirian (1997) documents a negative relationship by arguing that FDI is a substitute for trade in insurance services. However, in this study, it is argued that trade in insurance services

will build on the relationship between the US and its trading partner countries and stimulate FDI in insurance services. Thus, in this study, one would expect to see that trade in insurance services has a positive relationship with FDI in insurance.5

5). Exchange rate movements (ER) Increased uncertainty about exchange rates will lead to a lower level of FDI, if the FDI decision making is based on initial costs of establishing foreign branches, however it will increase FDI if foreign investment decision making is based on long term anticipated gains from income generating branches.

6) FDI in banking (BK) In this study, it is hypothesized that the availability of bancassurance following the increase in FDI in banking will increase FDI in the insurance sector.

However, Jeon (1992) argue that there is a negative relationship between imports and inward FDI in the host country because growing imports imply lower tariff/non-tariff trade barriers and therefore lead to a temporary fall in FDI. Trevino and Daniels (1994) have found insignificant influence of trade on FDI. Moshirians (1997) study document a negative relationship between bilateral trade in goods and FDI in insurance services.

7) Source countries insurance market size (PR) Moshirian expected in his research in 1997 that, similar to the foreign direct investment in the US banking industry, the market size of the insurance sector in the source countries should be a major factor influencing the foreign direct investment in the US insurance market, especially when there are several foreign insurance companies operating across the US. UK insurances companies have been very keen on investing in overseas insurance sector and around 30% of foreign direct investment in the US comes from the UK.

The best method to measure the size of insurance sectors of these countries is the total insurance premium of the source countries. Therefore, the weighted average insurance premiums of the source countries will be used to evaluate the size of the source countrys insurance market. The weighted average of the countrys insurance premiums is in a positive relation with the countrys foreign direct investment in the US.

In Moshirians research in 1997, it is found that the weighted average insurance premiums variable is statistically significant with the expected positive sign. It proves that the market size of the insurance sector in the source country has a significant positive impact on foreign direct investment in insurance services in the US.

Furthermore, it is proven by Liu et al. (1997) that the source countries insurance market size is positively correlated to the foreign direct investment in China. Therefore, in this literature, it is hypothesised that there is a positive correlation between the size of source countrys insurance sector and the foreign direct investment in insurance services in the US.

8) FDI in Manufacturing (MF) In 1997, Moshirian hypothesizes that the US bilateral relations with source countries should be one of the major factors contributing to foreign direct investment in the insurance sector of the US. In order to find out the result, foreign direct investment in manufacturing is used to measure the bilateral relations between the US and the host countries.

It is then found out that the foreign direct investment in manufacturing variable is statistically significant with a positive sign. It shows that foreign direct investment in manufacturing influences the capital inflow of foreign direct investment in insurance services in the US.

Therefore, in this literature, it is hypothesised that the foreign direct investment in manufacturing is positively related to the foreign direct investment in the insurance services in the US.

Given the above explanations for the model to be used in estimating FDI in insurance services, the reduced model for FDI in insurance services in the US can be expressed as:

IN = 0+ 1NI+ 2RR+ 3WG+ 4TI+ 5ER+ 6BK+ 7PR+ 8MF (4)

3. Data and methodology Data are from this subject website and methodology is OLS (ordinary least squares).

4. Empirical findings

In this part, please present your testing results and provide your analysis of these results. It is IMPORTANT to read the papers I posted on the web in order to understand the meanings of your testing.

Source countries insurance market size (PR) is not statistically significant as the t-value of this variable equals to -1.14 which is greater than -2. It indicates that the source countries insurance industry do not contribute to FDI in insurance services in the US. The result contradicts with Liu et al. (1997) and Moshirian (1997) papers where the market size of the insurance sector in the source countries is identified to be an important factor. This may suggest that not only source countries insurance company will invest in the insurance sector in the US, other investors are attracted to invest in the insurance services in the US because of the large market size of the insurance sector in the US. This empirical result supports the findings in Kravis and Lipsey (1982) and OSullivan (1985) papers that the market size of the host countrys market is one of the major determinants of FDI. It also supports the argument in Moshirian (1997) paper that the US demand for insurance services is one of the major factors contributing to the FDI in insurance sector in the US.

The FDI in manufacturing variable (MF) is statistically significant as the t-value of this variable equals to 8.55 which is larger than 2 and the result supports the hypothesis that foreign direct investment in manufacturing is positively related to the foreign direct investment in the insurance services in the US. It indicates that FDI in manufacturing has a significant positive impact on the expansion of FDI in insurance sector. The empirical result is also in accordance with Moshirian (1997) paper that the bilateral relations with the source countries is an important factor in expanding FDI in insurance sector in the US.

5. Conclusion

This part concludes your assignment. Reference: What are the papers or previous studies you have quoted in your assignment? Please list them here. Please delete the papers you did not use in the following and add the papers you have used which are not included in the following. Any interesting papers can be found in our library upon the help from a librarian.
References Baldwin, R.F., 1990. Factor market barriers are trade barriers: gains from trade from 1992. European Economic Review 34, 831-845. Bargas, S., Lowe, J., 1994. Direct investment positions on a historical basis. Survey of Current Business, June, 72-85. Barrell R., and Pain N., 1996. An econometric analysis of U.S. foreign direct investment. The Review of Economics and Statistics, 200-207. Barrell R., and Pain N., 1999. Trade restraints and Japanese direct investment flows. European Economic Review 43, 29-45. Browne M.J., and Kim K., 1993. An international analysis of life insurance demand. Journal of Risk and Insurance, 60: 616-634. Cushman, D. O., 1985. Real exchange rate risk, expectations, and the level of direct investment. Review of Economics and Statistics 67(2), 297-308. Cushman, D.O., 1988. Exchange-rate uncertainty and foreign direct investment in the US. Weltwirtschaftliches 124(2), 322-336. Froot, K.A., and Stein, J.C., 1991. Exchange rates and foreign direct investment: an imperfect capital markets approach. The Quarterly Journal of Economics 106(4), 1191-1217. Goldberg, L.G., and Grosse, R., 1994. Location choice of foreign banks in the United States. Journal of Economics and Business 46, 367-379. Goldberg, L.G., and Saunders, A., 1981. The determinants of foreign banking activity in the United States. Journal of Banking and Finance, 15, 1093-1112. Grosse, R., and Goldberg, L., 1991. Foreign bank activity in the United States: an analysis by country of origin. Journal of Banking and Finance 15(6), 1093-1112. Grosse, R., and Trevino, L.J., 1996. Foreign direct investment in the United States: an analysis on country of origin. Journal of International Business Studies 27 (1), 139-155. Helpman, E., and Krugman, P.R., 1989. Trade policy and market structure. IT Press, Cambridge, MA. Howard, L.S., 2000. Consolidation keeps reshaping insurance. National Underwriter. Hultman, C.W., McGee, L.R., 1989. Factors affecting the foreign banking presence in the US. Journal of Banking and Finance 13, 383-396. Jeon, Y., 1992. The determinants of Korean foreign direct investment in manufacturing industries. Weltwirtschaftliches Archiv 128(3), 527-545.

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Kravis, LB., Lipsey, R.E., 1982. The location of overseas production and production for export by US multinational firms. Journal of International Economics 12, 201-223. (Added) Liu, X., Song H., Wei, Y., and Romilly, P., 1997. Country characteristics and foreign direct investment in China: a panel data analysis. Weltwirtschaftliches Archiv 133(2), 313-329. (Used) Ma, Y., Morikawa, K., and Shone, R., 2000. A macroeconomic model of direct investment in foreign affiliates of Japanese firms. Japan and the World Economy 12, 311-355. Moshirian, F., 1997. Foreign direct investment in insurance services in the United States. Journal of Multinational Financial Management 7: 159-173. (Used) Moshirian, F., 1999. Sources of growth in international insurance services. Journal of Multinational Financial Management 9: 34-49. (Used) Moshiran, F., 2001. International investment in financial services. Journal of Banking and Finance 25(2), 317-337. (Used) Newey, W.K., and West, K.D., 1987. A simple, positive semi-definite, heteroscedasticity and autocorrelation consistent covariance matrix. Econometrica 55(3), 703-708. OSullivan, P., 1985. Determinants and impact of private foreign direct investment in host countries. Management International Review 25(4), 28-35. (Used) Outreville J.F., 1996. Life insurance markets in developing countries. Journal of Risk and Insurance 63 (2): 263-278. (Deleted) Poterba, J., 1991. Comparing the cost of capital in the United States and Japan: a survey of methods. Federal Reserve Bank of New York Quarterly Review 15 (3-4), 20-32. Trevino, L.J., and Daniels, J.D., 1994. An empirical assessment of the preconditions of Japanese manufacturing foreign direct investment in the United States. Weltwirtschaftliches Archiv 130, 576-599. Truett D.B., and Truett L.J., 1990. The demand for life insurance in Mexico and the United States: a comparative study. Journal of Risk and Insurance 57: 321-328. Ueda, K., 1990. Japanese capital outflows. Journal of Banking and Finance 14, 1079-1101. UNCTAD, 2001. World investment report: foreign direct investment and the challenge of development. United Nations Conference on Trade and Development, New York. WTO, 1996. Annual report. World Trade Organization. (Used) WTO, 1999. Annual report. World Trade Organization. Yamori, N., 1998. A note on the location of multinational banks: the case of Japanese financial institutions. Journal of Banking and Finance 22: 109-120. (Used)

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Possible extensions NOT Required:


1. 2.

You can identify and/or employ more advanced econometric technique to solve some of the problems in the regression. You can extend the data sample to be more updated, in order to investigate whether the empirical hypotheses change over time (all the data needed can be found at UNSW library).

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