A Theoretical Framework for Insurance Market Failure and Regulatory Response in Developing Economies: Evidence from Nigeria

This study develops a theoretical framework for analyzing insurance market failure and the design of optimal regulatory responses in developing economies, grounded in evidence from Nigeria's insurance sector over the period 2005 to 2023. Insurance markets in developing economies are prone to systemic failures arising from information asymmetries, adverse selection, moral hazard, thin markets, and weak institutional environments that differ qualitatively from market failure dynamics in advanced economies. Existing theoretical models of insurance regulation largely derive from developed market contexts and do not adequately capture the institutional complexities of environments characterized by low income, limited data infrastructure, informal economic dominance, and weak contract enforcement. This study employs a mixed theoretical and empirical design, integrating principal-agent theory, institutional economics, and regulatory theory to construct a Developing Economy Insurance Regulation (DEIR) framework. The framework is empirically tested using instrumental variable regression and regime-switching models applied to Nigerian insurance industry time series data. The study identifies regulatory thresholds beyond which solvency regulation enhances market development and tests for regulatory capture effects in NAICOM enforcement patterns. Preliminary theoretical analysis suggests that optimal regulation in developing insurance markets must simultaneously address solvency, information provision, and market development objectives in an integrated rather than sequential manner. The DEIR framework contributes an original theoretical contribution applicable to comparable developing economy insurance markets across sub-Saharan Africa. Keywords: Insurance Market Failure, Regulatory Framework, Developing Economies, Principal-Agent Theory, Nigeria.