Chapter 7 Insurance CompaniesChapter 7 Insurance CompaniesChapter 7 Insurance CompaniesChapter 7 Insurance Companies
• Types of Insurance
• Regulation
• Structure
• Types of Insurance
• Regulation
• Structure
BackgroundBackgroundBackgroundBackground
• insurers bear risk that others pay to avoid• underwrite risk• receive premiums• invest premiums• face contingent liabilities
• insurers bear risk that others pay to avoid• underwrite risk• receive premiums• invest premiums• face contingent liabilities
profit/lossprofit/lossprofit/lossprofit/loss
• premiums + investment income
- claims - overhead• premiums + investment income
- claims - overhead
II. Types of insuranceII. Types of insuranceII. Types of insuranceII. Types of insurance
• Life Insurance• term life insurance• cash value life insurance
• Life Insurance• term life insurance• cash value life insurance
term life insuranceterm life insuranceterm life insuranceterm life insurance
• policy period
• death benefit if occurs w/in policy period
• no cash value
• policy period
• death benefit if occurs w/in policy period
• no cash value
cash value life insurancecash value life insurancecash value life insurancecash value life insurance
• whole life insurance• death benefit• cash value builds over life of
policy• premiums cover
-- cost of insurance
-- investment capital
• whole life insurance• death benefit• cash value builds over life of
policy• premiums cover
-- cost of insurance
-- investment capital
• Universal life insurance• similar to whole life• buildup of cash value may be used
to finance future premiums
• Universal life insurance• similar to whole life• buildup of cash value may be used
to finance future premiums
• variable life insurance• policy holders chooses how to
invest premiums• benefits/value depend on
investment returns
• variable life insurance• policy holders chooses how to
invest premiums• benefits/value depend on
investment returns
other issuesother issuesother issuesother issues
• timing & amounts are predictable
• life insurance companies also offer pure investment products• annuities• GICs• over 50% of their liabilities
• timing & amounts are predictable
• life insurance companies also offer pure investment products• annuities• GICs• over 50% of their liabilities
Health InsuranceHealth InsuranceHealth InsuranceHealth Insurance
• pay all/some costs of medical treatments• fee-for-service• managed care
• a separate industry
• pay all/some costs of medical treatments• fee-for-service• managed care
• a separate industry
Property & CasualtyProperty & CasualtyProperty & CasualtyProperty & Casualty
• auto, home insurance
• timing/size of claims unpredictable
• separate industry
• auto, home insurance
• timing/size of claims unpredictable
• separate industry
Big losses for P&CBig losses for P&CBig losses for P&CBig losses for P&C
• 1992 Hurricane Andrew• $15.5 billion• today $30 billion
• 9/11 WTC attack• $35 billion
• 1992 Hurricane Andrew• $15.5 billion• today $30 billion
• 9/11 WTC attack• $35 billion
Liability insuranceLiability insuranceLiability insuranceLiability insurance
• risk of litigation
• timing/size of claims unpredictable• risk of litigation
• timing/size of claims unpredictable
Disability insuranceDisability insuranceDisability insuranceDisability insurance
• loss of ability to work
• more predictable, like life insurance• loss of ability to work
• more predictable, like life insurance
Long-term care Long-term care Long-term care Long-term care
• pays all/some costs of nursing care
• fairly new industry• pays all/some costs of nursing care
• fairly new industry
Structured settlementsStructured settlementsStructured settlementsStructured settlements
• fixed pmts. over time for disability/damages
• life insurance companies• fixed pmts. over time for disability/damages
• life insurance companies
GICsGICsGICsGICs
• firms pays a single premium
• insurer guarantees • annual interest rate (10%) • certain period (5 years)
• interest & premium paid at end of period
• firms pays a single premium
• insurer guarantees • annual interest rate (10%) • certain period (5 years)
• interest & premium paid at end of period
• example
$10 million x (1+.10)5 = $16.1 million
• large premiums• used by pension funds
• insurer bears investment risk• but insurer might default
• example
$10 million x (1+.10)5 = $16.1 million
• large premiums• used by pension funds
• insurer bears investment risk• but insurer might default
AnnuitiesAnnuitiesAnnuitiesAnnuities
• premiums paid and invested in stock/bond portfolio• premiums over time or lump sum
• investor receives payments• fixed, variable• life contingent
• premiums paid and invested in stock/bond portfolio• premiums over time or lump sum
• investor receives payments• fixed, variable• life contingent
• income & gains not taxed until withdrawn
• some guarantees on return
• like a mutual fund• but preferential tax treatment• higher expenses
• income & gains not taxed until withdrawn
• some guarantees on return
• like a mutual fund• but preferential tax treatment• higher expenses
ComparingComparingComparingComparing
• life/disability insurance predictable• invest in more long-term assets
• property and liability insurance less predictable• invest in more short-term assets
• life/disability insurance predictable• invest in more long-term assets
• property and liability insurance less predictable• invest in more short-term assets
III. RegulationIII. RegulationIII. RegulationIII. Regulation
• state level• type of assets permitted• required surplus
-- assets - liabilities
• state level• type of assets permitted• required surplus
-- assets - liabilities
• publicly-owned insurance co. also regulated by SEC
• no federal insurance on polices • credit-rating very important
• deregulation• repeal of Glass-Steagall 1999• more competition to insurance industry
• publicly-owned insurance co. also regulated by SEC
• no federal insurance on polices • credit-rating very important
• deregulation• repeal of Glass-Steagall 1999• more competition to insurance industry
• taxation• life insurance products get
favorable treatment
-- tax deferral on
-- annuities
-- cash value
-- death benefits not taxed
• taxation• life insurance products get
favorable treatment
-- tax deferral on
-- annuities
-- cash value
-- death benefits not taxed
IV. Structure & OwnershipIV. Structure & OwnershipIV. Structure & OwnershipIV. Structure & Ownership
• 3 functions• policy design• investment• sales
• 3 functions• policy design• investment• sales
manage & guarantee policymanage & guarantee policymanage & guarantee policymanage & guarantee policy
• design the policy• assess the risks• price the risks
• promise payment• role of credit rating• reinsurance to distribute risk
• design the policy• assess the risks• price the risks
• promise payment• role of credit rating• reinsurance to distribute risk
invest premiumsinvest premiumsinvest premiumsinvest premiums
• done “in-house” or
• outsource to investment company
• lag between premiums & claims• investment performance is
important
• done “in-house” or
• outsource to investment company
• lag between premiums & claims• investment performance is
important
sell policiessell policiessell policiessell policies• agents• sell policies of one company• franchisers• industry moving away from agents
• brokers• sell policies of many companys
• other distributors• commercial banks
• agents• sell policies of one company• franchisers• industry moving away from agents
• brokers• sell policies of many companys
• other distributors• commercial banks
OwnershipOwnershipOwnershipOwnership
• stock insurance co.• owned by shareholders• con: potential conflicts of interest
-- shareholders vs. policy holders• pro: access to capital
• stock insurance co.• owned by shareholders• con: potential conflicts of interest
-- shareholders vs. policy holders• pro: access to capital
• mutual insurance co.• owned by policy holders• pro: no conflicts, long-term view• con: limited access to capital• pro: protection from acquistion
• mutual insurance co.• owned by policy holders• pro: no conflicts, long-term view• con: limited access to capital• pro: protection from acquistion
• trend towards demutualization• raise capital for mergers
-- after Glass-Steagall• offer stock compensation to
officers
• trend towards demutualization• raise capital for mergers
-- after Glass-Steagall• offer stock compensation to
officers