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