Chapter 7 Insurance Companies

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Chapter 7 Insurance Companies

• Types of Insurance
• Regulation
• Structure

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Background

• insurers bear risk that others pay to avoid
• underwrite risk
• receive premiums
• invest premiums
• face contingent liabilities

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profit/loss

• premiums investment income
• - claims - overhead

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II. Types of insurance

• Life Insurance
• term life insurance
• cash value life insurance

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term life insurance

• policy period
• death benefit if occurs w/in policy period
• no cash value

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cash value life insurance

• whole life insurance
• death benefit
• cash value builds over life of policy
• premiums cover
• -- cost of insurance
• -- investment capital

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• Universal life insurance
• similar to whole life
• buildup of cash value may be used to finance
  future premiums

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• variable life insurance
• policy holders chooses how to invest premiums
• benefits/value depend on investment returns

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other issues

• timing amounts are predictable
• life insurance companies also offer pure
  investment products
• annuities
• GICs
• over 50 of their liabilities

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Health Insurance

• pay all/some costs of medical treatments
• fee-for-service
• managed care
• a separate industry

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Property Casualty

• auto, home insurance
• timing/size of claims unpredictable
• separate industry

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Big losses for PC

• 1992 Hurricane Andrew
• 15.5 billion
• today 30 billion
• 9/11 WTC attack
• 35 billion

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Liability insurance

• risk of litigation
• timing/size of claims unpredictable

Disability insurance

• loss of ability to work
• more predictable, like life insurance

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Long-term care

• pays all/some costs of nursing care
• fairly new industry

Structured settlements

• fixed pmts. over time for disability/damages
• life insurance companies

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GICs

• firms pays a single premium
• insurer guarantees
• annual interest rate (10)
• certain period (5 years)
• interest premium paid at end of period

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• example
• 10 million x (1.10)5 16.1 million
• large premiums
• used by pension funds
• insurer bears investment risk
• but insurer might default

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Annuities

• premiums paid and invested in stock/bond
  portfolio
• premiums over time or lump sum
• investor receives payments
• fixed, variable
• life contingent

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• income gains not taxed until withdrawn
• some guarantees on return
• like a mutual fund
• but preferential tax treatment
• higher expenses

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Comparing

• life/disability insurance predictable
• invest in more long-term assets
• property and liability insurance less predictable
• invest in more short-term assets

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III. Regulation

• state level
• type of assets permitted
• required surplus
• -- assets - liabilities

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• 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

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• taxation
• life insurance products get favorable treatment
• -- tax deferral on
• -- annuities
• -- cash value
• -- death benefits not taxed

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IV. Structure Ownership

• 3 functions
• policy design
• investment
• sales

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manage guarantee policy

• design the policy
• assess the risks
• price the risks
• promise payment
• role of credit rating
• reinsurance to distribute risk

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invest premiums

• done in-house or
• outsource to investment company
• lag between premiums claims
• investment performance is important

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sell policies

• agents
• sell policies of one company
• franchisers
• industry moving away from agents
• brokers
• sell policies of many companys
• other distributors
• commercial banks

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Ownership

• stock insurance co.
• owned by shareholders
• con potential conflicts of interest
• -- shareholders vs. policy holders
• pro access to capital

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• mutual insurance co.
• owned by policy holders
• pro no conflicts, long-term view
• con limited access to capital
• pro protection from acquistion

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• trend towards demutualization
• raise capital for mergers
• -- after Glass-Steagall
• offer stock compensation to officers