Copyright© 2003 John Wiley and Sons, Inc. Power Point Slides for: Financial Institutions, Markets, and Money, 8 th Edition Authors: Kidwell, Blackwell,

Copyright© 2003 John Wiley and Sons, Inc.

Power Point Slides for:

Financial Institutions, Markets, and Money, 8th EditionAuthors: Kidwell, Blackwell, Peterson and Whidbee

Prepared by: David R. Durst, The University of Akron

CHAPTER 18

INSURANCE COMPANIES AND PENSION FUNDS


The Insurance Service --

Indemnify another against risk of economic loss.Requires pooling of a large number of similar, but independent risks -- law of large numbers.Insurance is the last step after other pure risk control and reduction techniques of risk management.Pure risk, the chance of loss, differs from speculative or investment risk which is related to the variability of returns where one can have a gain or a loss.Insurance reduces society's cost of bearing risk.


The Insurance Mechanism

An insurer assumes objective risk which is the deviation of actual losses from expected losses. It is part of the operating risk of an insurance company.


Insurable Risks

homogeneous or similar.fortuitous, random or occurring by chance.circumstances of loss can be identifiable.a probability of loss can be estimated.the losses occur independent of each other--not all at once, such as a flood, wiping out the insurer.premiums must be economically feasible for the insured.


Objective risk control methods include:

use of loss prevention techniques such as "safety" programs.accept "average" risks as customers.require deductibles or shared losses with the insured.


Insurance premiums represent the sum of:

expected losses, plusoperating costs, plustarget profit, lesspremium investment income


Interest rate risk affects insurance companies.

Insurance contracts are long-term contracts: interest rates vary providing incentives for cancellations and revision of intentions.high interest rates encourage "cash flow underwriting" and policy loans.


Life/Health Insurance Companies

Dominated in numbers by stock companies; in asset size, by mutuals (32%).Oldest financial intermediary in U.S. (1759)Slow growth in 1990’s after pension and mutual funds


Term Insurance

GeneralPayment for death onlyLower premiumLarge amount of protection per premium dollar


Term Insurance (concluded)

Term policy variablesStraight -- coverage for specific time period with premiums increasing with age.Renewable -- option to continue after expiration date, independent of health changes.Decreasing -- pay level premiums over a period of years while level of coverage declines.Convertible -- policyholder may convert to a whole life policy for an added premium fee.


Whole Life Insurance: General Characteristics

Level premiums for constant level of protection.Premium includes cost of insurance (decreasing term) and savings contribution.Cash values (savings accumulated by insured) increase with time.Death benefit includes decreasing term amount and "return" of savings.


Whole Life Insurance: General Characteristics (concluded)

Provides "living" benefits in form of accumulated savings.Combines life insurance and savings (at a relatively low but contractual rate).Interest or dividends on cash values accumulate free of income taxes-important tax shelter.


Endowment life policy

Pays face value of policy at death or at maturity of policy contains term and endowment concepts.More savings oriented than term or whole life--a reverse annuity.


Universal life

The most popular interest-sensitive permanent policies.Flexible premium policy with varying death benefit and premium amounts.Pays market rate on savings.


Variable Life

Popular in the 1990’s with rapid growth in equity values.Fixed-premiumInsured direct investment of cash valuesGuaranteed death benefitNo guaranteed cash value


AnnuitiesSuperannuation- risk of living beyond one’s meansA life annuity, for a given payment, pays a life long stream of payments.The period of time and survivorship terms vary.The longer the "certainty," the less the payments.


Health Insurance

Covers medical, disability, and dental expenses.Insurance companies write about sixty percent of health insurance premiums.


Balance Sheet of Life Insurance Companies

Liabilities and net worthLife insurance reserves -- funds owed for life insurance policies, including cash values and losses owed, not yet paid.Pension fund reserves -- accumulated commitments to pay future pensions.Surplus and net worth


Balance Sheet of Life Insurance Companies (concluded)

Assets -- long-term matching liabilities

Corporate bonds-largest financial investmentCorporate equities-Variable lifeMortgagesU.S. government securitiesPolicy loans


Property/Liability Insurance Companies

Property insurance -- protection from financial loss of property from perils such as fire and theft.Casualty insurance -- liability, worker's compensation, auto, aircraft, marine


Life vs. P/L operations and practices

P/L policies shorter term than lifeP/L loss payments more erraticP/L loss payments increase with inflationP/L premiums net of losses and expenses is taxedBoth life and P/L firms generate revenue from premiums and investment income.


Balance Sheet of P/L Insurance Companies

Assets -- selected for income, inflation hedge, liquidity, and tax sheltering

State and municipal bonds (tax free) and corporate bondsCorporate stock (inflation hedge and income)Government securities (liquidity and income)Trade credit ($ owed by customers and agents)


Balance Sheet of P/L Insurance Companies (concluded)

Liabilities and net worthPolicy reserves include:• unearned premium reserve.• losses incurred, not paid.

Surplus and net worth


Types of Property/Casualty/ Liability Policies

Property -- insurance against losses associated with physical damage.Liability -- insurance against loss arising from the damage to the property or personal injury to others.


Types of Property/Casualty/ Liability Policies (continued)

Surety and fidelity bondsBond -- agreement by one party (surety) to be accountable to a third person (the obligee) for the debt or default of another party (principal).Surety bond -- provides financial protection against failure to perform an agreement such as construction.Fidelity bond -- provides financial protection from the infidelity or dishonesty of employees, such as embezzlement.


Types of Property/Casualty/ Liability Policies (continued)

Marine insurance -- covers financial losses related to transportation.

Ocean marine -- ocean transportationInland marine -- inland transportation and some personal property such as furs and jewelry

Homeowner's insurance -- Multi-peril or multi-line policy covering most risks of home ownership and renting. Includes property and liability insurance.


Types of Property/Casualty/ Liability Policies (concluded)

Family personal auto insurance -- A multi-peril policy covering most of the risks of owning and driving an auto

liability.physical damage (collision).medical.uninsured motorist.


Types of Pension Plans

Private Pension PlansInsured -- assured by contracting with life insurance firmsNoninsured

• Trustee managed by a third party• Non-trusteed -- managed by firm or labor union

Government-sponsored Pension PlansFederal Social Security (FICA)State and municipality


Pension Plan TermsFully funded -- contributing a pool of funds sufficient to cover future obligations versus paying retirement benefits from sales or tax revenues.Contributory -- employee contribution deducted from pay.Noncontributory -- employer makes all funding payments.Defined benefit plan -- contributions are made to meet "defined" retirement benefits for pensioners.


Pension Plan Terms (concluded)

Defined contribution plan -- benefits are variable, but contributions are defined in plan. 401k’s--most popular today.Vesting -- employee assured of retirement benefits after a set period of time.Portability -- ability to transfer vested benefits on to other pension fund as a single plan.


Pension Fund Portfolio Management Factors

Little need for liquidityPension fund income exempt from federal income taxesThe higher the earnings rate, the lower the contribution for a defined benefit planPension funds face risk/return trade-off decisions for their beneficiaries.

Documents

Copyright© 2003 John Wiley and Sons, Inc. Power Point Slides for: Financial Institutions, Markets, and Money, 8 th Edition Authors: Kidwell, Blackwell,