Fin 308 - Topic 5 Outline
Fin 308 - Topic 5 Outline 308
Popular in Financial Institutions and Markets
Popular in Finance
This 9 page Class Notes was uploaded by ag28 on Wednesday October 7, 2015. The Class Notes belongs to 308 at Clemson University taught by Chernykh in Fall 2015. Since its upload, it has received 14 views. For similar materials see Financial Institutions and Markets in Finance at Clemson University.
Reviews for Fin 308 - Topic 5 Outline
Report this Material
What is Karma?
Karma is the currency of StudySoup.
Date Created: 10/07/15
Clemson University Department of Finance FIN 3080 Dr Lucy Chernykh Financial Institutions and Markets Topic 5 Insurance Companies Ch 15 Outline 0 Fundamentals of Insurance 0 Insurance industry structure and types of insurance 0 Operations and balance sheet 0 Performance evaluation 0 Underwriting cycles 0 Regulation 0 Major insurance management issues FUNDAMENTALS OF INSURANCE The nature amp functions of insurance Risk sharing amp risk transfer Risk reduction by pooling of losses 0 Make prediction of risks for group as a whole 0 The larger the pool the more accurately you can make predictions Probability theory amp the Law of Large Numbers 0 As the number of exposures increases the actual loss will be closer to eXpected loss Insurance companies assume the risk of their clients in return for a fee called the premium The insurance company must have a large number of insured so that the risk can be spread out among many different policies The loss and the probability of loss must be guantifiable you can predict the probability If probability of loss is difficult to assess insurance companies will not cover it plays a large role in the design of insurance products When parties of a transaction have different amounts of information one has more one has less Reduced by screening driving record health records etc Adverse selection occurs before the transaction ex car insurance people with bad driving records have more incentive to buy car insurance Moral hazard occurs after transaction is finalized Once you have insurance you have less insurance to be risk adverse ex knowing you have insurance so you don t lock your car Deductibles are included to reduce your moral hazard incentives because you have to cover the first part of a loss Insurance Industry Structure Life Insurance almost 3X larger in total asset size than PampC Insurance companies Market share of top 10 54 Market share of other companies 46 Top 10 writers MetLife 16 of market share Prudential Financial 76 market share Propertv amp Casualty Insurance Market share of top 10 55 Market share of other companies 45 Top 10 writers State Farm 103 market share Liberty Mutual 51 market share Allstate 51 Other types of nonlife insurance firms and products Financial Guarantee Insurance Credit Insurance PMI Property Mortgage Insurance Reinsurance etc US insurance industry size Employs more than 2 25M million people 40 GDP of the HS 1 trillion premiums are being issued each year currently Life Insurance Typical Policies Term Life no savings attached individual s beneficiary receives payout at death of policyholder and the term of coverage can vary from 1 year to 40 years or more Simplest form of life insurance and most popular for people who have a family and people depending on the income they bring in Whole Life protects individual over an entire lifetime in return for periodic premiums beneficiaries receive face value of the contract Universal Life includes both a term life portion and a savings portions Includes some investment component Annuities pays a benefit to the insured until death to cover retirement years involves different methods of liquidating a fund over a long period of time PropertyCasualty Insurance Propertv Insurance protects businesses and owners from the risk associated with ownership Casualtv or Liabilitv Insurance protects against financial losses because of a Claim of negligence Reinsurance allocates a portion of the risk to another company in exchange for a portion of the premium INSURANCE COMPANY OPERATIONS Source of revenues Premiums received on insurance policies main cash in ow for insurance companies Investment earnings on reserves 0 Insurance companies make investments with the cash they receive and earn interest on these investments Hire people who know about financesinvestments 0 Life insurance companies have to be conservative cannot invest in junk bonds or low grade bonds Maior expenses Benefit loss payments Additions to reserves Operating eXpenses Investment eXpenses Insurance Company Balance Sheets Life Insurer versus PC Insurer Assets Life insurance is long term so financial assets are long term 0 More predictability in their payoutsclaims PC hold shorter term securities since claims are unexpected greater liquidity risk 0 Lower predictability Life PampC ASSETS Corporate bonds 40 26 Stocks 26 16 GOV securities 10 16 Municipal Bonds 2 Mortgages I 0 Other assets 13 18 LIAB Reserves 94 61 EQUITY 6 PERFORMANCE EVALUATION OF PC COMPANIES Leee Expe neee Le He e Tefall Fremmme Earned E penee Hattie P Em39W Expenses llJ39etell Premiums W i en 31 mhiined Hattie Leee Re e Expense Hattie quot91 39 eetellll Fre tebiilltity 1 III I Example a 80 loss ratio 28 expense ratio 108 or 108 combined ratio b 12 investment yield Operating ratio 108 12 96 Overall profitability 100 96 4 Thus the insurance company spends 108 for every 100 it writes in premium investment yield is needed to earn a profit for insurance companies US PC Operating Income Huge drop caused by 911 insurance companies did not profit Increase premiums to recover from huge losses Example Combined ratio Since many insurers consistently generate a loss from underwriting operations combined ratiogt1 the income generated from investments is crucial to an insurance company s profitability Underwriting Cycles Hard market period Insurers raise premiums Insurance coverage is hard to get Average cycle is about 7 years Soft market period Investment yield is high premiums are lowered Insurance coverage is amply available Companies operate with high combined ratio INSURANCE REGULATION 0 Chartered at the state level and regulated by state commissions safety amp soundness practices etc 0 The McCarran Ferguson Act of 1945 explicitly exempts insurance companies from any type of federal regulation 0 Unique to the US that everything is regulated at state level 0 The National Association of Insurance Commissioners NAIC provides services to the state 0 Services are provided at the state level 0 Do different types of standardized exams for insurance companies they are not regulated these are simply just assessments O Standardized examination system 0 The Insurance Regulatory Information System IRIS to identify insurers with key performance ratios outside normal ranges 0 The Financial Services Modernization Act of 1999 allowed CBs IBs and ICs to eXist as subsidiaries under one Financial Holding Company FHC O CoeXistence of commercial banks investment banking and insurance companies 0 Any of these could be one branch of a larger holding company 0 Dodd Frank created Federal Insurance Office FIG 0 Title 5 talks about the creation of the Federal Insurance Office 0 Created a unit within the Treasury Department 0 It is federal level but does not have any regulatory powers so insurance is still regulated at the state level 0 This Office has nothing to do with Health insurance Not involved in regulation but serve as an advisory and consulting board 0 Look carefully at insurance business models to look out for threats to financial 0 system Then share that information with regulators Submit candidates to Financial Oversight Committees to be added to list of SIFIs 0 Work with state level commissions to notify them of insurance programs that need 0 to be improved so that everyone can afford some kind of insurance Statutorv Accounting Principles SAP A set of accounting regulations prescribed by the NAIC for the preparation of an insurance firm39s financial statements Insurers are subject to statutory accounting principles SAP as well as GAAP 0 SAP is regarded as more regulatory and conservative than the GAAP method of preparing financial statements I Separate compleX analysis Private Monitoring amp Rating used to make sure that company is stable AM Best specific Standard amp Poor s large Moody s large Duff amp Phelps international INSURANCE MANAGEMENT RISK MANAGEMENT Major insurance management issues reduce adverse selection moral hazards and asymmetric information Screening combats asymmetric information Risk B ased Premium high risk high premium up to a certain level where the insurance company will not cover the risk Restrictive Provisions asymmetric information moral hazard Prevention of Fraud intentionally cause damage Cancellation of Insurance miscellaneous provisions Deductibles used to reduce moral hazard by requiring insured to cover part of loss Coinsurance helps to reduce adverse selection Pay close attention to moral hazard adverse selection and asymmetric information and examples of these