Chapter 6 – Insurance BA 543 Financial Markets and Institutions

Chapter 6 – Insurance Why are Insurance Companies considered Financial Intermediaries? They transfer risk from a party that does not want to bear the risk to a party that can bear the risk Individuals transfer the risk they cannot afford and keep the risk they can afford The process Underwrite policies (accept or reject applicants) Differentiate policy holders (charge different) Invest the proceeds (financial management)

Chapter 6 – Insurance Transfer of Risk Payment (Premium) moves risk of loss to Insurance Company Payout at time of “event” Premium at start of insurance period Law of Large Numbers for Insurance Company Insurance Company makes money Event Payments less than Premiums Earnings on funds prior to Event Payment

Chapter 6 – Types of Insurance See Table Page 97 Life Term Whole Life Health Medical Dental Property and Casualty Property (House, Car, Boat, etc.) Liability

Chapter 6 – Insurance Determining Premium Based on Event probability Event cost Varies across companies and policies Demographics/Characteristics of pool Deductibles  Taking back a portion of the risk  Reducing some of the volatility of the event Premium Example – Insurance for Bikes

Chapter 6 – Insurance Bike Example Four Cities…North Park, South Park, East Park and West Part and insurance for theft only NP probability of theft 20%, average cost of bike $250 SP probability of theft 15%, average cost of bike $300 EP probability of theft 10%, average cost of bike $400 WP probability of theft 5%, average cost of bike $600 Insurance Premium with no profit? Across all cities…$41.25 one policy for all bike owners Who self insures? (Leaves the pool voluntarily) Who ultimately buys insurance? Is mandatory insurance good?

Chapter 6 – Insurance Other Insurance Products Disability Insurance Long-Term care Umbrella (Liability Extension) Structured Settlements Investment Products GICs (Guaranteed Investment Contracts) – Like a zero coupon bond… Annuities Immediate Deferred (accumulation and distribution phase)

Chapter 6 – Insurance The Industry – Separated at Glass-Steagall Regulation McCarran Ferguson Act States Regulate NAIC – National Association of Insurance Commissioners  Voluntary Association  Advocate “Best Practices” (often write proposed legislation for states) Oversight Rated by Agencies (Moody’s, Standard & Poor’s) Surplus requirements

Chapter 6 – Insurance Organization Three Companies in One… Home Office – Writes and guarantees contracts Investment Company – manages the investments Distribution Company  Sells the products  Can be employees or the firm or independent agents Bankassurance When commercial banks distribute insurance company products

Chapter 6 – Insurance Investing by Insurance Companies Need to match the liabilities (guaranteed products) Life vs. Property and Casualty  Life more predictable  Property and Casualty more volatile Internationalization U.S. companies expanding overseas Foreign Companies coming here AXA, ING, Allizance, Fortis, Aegon Less regulation here…access to U.S. markets

Chapter 6 – Insurance Hot topic of the Day - Health Insurance Single Provider vs. Private Insurance Medicare and VA examples of single provider Group plans (company plans) example of private insurance Which is better? What are the metrics to measure for best? Life expectancy Infant death rates Cost Access Patient Protection and Affordable Care Act 2014 Health Insurance Exchanges