Insurance and Pension Fund Operations CHAPTER 25 Insurance and Pension Fund Operations

CHAPTER 25 OVERVIEW This chapter will: A. Describe the main uses of insurance company funds B. Explain the exposure of insurance companies to various forms of risk C. Identify the factors that affect the value of insurance companies D. Describe the common types of private pension plans E. Explain how pension funds are managed

Insurance Company Provide various insurance and investment services to individuals and charge a fee called premium. Life insurance, property and casualty insurance, health insurance, and business insurance. Adverse selection problem-those who are most likely to need insurance are most likely to purchase it. Moral hazard problem-insurance can cause the insured to take more risks because they are protected.

Premium Determination Premium is based on the probability of the condition under which the company will have to provide a payment to the insured (or beneficiary) and the potential size of the payment. Competition Adverse selection problem Moral hazard problem

Main Sources of Funds Insurance premium Provision of annuity plans, which offer a predetermined amount of retirement income to individuals. Investment Equity

Exhibit 25.1 Distribution of U.S. Life Insurance Company Income Source: 2007 Life Insurance Fact Book

Uses of Funds a. Government Securities b. Corporate Securities c. Mortgages d. Real Estate e. Policy Loans

Exhibit 25.2 Assets of U.S. Life Insurance Companies Source: 2007 Life Insurance Fact Book

Exhibit 25.4 Assets of Property and Casualty Insurance Companies Source: Federal Reserve

Risk Exposure 1. Interest Rate Risk 2. Credit Risk 3. Market Risk 4. Liquidity Risk

Exhibit 25.6 Participation of Insurance Companies in Financial markets

Property and Casualty Reinsurance Property and casualty insurance commonly obtain reinsurance, which the insurance company allocates a portion of their return and risk to other insurance companies.

Regulation of Insurance Companies a. Regulated by state agencies b. Insurance company agents must be licensed c. National Association of Insurance Commissioners (NAIC) d. Regulation of Capital

D. Common Types of Pension Funds 1. Background a. Public Pension Funds b. Private Pension Plans 1.) Defined-Benefit Plan 2.) Defined-Contribution Plan c. Underfunded Pensions

Pension and Pension Funds Pension plans provide a savings plan for employees that can be used for retirement, e.g. 401K. They receive premium from the employer and/or the employee.

Common Types of Pension Funds 1. Public pension funds for example, Social Security 2. Private pension funds

Pension Fund Management 1. Management of Insured plans pension funds are managed by life insurance companies. Contributions are often used to purchase annuity policies. The investment concentrates on bonds and mortgages. 2. Management of Trust Portfolios pension funds are managed by the trust department of financial institutions such as commercial banks. The investment concentrates on stocks.

Exhibit 25.10 Participation of Pension Funds in Financial Markets

Homework Assignment 15 Questions: 1 2 5 8 9 10 14 21 24