Insurance Companies Chapter 2 Financial Institutions Management, 3/e By Anthony Saunders

Insurance Companies Differences in services provided by: Life Insurance Companies Property and Casualty Insurance Size, Structure and Composition of the Industry. Trends in terms of size and number of firms. Demutualization Consolidation and competition from other FIs.

Life Insurance Companies Life Insurance Products: Ordinary life Term life, Whole life, Endowment life. Variable life, Universal life, Variable universal life. Group life Industrial life Credit life

Other Life Insurer Activities Annuities Reverse of life insurance activities. Private pension funds Compete with other financial service companies. Accident and health insurance Morbidity insurance

Balance Sheet Long-term liabilities Long-term assets Net policy reserves to meet policyholders’ claims. Long-term assets Need to generate competitive returns on savings components of life insurance policies. Bonds, equities, government securities Policy loans

Regulation of Life Insurance Companies McCarran-Ferguson Act of 1945 Confirms primacy of state over federal regulation. State insurance commissions Coordinated examination system developed by the National Association of Insurance Commissioners (NAIC). States promote life insurance guaranty funds Not permanent funds (like FDIC) Required contributions from surviving within-state firms.

Property and Casualty Insurance Size and Structure Currently about 2,300 companies. Highly concentrated. Top 10 firms have 42% of market in terms of premiums written. Balance sheet Similar to life insurance companies. Major liabilities: loss reserves, loss adjustment expense and unearned premiums.

Loss Risk Underwriting risk may result from Property versus liability: Unexpected increases in loss rates Unexpected increases in expenses Unexpected decreases in investment yields or returns Property versus liability: Losses from liability insurance less predictable. Example: claims due to asbestos damage to workers’ health.

Loss Rates Severity versus frequency: Loss rates are more predictable on low-severity, high-frequency lines (such as fire, auto, and homeowners peril) than on high-severity, low-frequency lines (such as earthquake, hurricane, financial guaranty). Claims in high-severity, low-frequency lines may not be independent. Higher uncertainty forces PC firms to invest in more short-term assets and hold larger capital and reserves than life insurance firms.

Long Tail Versus Short Tail Long-tail risk exposure: Arises where peril occurs during coverage period but claim is made many years later. Examples: Asbestos cases and Dalkon shield case. Product inflation versus social inflation Unexpected inflation may be systematic or line-specific. Social inflation: unexpected changes in awards by juries.

Trends Combined ratio: Loss ratios have generally increased. Expense ratios have generally decreased. Trend toward selling directly through their own brokers rather than independent brokers. Combined ratio: Includes both loss and expense experience. If greater than 100, then premiums are insufficient to cover losses and expenses.

Investment Yield / Return Risk Operating ratio = Combined ratio after dividends minus investment yield. Importance of investment income: Causes PC managers to place importance on measuring and managing credit risk and interest rate risk.

Recent Trends PC industry was not very profitable during 1987 - 96. Reasons: Succession of catastrophes (Hurricane Hugo 1989, San Francisco Earthquake 1991, Oakland fires 1991, Hurricane Andrew 1991) -- trough of underwriting cycle.

Regulation PC insurers are chartered and regulated by state commissions. State guaranty funds National Association of Insurance Commissioners (NAIC) provides various services to state regulatory commissions. Includes Insurance Regulatory Information System (IRIS). Some lines face rate regulation.