J. K. Dietrich - FBE Fall, 2005 Value Creation in Insurance, Information and Asset Management Services Week 8 - October 13, 2005

J. K. Dietrich - FBE Fall, 2005 Life Insurance u Life and annuity contract –Probabilities determined –Cash flows from coverage are predictable –Principal-agent problems with moral hazard limited, adverse selection tolerable u Cancellations, lapses, policy loans u Inflation, taxes, and product innovation –Universal life insurance –Annuities

J. K. Dietrich - FBE Fall, 2005 Life Insurance Contracts Age Retirement Death Whole Life ContractLimited Pay Life Premiums, Benefits

J. K. Dietrich - FBE Fall, 2005 Life Insurance Contracts (cont’d) Age Retirement Death Endowment PolicyLife and Annuity Premiums, Benefits

J. K. Dietrich - FBE Fall, 2005 Casualty Insurance u Casualty contract –Period –Incidence and severity of claims –Catastrophic losses u Principal-agent problems –Insured and adverse selection –Insured and moral hazard –Correlation of incidence and severity with systematic risk

J. K. Dietrich - FBE Fall, 2005 Reinsurance Example Loss Claims Payments 0 Retained by Underwriter Paid by Reinsurer A Paid by Reinsurers B & C

J. K. Dietrich - FBE Fall, 2005 Finite Risk Insurance u Major issue in Spitzer investigation of AIG u Reinsurance should involve a transfer of risk (as in previous examples), otherwise it should be accounted for as a loan u Finite risk insurance transfers to the reinsurer payment responsibility for future claims in exchange for a premium equal to their expected present value, but claims have risk of being higher u If risk transfer is real, reserves on insurer’s book can be reduced (or increased relative to other liabilities)

J. K. Dietrich - FBE Fall, 2005 Insurance Pricing in Equilibrium u Premiums compensate insurers for insurance costs and losses and systematic risk: where and P, X and L are premiums, expenses and losses and k is a time to claim payment measure

J. K. Dietrich - FBE Fall, 2005 Inefficiencies in Insurance u Pricing and term setting u Marketing and information u Monitoring and controlling u Production and delivery u Funding and investing u Risk bearing and sharing

J. K. Dietrich - FBE Fall, 2005 Asset Management u Economics of the industry –Performance measurement –Principal-agent problems u A “temporary” disequilibrium –Historical perspective u Basic problem: luck versus skill u The value chain in asset management u Strategic challenges

J. K. Dietrich - FBE Fall, 2005 Information and Advice u Markets –Retail customer specific information »Credit information »Loan application and transaction sources »Advice based on scoring, marketing, etc. –Wholesale information and analytical services »Dun and Bradstreet »Rating agencies u Current issues in bundling, pricing

J. K. Dietrich - FBE Fall, 2005 Next Week... u Prepare DFA and Bloomberg cases for discussion on October 20 u Part 2 of project due on October 20 u Take-home midterm will be distributed to be due in class on October 27