1. The Financial Services Industry: Insurance Companies
Chapter 3
The Financial Services Industry: Insurance Companies

2. Overview In this segment ... Insurance Companies: Two major groups:
Life, Property & Casualty
Size, structure and composition
Balance sheets and recent trends
Regulation of insurance companies
Global competition and trends

3. Insurance Companies Differences in services provided by:
Life Insurance Companies
Property and Casualty Insurance

4. Life Insurance Companies
Size, Structure and Composition of the Industry:
In 1988: 2,300 life insurance companies with aggregate assets of $1.12 trillion
In early 2000s: 1,100 companies / $3.1 trillion
5 largest wrote 21% of new premium business
Large scale mergers

5. Biggest Life Insurers

6. Life Insurance: Issues
Demutualization
Adverse selection
Insured have higher risk than general population
Alleviated by grouping of policyholders into risk pools

7. 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

8. 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
Effects of growth in HMO enrollment

9. 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

10. 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.
Financial Services Modernization Act, 1999

11. Web Resources
For more detailed information on insurance regulation, visit:
Web Surf

12. Property and Casualty Insurance
Size and Structure
Currently about 2,500 companies.
Highly concentrated. Top 10 firms have 51% of market in terms of premiums written.
Top 250: 96%
Balance sheet
Similar to life insurance cos. (Smaller asset base)
Major liabilities: loss reserves, loss adjustment expense and unearned premiums.

13. Property-Casualty Changing composition of net premiums written
decline in fire insurance and allied lines since 1960
Homeowners MP: 10.9% vs. 5.2% in 1960
Commercial MP: 7.1% vs. 0.4% in 1960
Auto L&PD: 44.9% vs. 43% in 1960
Other liability: 19.8% in 2000 vs. 6.6% in 1960

14. 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.

15. Loss Rates Severity versus frequency:
Loss rates more predictable on low-severity, high-frequency lines (such as fire, auto, 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.

16. 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.

17. 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.

18. 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.

19. Recent Trends PC industry was not very profitable during 1987 - 2000.
Reasons:
Succession of catastrophes (Hurricane Hugo 1989, San Francisco Earthquake 1991, Oakland fires 1991, Hurricane Andrew 1991) -- trough of underwriting cycle.
More recently, September 11, 2001 terrorist attacks created an insurance crisis (and heightened demand).

20. Regulation PC insurers 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.

21. Global Issues Insurance industry becoming more global
Regulatory and tax effects in Cayman Islands and Bahamas
Introduction and acceleration of insurance market reforms
cross-country mergers (insurance companies as well as universal banks)

22. Pertinent Websites A.M. Best: www.ambest.com
Federal Reserve:
Insurance Information Institute:
Insurance Services Offices:
National Association of Insurance Commissioners:
State of NY Insurance Guarantee Fund:
Web Surf