1 Chapter 25 Insurance and Pension Fund Operations Financial Markets and Institutions, 7e, Jeff Madura Copyright ©2006 by South-Western, a division of Thomson Learning. All rights reserved. 2 Chapter Outline  Background  Life insurance operations  Property and casualty insurance operations  Health care insurance operations  Business insurance  Regulation of insurance companies  Exposure to risk  Valuation of an insurance company  Performance evaluation 3 Chapter Outline (cont’d)  Interaction with other financial institutions  Participation in financial markets  Multinational insurance companies  Background on pension funds  Pension regulations  Pension fund management  Performance of pension funds  Pension fund participation in financial markets  Participation in financial markets 4 Background  Insurance companies:  Provide various form of insurance and investment services to individuals  Charge a fee (premium) for the services  Provide a payment to the insured (or a named beneficiary) under conditions specified by the insurance policy contract  Help individuals or firms to reduce the potential financial damage due to specified conditions  Common types of insurance are life insurance, property and casualty insurance, health insurance, and business insurance 5 Background (cont’d)  Individuals who are more exposed to specific conditions that cause financial damage will purchase insurance against those conditions  Adverse selection problem  Insurance can cause the insured to take more risks because they are protected  Moral hazard problem  Underwriters are employed by insurance companies to calculate the risk of specific insurance policies  Decide what types of policies to offer based on the potential level of claims and the premiums that they could charge 6 Background (cont’d)  Determinants of insurance premiums  The premium is based on:  The probability of the condition under which the company will need to provide payment  The potential size of the payment in present value terms  The degree of competition in the industry for that type of insurance  Overhead expenses and insurance company profit  Whether the policy is for an individual or a group 7 Background (cont’d)  Investments by insurance companies  Insurance companies invest premiums and fees until the funds are needed to pay claims  Investment decisions balance the goals of return, liquidity, and risk  Those insurance companies whose claims are less predictable need to maintain more liquidity 8 Life Insurance Operations  Life insurance companies:  Are a dominant force in the industry  Generate more than $100 billion in premiums each year  Compensate the beneficiary of a policy upon the policyholder’s death  Charge a premium that reflects the probability of making a payment as well as the size and timing of the payment  Have historically forecasted with reasonable accuracy the benefits they will have to provide  Use actuarial tables and mortality figures to forecast the percentage of policies that will require compensation 9 Life Insurance Operations (cont’d)  Group plans:  Are offered to employees of a corporation  Can be distributed at a low cost because of high volume  Make up about 40 percent of total life coverage 10 Life Insurance Operations (cont’d)  There are about 2,000 life insurance companies  Companies are classified as either stock or mutual ownership  A stock-owned company is owned by shareholders  A mutual company is owned by the policyholders  About 95 percent of companies are stock-owned  Mutual companies are large and account for more than 46 percent of total assets of all life insurance companies [...]... care insurance have incurred major losses Insurance companies increased their premiums  The status of health care insurance and reimbursement is subject to changes caused by possible health care reform 25 Business Insurance   Insurance companies provide a wide variety of business insurance policies Property insurance:    Protects a firm against the risk associated with ownership of property Provides . 1 Chapter 25 Insurance and Pension Fund Operations Financial Markets and Institutions,. ©2006 by South-Western, a division of Thomson Learning. All rights reserved. 2 Chapter Outline  Background  Life insurance operations  Property and casualty