Professional Documents
Culture Documents
Chapter Fifteen: Insurance Companies
Chapter Fifteen: Insurance Companies
Chapter Fifteen: Insurance Companies
Insurance Companies
•• Approximately
Approximately1,300
1,300life
lifeinsurance
insurancecompanies
companiesexist
existin
inthe
the
U.S.
U.S.in
inthe
themid-2000s
mid-2000s
–– compares
comparestoto2,300
2,300inin1988
1988
–– the
theindustry
industryhas
hasseen
seenconsolidation
consolidationtototake
takeadvantage
advantageof
ofscale
scaleand
and
scope
scopeeconomies
economies
•• Aggregate
Aggregateindustry
industryassets
assetswere
were$4.8
$4.8trillion
trillionatatthe
the
beginning
beginningof
of2007
2007
–– compares
comparestoto$1.1
$1.1trillion
trillioninin1988
1988
•• Life
Lifeinsurance
insurancecompanies
companiescan
canbe
beeither
eitherstock
stockor
ormutually
mutually
owned
owned(where
(wherethe
thepolicyholders
policyholdersare
arethe
theowners)
owners)
•• Life
Lifeinsurers
insurerspool
poolthe
therisks
risksof
ofindividuals
individualsto
todiversify
diversify
away
awaysome
someofofthe
thecustomer-specific
customer-specificrisk
risk
–– thus,
thus,they
theyare
areable
abletotooffer
offerinsurance
insuranceservices
servicesatataacost
costlower
lowerthan
than
any
anyindividual
individualcould
couldachieve
achievesaving
savingfunds
fundsonontheir
theirown
own
–– allows
allowsthe
thetransfer
transferofofincome
incomerelated
relateduncertainties
uncertaintiesfrom
fromthe
the
individual
individualtotothe
thegroup
group
•• Other
Otheractivities
activitiesof
oflife
lifeinsurance
insurancecompanies
companies
–– sell
sellannuities,
annuities,which
whichare
aresavings
savingscontracts
contractsthat
thatinvolve
involvethe
the
liquidation
liquidationof
ofthose
thosefunds
fundssaved
savedover
overaaperiod
periodofoftime
time
–– manage
managepension
pensionplans
plans(e.g.,
(e.g.,tax-deferred
tax-deferredsavings
savingsplans)
plans)
–– provide
provideaccident
accidentand
andhealth
healthinsurance
insurance
•• Insurance
Insurance companies
companies accept
accept or
or underwrite
underwrite risk
risk
that
that aa prespecified
prespecified event
event will
will occur
occur in
in return
return for
for
insurance
insurance premiums
premiums
–– underwriting
underwritingdecisions
decisionsdetermine
determinewhich
whichrisks
risksare
are
accepted
acceptedand
andwhich
whichare
arenot
not
–– underwriting
underwritingdecisions
decisionsdetermine
determinehow
howmuch
muchto tocharge
charge
(in
(inthe
theform
formof
ofpremiums)
premiums)forforaccepted
acceptedrisk
risk
•• The
The adverse
adverse selection
selection problem
problem isis the
the problem
problem
that
that customers
customers who
who apply
apply for
for insurance
insurance policies
policies
are
are more
more likely
likely to
to be
be those
those in
in need
need of
of coverage
coverage
•• Moral
Moralhazard
hazardoccurs
occurswhen,
when,after
afteran
aninsurer
insurerand
andaa
customer
customerenter
enterinto
intoan
aninsurance
insurancecontract,
contract,the
theinsured
insured
takes
takesan
anaction
actionnot
nottaken
takeninto
intoaccount
accountininthe
thecontract
contractthat
that
changes
changesthe
thevalue
valueof
ofthe
theinsurance
insurance
•• Actuaries
Actuariesreduce
reducethe
therisks
risksof
ofunderwriting
underwritinginsurance
insurance
–– with
withlife
lifeinsurance,
insurance,actuaries
actuariesanalyze
analyzemortality,
mortality,produce
producelife
life
tables,
tables,and
andapply
applythe
thetime-value-of-money
time-value-of-moneytotoproduce
producelife
life
insurance
insuranceannuities
annuitiesand
andendowment
endowmentpolicies
policies
–– with
withhealth
healthinsurance,
insurance,actuaries
actuariesanalyze
analyzethe
therates
ratesof
ofdisability,
disability,
morbidity,
morbidity,mortality,
mortality,fertility,
fertility,etc.
etc.
•• Ordinary
Ordinary life
life insurance
insurance isis marketed
marketed to
to
individuals—policyholders
individuals—policyholders make make periodic
periodic
premium
premium payments
payments in in exchange
exchange for
for coverage
coverage
–– term
termlife
life
•• beneficiary
beneficiaryreceives
receivespayout
payoutatattime
timeofofdeath
death
•• ififinsured
insuredlives
livesbeyond
beyondthe
theterm
termof ofthe
thecontract
contractno
nobenefits
benefitsare
are
paid
paid
–– whole
wholelife
life
•• policy
policyprotects
protectsover
overentire
entirelifetime
lifetime
•• beneficiary
beneficiaryreceives
receivesface
facevalue
valueofofcontract
contractupon
upondeath
death
•• Group
Group life
life insurance
insurance covers
covers aa large
large number
number of
of
persons
persons under
under aa single
single policy
policy
–– contributory—both
contributory—boththetheemployer
employerandandthe
theemployee
employee
cover
coveraashare
shareof
ofthe
thepremiums
premiums
–– noncontributory—the
noncontributory—thecosts
costsare
areborne
borneentirely
entirelyby
bythe
the
employer
employer
•• Credit
Credit life
life insurance
insurance protects
protects lenders
lenders against
against
borrower
borrower death
death
•• Other
Other life
life insurance
insurance activities
activities
–– annuities
annuitiesare
areinvestment
investmentvehicles
vehiclesthat
thatliquidate
liquidateaafund
fund
over
overaalong
longperiod
periodofoftime
time
–– private
privatepension
pensionfunds
fundscompete
competewith
withother
otherfinancial
financial
service
servicecompanies
companies
–– accident
accidentand
andhealth
healthinsurance
insuranceaccounted
accountedforformore
more
than
than$142
$142billion
billionof
ofpremiums
premiumswritten
writteninin2007
2007
•• Fire
Fireinsurance
insuranceand
andallied
alliedlines
lines
–– 4.3%
4.3%of
ofpremiums
premiumswritten
writteninin2006
2006vs.
vs.16.6%
16.6%inin1960
1960
•• Homeowners
Homeownersmultiple
multipleperil
peril(MP)
(MP)
–– 12.5%
12.5%of
ofpremiums
premiumswritten
writteninin2006
2006vs.
vs.5.2%
5.2%inin1960
1960
•• Common
Commonmultiple
multipleperil
peril
–– 4.3%
4.3%of
ofpremiums
premiumswritten
writteninin2006
2006vs.
vs.0.4%
0.4%inin1960
1960
•• Auto
Autoliability
liabilityand
andphysical
physicaldamage
damage(PD)
(PD)
–– 39.3%
39.3%of
ofpremiums
premiumswritten
writteninin2006
2006vs.
vs.43.0%
43.0%inin1960
1960
•• Liability
Liabilityinsurance
insurance(other
(otherthan
thanauto)
auto)
–– 14.7%
14.7%of
ofpremiums
premiumswritten
writteninin2006
2006vs.
vs.6.6%
6.6%inin1960
1960
•• Underwriting
Underwriting risk risk isis the
the risk
risk that
that premiums
premiums are
are
insufficient
insufficient to
to cover
cover losses
losses andand administrative
administrative
expenses
expenses after
after taking
taking into
into account
account investment
investment
income
income
•• Underwriting
Underwriting riskrisk may
may result
result from
from
–– unexpected
unexpectedincreases
increasesin
inloss
lossrates
rates
–– unexpected
unexpectedincreases
increasesin
inexpenses
expenses
–– unexpected
unexpecteddecreases
decreasesinininvestment
investmentyields
yields
•• The
The combined
combined ratio
ratio isis aa measure
measure of
of overall
overall
profitability
profitability
–– equals
equalsthe
theloss
lossratio
ratioplus
plusLAE
LAEto topremiums
premiumswritten
written
plus
pluscommissions
commissionsand andother
otherexpenses
expensesto
topremiums
premiums
written
written
•• Investment
Investment yield
yield isis measured
measured as as net
net interest
interest
income
income divided
divided byby premiums
premiums earned
earned
•• The
The operating
operating ratio
ratio isis also
also aa measure
measure of of overall
overall
profitability
profitability
–– equals
equalsthe
thecombined
combinedratio
ratiominus
minusthe
theinvestment
investmentyield
yield
•• Much
Muchof ofthe
the1987
1987toto2007
2007period
periodwas
wascharacterized
characterizedby
by
catastrophes
catastrophesofofhistorically
historicallyhigh
highseverity
severity
–– 9/11/2001
9/11/2001terrorist
terroristattacks
attacks
–– 2004
2004Florida
Floridahurricanes
hurricanes
–– 2005
2005hurricane
hurricaneKatrina
Katrina
•• An
Anunderwriting
underwritingcycle
cycleisisaapattern
patternthat
thatthe
theprofits
profitsin
inthe
the
P&C
P&Cindustry
industrytend
tendto
tofollow
follow
•• The
Thefederal
federalgovernment
governmenthashasincreasingly
increasinglyincreased
increasedtheir
their
role
roleof
ofproviding
providingcompensation
compensationand andreconstruction
reconstruction
assistance
assistancefollowing
followingnatural
naturaldisasters
disasters