CHAPTER

25
Insurance and
Pension Fund
Operations
Chapter Objectives

 Describe the different types of insurance

policies and their sources of funds
 Describe the main sources and uses of
insurance company funds
 Explain the exposure of insurance companies
to various forms of risk
Insurance Companies

 Provide contractual risk management for:

• Risks of insurable asset losses (auto insurance)
• Risks of liability claims (product liability)
• Risk of large medical costs (health insurance)
• Risk of disability (disability insurance)
• Risk of premature death (life insurance)
Insurance Concepts

 Insure unexpected, independent risk

occurrence
 Premium covers losses, administrative
expenses and profits
 Insured contracts for known loss (premium) in
return for protection
 Moral hazard and adverse selection
Insurance Concepts

Insurance companies provide various forms of

insurance and investment services to individuals and
charge a fee (called a premium) for this financial
service.

In general, the insurance provides a payment to the

insured (or a named beneficiary) under conditions
specified by the insurance policy contract. These
conditions typically result in expenses or lost income,
so the insurance is a means of financial protection.
Background

 Life insurance companies

 Provide risk management contracts for individuals
and businesses
• Risk areas include premature death, health maintenance
costs, and disability
• Life insurance provides cash benefits to the beneficiary of a
policy on the policyholder’s death
• Life insurance premiums reflect
 Probability of making payment to the beneficiary
-The insurance premium is higher when there is more uncertainty.
Types of Life Insurance Policies

 Whole life insurance

 Term insurance

 Variable life insurance

 Universal life insurance

 Group plans
Types of Life Insurance Policies

Cash Value Term Insurance

Insurance
Group
Group
Universal Life

Variable Life

Whole Life Term

Cash value insurance

•A portion of each premium payment is allocated to the cost of insurance and the
remainder deposited into a cash value account.
•While premiums are paid and interest accrues, the cash value builds over time.
Types of Life Insurance Policies

1. Whole life insurance includes both a death

benefit and a savings component that
 It never expires as long as you keep making your
premium payments.
 Builds a cash value amount for the future for the
owner of the policy
 Generates periodic cash flow payments over the life of
the policy for the insurance company to reinvest
 Pays fixed death benefit at death
Types of Life Insurance Policies

2. Term life insurance characteristics

 Temporary, providing death benefits only over a
specified term. Term insurance is a type of life
insurance policy that provides coverage for a certain
period of time, such as 10, 20 & 30 years.
 Premiums paid represent only insurance with no
saving component
 Considerably less expensive than whole life insurance
 Term insurance is for those who would rather invest
their savings themselves in other securities.
Types of Life Insurance Policies

3. Variable life insurance

 Whole life with variable cash value amounts
 Cash values invested in equities and will vary with
the investment performance

4. Universal life insurance

 Combines the features of term and whole life
 Variable premiums over time -buys terms and
invests difference in a variety of investments
 Builds a varying cash value based on contributions
and investment performance
Types of Life Insurance Policies

5. Group plans
 Employees of a corporation offered life insurance
or life insurance purchased on life of employee
 Cash value or term insurance
 Low cost (term) because of its high volume
 Can cover group members and dependents
Sources of Life Insurance Company
Funds
Life insurance companies obtain much of their
funds from premiums
 Cash value reserves - accumulated cash values
owed insured's (liability)
 Pension reserves - accumulated “insured” pension
commitments (liability)
 Annuity/ Pension reserves - accumulated annuity
commitments (liability)
 Loss reserves - losses incurred, not yet paid
 Capital funds
Uses of Life Insurance Company Funds

 Corporate bonds
 Government securities
 Common stock
 Commercial mortgage
 Real Estate
 Policy loans to insured
Uses of Funds - Policy Loans

 Policy loans are loans to policyholders

 Whole life policies
 Borrow up to the cash value of the policy
 Guaranteed interest rate is stated in the
policy
Insurance Company Capital

 Capital
 Build capital by issuing new stock (stock
companies) or retaining earnings
 Used to finance investments in fixed assets
 Cushion against operating losses
 Capital requirements vary depending on asset risk
 Credibility with customers is also enhanced by
adequate capital
Regulation
 Insurance companies are highly regulated by state
insurance agencies
 The National Association of Insurance
Commissioners (NAIC)
• Provides coordination among states in regulatory matters
• Adopted uniform regulatory reporting standards
 State Regulators
• Make sure insurance companies provide adequate service
• States approve/review rates
• Agent licensure
• Forms are approved to avoid misleading wording
Regulation

Who regulates Insurance companies of

Bangladesh?
Insurance Development and Regulatory
Authority of Bangladesh (IDRA) is the only
government body for regulating and developing
the insurance sector of Bangladesh since 2010.
Financial Risks of Life Insurance
Companies

Financial Risk includes

 Interest Rate Risk
 Credit Risk
 Market Risk
 Liquidity Risk
Exposure to Financial Risks

 Interest rate risk

• Fixed rate assets in company portfolios have
market values sensitive to interest rate changes
• Firm measures and manages risks
 Credit risk
• Mortgages, corporate bonds and real estate
holdings can involve default
• Investment-grade securities
• Diversify portfolio among debt issuers
Exposure to Financial Risks

 Market risk
• Exists because events like significant
market value decreases reduce capital
• Economic downturn affects real estate
investments
Exposure to Financial Risks

 Liquidity risk occurs because a high frequency

of claims may require the life insurance
company to liquidate assets
• Life insurance companies have high cash flow
from premiums to offset normal cash needs
• In case of large disaster (9/11) may be forced to
sell assets to generate cash
• Companies try to balance the age distribution of
their customer base
• As interest rates rise, voluntary terminations of
policies occur
Property and Casualty Insurance (PC)
Versus Life Insurance Companies
 PC have shorter contracts
 PC have more varied risk areas
 Life companies larger due to long-term
savings and pension contracts
 PC has wider distribution of Occurrences
• PC’s need liquid, marketable assets
• PC’s earnings more volatile
Other Issues

 Insurance companies interact in a variety of

ways with other financial institutions
 Insurance companies participate in a full range
of financial markets
 Multinational insurance companies
 Insurance companies operate in many countries
 Some countries lack developed markets for
insurance
 Multinational investments