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Chapter Fifteen

Chapter Fifteen. Insurance Companies. Life Insurance. Four basic classes Ordinary life - marketed on an individual basis in units of $1,000 with policyholders making periodic payments

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Chapter Fifteen

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  1. Chapter Fifteen Insurance Companies

  2. Life Insurance • Four basic classes • Ordinary life - marketed on an individual basis in units of $1,000 with policyholders making periodic payments • Term Life - closes to pure life insurance, no savings attached, individual’s beneficiary receives payout at death of policyholder, term of coverage can vary from 1 year to 40 years or more. • Whole Life - protects individual over an entire lifetime in return for periodic premiums, beneficiaries receive face value of the contract. • Endowment Life - combines both term elements with a savings element, guarantees payout to the beneficiaries if death occurs during some endowment period or to the insured person who lives to the endowment date. (continued)

  3. Variable life - invests fixed premium payments in mutual funds of stocks, bonds, and money market instruments with policyholder determining risk level • Universal life and Variable universal life - allows the policyholder to change both the premium amounts and the maturity of the contract • Group Life Insurance • covers a large number of insured persons under a single policy • Industrial Life • involves weekly payments collected directly by representatives • Credit Life • protects lender against a borrower’s death

  4. Other Life Insurer Activities • Annuities • reverse of life insurance principles, involve different methods of liquidating a fund over a long period of time, a popular mechanism for retirement savings • Private Pension Fund • an alternative pension plan offered by insurance companies to private employers, innovative pension plans based on guaranteed investment contracts • Accident and Health Insurance • protects against morbidity or ill health risk • major activity line is group insurance • Life insurance companies write more than 50% of all policies but HMOs (nonregulated providers) have cut into their business • face loss exposures similar to those of property-casualty insurers

  5. Balance Sheet • Assets • corporate bonds, equities, and government securities • policy loans - loans made by an insurance company to its policyholders using their policies as collateral • Liabilities • policy reserves - reflects their expected payment commitments on existing policy contracts • surrender value of a policy - the cash value of a policy if a policyholder surrenders the policy prior to maturity • separate account - annuity program sponsored by life insurance companies, payoff on policy linked to assets in which policy premiums are invested

  6. Life Insurance Company Assets, 1999

  7. Regulation • McCarran-Ferguson Act of 1945 - confirms the primacy of state over federal regulation of insurance companies • Insurance guarantee fund - a fund of required contributions from within-state insurance

  8. Property-Casualty Insurance Companies • Net premiums written - the entire amount of premiums on insurance contracts written • Important P&C lines include the following • Fire Insurance and Allied Lines • protects against fire, lightening, and removal of damaged property • Homeowners Multiple Peril insurance • protects against damage to personal dwelling, contents, liability • Commercial Multiple Peril Insurance • protects commercial firms similar to homeowners • Automobile Liability and Physical Damage insurance • Liability Insurance (other than auto) • provides protection to individuals or firms against legal liability

  9. Balance Sheet and Underwriting Risk • Unearned premium - reserves set aside that contain the portion of a premium that has been paid before insurance coverage has been provided • Loss Risk • property versus liability • severity versus frequency • long tail versus short tail • product inflation versus social inflation • Loss Ratio - measures the actual losses incurred on a specific policy line, measures the ratio of losses incurred to premiums earned(continued)

  10. Expense Risk • loss adjustment expenses (LAE) • commissions and other expenses • combined ratio - equal to the loss ratio plus the ratios of LAE to premiums written and commissions and other expenses to premiums written • Investment Yield/Return Risk • operating ratio - measure of the overall profitability of the insurer, equals the combined ratio minus the investment yield • behavior of interest rates and default rates on P&C insurers’ investments is crucial to the P&C insurers’ overall profitability

  11. Regulation • Chartered at the state level and regulated by state commissions • The National Association of Insurance Commissioners (NAIC) provides various services to the state, such as: • standardized examination system • the Insurance Regulatory Information System (IRIS) to identify insurers with loss, combined, and other ratios operating outside normal ranges • Rate regulation • state commissions set ceilings on the premiums for auto and workers’ compensation insurance

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