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1、Ch 3 Insurance Companies (Based on Saunders et al,2006)Outline1.Insurance Companies:IntroductionDifferences and commonalities with depository institutions2.Quick Facts about Insurance Companies in Canada3.Life Insurance CompaniesTypes of life insuranceOther financial servicesHealth Insurance4.Owners
2、hip5.Balance Sheet6.Property and Casualty Insurance Companies7.How do Insurance companies deal with adverse selection and moral hazard?8.Conclusions11.IntroductionWhy do people buy insurance?A:nInsurance companies(IC)are in the business of assuming risk on behalf of their customers in exchange for a
3、 fee,called premium.nInsurer Profits=total premium actual claims to the IC.nPremiums Peoples expected amount of any loss suffered.2 2.Quick Facts about Insurance Companies in CanadanCanadian and Foreign Company Operations in Canada1980=170;1998=129,2002=109,2005=95nHealth insurance protection was pr
4、ovided to Canadians by 83 life insurers and 44 property and casualty insurers.nWorking in the industry were 118,900 Canadians 52,700 full-time employees and agents,and 66,200 independent agents.nMajor life insurance companies in CanadaManuLife Insurance,Sun Life Financial,Great-West Lifeco,others:De
5、sjardins Financial,Allstate Canada,Standard Life).Former 3 control more than 50%of the market.3nMain difference with banks and near banksDepositary institutions take deposits(liabilities)and make loans(assets)Insurance companies receive premiums from policies which are based on contingent(actuarial)
6、liabilities and invest them on bonds,mortgages and stocks(assets).nCommonalities with Banks and Near BanksnBoth are Financial intermediaries nBoth are exposed to similar risks through their asset activities:liquidity,credit,market,operational risknInsurance companies can offer similar product than d
7、epositary institutions from their own banks and LMTs.They can also offer bank products from their insurance officesnDepositary institutions can offer similar insurance products than insurance companies through subsidiaries.4Great-West profit up 49%(National Post 30Apr04)Great-West Lifeco Inc.,Canada
8、s third-largest insurer by assets said first quarter profit jumped 49%,bolstered by revenue from its July purchase of Canada Life Financial Corp.Net income climbed to$376-million,or$0.83 a diluted share,from 253-million($0.68)a year earlier,the company said in a statement.However,the stock price dro
9、ps at the close on the announcement day almost$2.Why?53.Life Insurance CompaniesnLife insurance firms collect premiums during a persons lifetime that must be invested until a death benefit is paid to the insurance contracts beneficiaries.6Biggest Life Insurers7nTypes of Life InsurancenIndividual Lif
10、e Insurance:Tailored to specific needs of policy holder.nCostly compared to group life insurancenWhole life insurance:It combines a death benefit with a kind of savings plan(surrender value).nTerm insurance.It covers a specified period of time and pays the face amount upon death but accrues no cash
11、value.nUniversal Life and Variable Universal Life.More popular:It combines a term life insurance and one for savings.The policyholder can change the maturity and amount of premium.nCredit life insurance.Protects lenders against a borrowers debt prior to the repayment of a debt(e.g.,mortgage or car l
12、oan)nGroup Life Insurance:Cover a group of people under a single policynDecrease adverse selection and moral hazard.nTerm insurance only.8Other financial services:nWealth managementSale and management of annuity contracts,and registered retirement savings plans(RRSP)RRSP.Plan in which tax deductible
13、 contributions are made to accumulate a retirement fund.nManagement of pension funds.9nLife annuity(longevity insurance):Reverse of life insurance.n nWhile While life insurancelife insurance involves different contractual methods to build up a fund and the eventual payout of a lump sum to the benefi
14、ciary,n AnnuitiesAnnuities involve different methods of liquidating a fund over a long period of time nIt involves a periodic payment to the annuitant until his or her death(mostly).10Numerical example:Life Insurance vs.Life AnnuitynLife Insurance(insurance against early death)nPeter Lewis is 55 yrs
15、 old.He bought an insurance life contract that will pay$20,000 to its beneficiaries when he dies.His yearly contributions are$1,200 indefinitely.Assume a life expectancy of 78 years.Also suppose that$1 today is worth$1 any time in the future.Determine the profit(loss)of the insurance company if he d
16、iesnfive years later.A:Profit=Premium Insurance Claim=$1,200*5-$20,000=-$14,000nat the age of 78 years:A:$1,200*23-$20,000=$7,600(Normal or Expected Profit)nat the age of 90 years:A:$1,200*35-$20,000=$22,000 nLife Annuity(longevity insurance)nPeter Lewis is 55 yrs old.He invested in a life annuity c
17、ontract the lump sum of$27,600.Under this contract the insurance company will pay$1,050 indefinitely until his death.Assume a life expectancy of 78 years.Also suppose that$1 today is worth$1 any time in the future.Determine the profit(loss)of the insurance company if he diesnfive years later.A:Profi
18、t=Premium Insurance Claim=$27,600-$1,050*5=+$22,350nat the age of 78 years:A:$27,600-$1,050*23=$3,450(Normal or Expected Profit)nat the age of 90 years:A:$27,600-$1,050*35=-$9,15011nThere are many types of annuities addressing different clientele needs.nThe payment of the accumulated funds through a
19、nnuities vary in features such as nmaturity,ngroup or individual,nfor immediate or deferred disbursement,nliquidated after retirement,nfixed or variable payment and so on.nAnnuities provide 53 per cent of total premium income nIn pricing annuities,insurance companies use mortality tables that show t
20、he probabilities that individuals of various ages will die within a year.12Life expectancy at various ages in CanadanAgeMaleFemale1560672551573541474532375523286516207510128557 www.life-insurance-Since death rates for the population as a whole are predictable with a high degree of certainty,insuranc
21、e companies can fairly predict what what the payouts to policyholders will be in the future.invest in illiquid assets(usually corporate and mortgage bonds)13Health Insurance nPrivate health insurance companies protect against health related risk over and above the coverage provided by the government
22、(i.e.,extended health care,disability,dental care and eye care).14n4.Ownership:nMutual companies:Owned and operated for the benefit of participant policyholders.Each participant has one vote for selecting board of directorsnJoin Stock Companies:Votes are in proportion of amount owned by shareholders
23、.nTrend Demutualization of Insurance CompaniesnReason:Facilitates consolidation through mergers and acquisitionsnThe big 5 Insurance companies are already demutualized(ManuLife Assurance,Sun Life Financial-(Clarica),Great-West,Canada Life)155.Balance Sheet Life Canadian Insurance Companies(Consolida
24、ted Federally Registered Insurance firms,Q2,2002)nHighlightsnAssets(excluding segregated funds):Investment in bonds(57.5%)and mortgage bonds(14.7%)(investments based on prudent person test)n58%of Canadian policy income is from abroad;15%of total premium is from foreign Insurance firms.nLiabilities:A
25、ctuarial liabilities*(71.4%)nEquity capital is 9.98%of total assets(Banks is 6.8%)nSegregated funds amount to 36.8%of total assetsSegregated funds are variable life policy assets in which claims are based on the returns of a pool of segregated securities(guarantying 75-100 of initial investment depe
26、nding on the policy).*Actuarial liabilities:Expected payment commitments on existing policy contracts.166.Property and Casualty Insurance Companies nProperty insurance cover losses of real and personal property(e.g.,theft,fire,accidents,natural disasters,man made disasters)nCasualty(liability)insura
27、nce protects against legal liability exposures(e.g.,medical malpractice)17nQuick Facts230 federally registered P&C insurance companies(2002)Market shares among top insurers is proportionally distributedHigh growth(See Figure_)E.g.,in 2001 Net premiums($21.2 billion)vs.Claims incurred($16.2 billion)T
28、ypes of property coverage(2001)(See graph)nAutomobile(53.1%),personal property(16.4%),commercial liability(10.3%),accident and sickness(3.2%),other(4.0%)nLast few years:P&C severely affected by SARS,power outage(ON),forest fires(BC),mad cow disease(AB),18nPartial Balance Sheet(C$billions of dollars)
29、nAssets 1998 Q3-2003nBonds and debentures$14.09(40.72%)$18.86(38.24%)Total$34.40(100%)$49,32 (100%)nLiabilities 1998 Q3-2003nUnpaid claims and adjustment expenses$15.99 (46.49%)$22.46(45.5%)nUnearned premiums*$7.098 (20.63%)$12.361(25.6%)nEquity$9.308(27.05%)$11.386(23.08%)Total$34.40(100%)$49,32 (1
30、00%)*Unearned premiums representing the unexpired part of policiesnP&C company assets are more liquid than those of Life insurance companies and their investment horizon is shorter.Why?19nRegulatory agenciesnFederally registered,with capital adequacy standards met by OSFIAuto Insurance subject to pr
31、ovincial lawnProperty and Casualty Insurance Compensation Corporation(PACIC).Covers claims in case the insurance company goes bankrupt,of up to$200,000.207.Insurance Companies face at great extent adverse selection and moral hazardPractices used to reduce these problemsnInformation collection and sc
32、reening(medical history,driving habits,)nRisk-based premiums(age,gender,married/single,)nRestrictive provisions nPrevention of fraud(investigation)nCancellation of insurance nDeductibles(fixed amount payment reduction)nCoinsurance(%amount payment reduction)nLimits on the amount of insurance(payment
33、market value)218.ConclusionsnLife insurance companies insure people against financial hazards following death,and sell annuities.nThey acquire funds from premiums and invest mainly in corporate bonds and mortgages.They are restricted in the amount of stock bought.nHigh concentration of ownership amo
34、ng the three largest life insurers.nProperty and Casualty(P&C)Insurance companies receive funds from premiums.They use their funds to buy more liquid assets because they have more possibility of of loss if major disasters occur.nInsurance companies are experts in determining the amount of premiums(liabilities)compared with asset investments.nSkilful in addressing problems of adverse selection and moral hazard.22