Chapter 4
Insurance Companies
• Insurance companies are risk bearers
• They accept risk in return for premiums
• Acceptance of risk is the underwriting process
• Sources of Income
• Premiums
• Profit if premiums exceed underwriting loss plus expenses
• Loss if underwriting loss plus expenses exceed premiums
• Investment income
• Premiums earn investment income
Major Forms of Insurance Companies
• Stock insurance company
• Owned by independent shareholders and publicly traded
• Mutual insurance company
• Policyholders are owners
Types of Insurance
• Life Insurance
• Health Insurance
• Property and Casualty Insurance
• Liability Insurance
• Disability Insurance
• Long-term Care Insurance
• Structured Settlements
• Investment-Oriented Products
• Annuity
Insurance Companies vs. Types of Products
Multiline Insurance
• Life and Health Insurance Company (L&H)
– Specializes in life and health insurance
• Property and Casualty Insurance Company (P&C)
– Specializes in property and casualty insurance
Monoline Insurance Companies
• Specialize in financial guarantees for
– Municipal bonds
– Asset-backed securities
Fundamentals of insurance Industry
• Premiums, as income, are invested for future returns
• The timing of payouts for claims is uncertain
• Payouts may be massive depending on the disaster
• Requires prudent portfolio management
Insurance Regulation
• Insurance companies are regulated by the States
– McCarran Ferguson Act 1945
• States craft laws and regulations based on models developed by the NAIC (National
Association of Insurance Commissioners)
• Insurance companies may also be rated by rating agencies
– Moody’s, S&P, Best, Fitch, etc.
• States impose statutory surplus or reserve rules
– Important as it becomes the ultimate immediate amount available to pay
claims
Deregulation
• Gramm-Leach-Bliley Act (GLB) 1999
– Removed anti-affiliation restrictions
• Commercial banks
• Investment banks
• Insurance companies
• The GLB accelerated and facilitated affiliations between these institutions
Structure of Insurance Companies
• Insurance company organization
– Home office (designs and guarantees the product)
– Investment company (invests premiums)
– Marketing (distribution component)
Bankassurance
– More recently the investment and distribution functions are being performed
by independent firms and banks
– Reinsurance
– The spreading of risk among other insurance companies for a portion of the
premiums
Life Insurance Types
• Term
– Fixed rate/fixed number of years/declining coverage
• Permanent Life or Cash Value
– Cash value (inside buildup) increases/favorable tax treatment
• Guaranteed cash value life
– Participating
• Dividend paid based on investment returns and realized actuarial
experience
– Nonparticipating
• Dividend and cash values are guaranteed
• Variable Life
– Cash value/death benefit dependent on owner directed asset allocation
• Universal Life
– Flexible premium separates term from cash value elements
• Variable Universal Life
– Combines features of Variable Life and Universal Life
• Survivorship (Second to Die)
– Death benefit is not paid until the second of both insured dies
General Account Vs Separate Account
Genera; Account
– Insurance companies must support the guaranteed performance from the
investment portfolio of the overall company
• Whole life
• Universal life
• Fixed annuities
– Separate Account Products
– Insurance products that receive no guarantee from the general account
– Participating policies
– Provides guarantee of minimum dividend, but dividend may increase if
investment portfolio performs well
Insurance Company Investment Strategies
• Investment portfolios should reflect liabilities or the insurance products underwritten
and should consider
– The expected average time to payout
– The actuarial accuracy of estimates of when and how much the payouts will
be
– Other factors
• Difference between L&H and P&C Portfolios
– Less common stock
– Less municipal bonds
– Less longer maturity bonds
– More private placement
– More commercial mortgages