CHAPTER 4

INSURANCE COMPANIES
Learning Objectives:
 The nature of the business of insurance companies.
 How insurance companies generate income.
 The difference between a stock company and a mutual company.
 The different types of life insurance policies and property and casualty
insurance policy.
 Who regulates insurance companies.
 The impact of financial modernization act of 1999 on the insurance
industry.
 The structure of an insurance company.
 Insurance company investment strategies.

Insurance is a means of protection from financial loss. It is a form of risk management,

primarily used to hedge against the risk of a contingent or uncertain loss.
An entity which provides insurance is known as an insurer, insurance company, insurance carrier
or underwriter. A person or entity who buys insurance is known as an insured or as a
policyholder. The insurance transaction involves the insured assuming a guaranteed and known
relatively small loss in the form of payment to the insurer in exchange for the insurer's promise
to compensate the insured in the event of a covered loss. The loss may or may not be financial,
but it must be reducible to financial terms, and usually involves something in which the insured
has an insurable interest established by ownership, possession, or pre-existing relationship.
The insured receives a contract, called the insurance policy, which details the conditions and
circumstances under which the insurer will compensate the insured. The amount of money
charged by the insurer to the Policyholder for the coverage set forth in the insurance policy is
called the premium. If the insured experiences a loss which is potentially covered by the
insurance policy, the insured submits a claim to the insurer for processing by a claims adjuster.
The insurer may hedge its own risk by taking out reinsurance, whereby another insurance
company agrees to carry some of the risk, especially if the primary insurer deems the risk too
large for it to carry.
Sources of Income
To generate revenue, insurance companies will invest a portion of the small amount of money
earned from annual premiums. By taking this money and putting it in low-risk
investments, insurance companies can earn additional profits, which help improve their balance
sheets and bottom line.

Major forms of Insurance companies: Stock versus Mutual

MAIN GOALS:

The primary mission of a mutual insurer is to continuously maintain enough capital to meet
policyholder needs. On the other hand, the main goal of a stock insurer is to maximize profits for
its shareholders.

OWNERSHIP AND LEADERSHIP:

The major difference between mutual and stock insurance companies is their ownership
structure. A mutual insurance company is owned by its policyholders, while a stock insurance
company is owned by its shareholders and can be either privately held or publicly traded.
Policyholders of a stock company have no control over the company’s management unless they
are investors as well. Policyholders of mutual insurers are also the owners of the company and
therefore get to vote on its board of directors.

EARNINGS:

Both mutual and stock insurance companies earn their income by collecting premiums from
policyholders—the difference lies in what they do with those earnings. Mutual insurers may
distribute surplus profits to policyholders through dividends, or retain them in exchange for
discounts on future premiums. Stock insurers can distribute surplus profits to shareholders in the
form of dividends, use the money to pay off debt, or invest it back into the company. Stock
companies are also able to issue shares of stock to generate income, but mutual insurers don’t
have this option, and must take out loans or increase premium rates if additional money is
needed.
INVESTMENTS:

Due to their varying goals, the investment strategies of these two kinds of insurance providers
are often different. Since stock insurers are under pressure from investors to maximize profits in
order to higher dividend payouts, they tend to be more concerned with short-term results.
They’re more likely to invest in higher-yielding, riskier assets than mutual companies. Mutual
insurers are more long-term focused, leading them to invest in conservative, low-yield assets.

RISK:

Stock insurers offer policyholders greater stability, as they have more options available to
generate earnings. This makes it easier for them to overcome financial difficulties, while a
mutual’s reliance on policy premiums as their main source of income can be a major
disadvantage. If they’re unable to raise enough funds, they may be forced out of business. When
a mutual company is sold, policyholders may receive a cut of the money from the sale. Instead of
dissolving the company, a mutual insurer that is in financial trouble also has the option to turn
into a stock company, through a process called demutualization.

TYPES OF INSURANCE:

 Life Insurance
Insurance that pays out a sum of money either on the death of the insured person
or after a set period.

 Health Insurance
Health insurance is a type of insurance coverage that pays for medical and
surgical expenses incurred by the insured. Health insurance can reimburse the insured for
expenses incurred from illness or injury, or pay the care provider directly.

 Property and Casualty Insurance

Property insurance and casualty insurance are types of coverage that help
protect the stuff you own — your home or car, for example — and also provide liability
coverage to help protect you if you're found legally responsible for an accident that
causes injuries to another person or damage to another person's belongings.

 Liability Insurance
 Liability insurance (also called third-party insurance) is a part of the
general insurance system of risk financing to protect the purchaser (the "insured") from
the risks of liabilities imposed by lawsuits and similar claims.

 Long-term care Insurance

Long-term care (LTC) insurance is coverage that provides nursing-home care,
home-health care, personal or adult day care for individuals above the age of 65 or with a
chronic or disabling condition that needs constant supervision. LTC insurance offers
more flexibility and options than many public assistance programs.

 Structured Settlements
A structured settlement is a negotiated financial or insurance arrangement through
which a claimant agrees to resolve a personal injury tort claim by receiving part or all of
a settlement in the form of periodic payments on an agreed schedule, rather than as
a lump sum. As part of the negotiations, a structured settlement may be offered by the
defendant or requested by the plaintiff. Ultimately both parties must agree on the terms of
settlement. A settlement may allow the parties to a lawsuit to reduce legal and other costs
by avoiding trial.

 Investment- oriented Products

Insurance companies increasingly offer products with a significant investment
component in addition to their insurance component.

 Annuity
An annuity is a type of policy issued by an insurance company designed to accept
and grow funds, and upon annuitization, create a stream of income or payments. The
money you pay in can be either a lump sum or a number of payments. These
contributions generally earn a rate of return, generally tax-deferred.

Who regulates Insurance companies?

 Firstly, Insurance companies are being regulated by the government of the location,
where the company is located and the location where the client is currently positioned.
As per Wikipedia - Insurance Regulatory Law is the body of statutory law,
administrative regulations and jurisprudence that governs and regulates the insurance
industry and those engaged in the business of insurance. Secondly, there are private
rules and regulations of the companies themselves, which are directly mentioned in the
 company’s policies. As same as government regulations, company policies are equally
imperative and followed by both sides (i.e. the company and the client) during any
kind of insurance lead. Last but not the least, the third party regulations also adds-on,
in case of outsourcing insurance projects to the third party firms. This is now very
common as insurance companies use to hire Companies in order to manage their all
operational and non-operational activities appropriately.

The impact of financial modernization act of 1999 on the insurance industry.

This legislation is also known as the Gramm-Leach-Bililey Act, the law was enacted in 1999 and
removed some of the last restrictions of the Glass-Steagall Act of 1933. When the financial
industry began to struggle during economic downturns, supporters of deregulation argued that if
allowed to collaborate, companies could establish divisions that would be profitable when their
main operations suffered slowdowns. This would help financial services firms avoid major losses
and closures.

Prior to the enactment of the law, banks could use alternate methods to get into the insurance
market. Certain states created their own laws that granted state-chartered banks the ability to sell
insurance. An interpretation of federal law also gave national banks permission to sell insurance
on a national level if it was done from offices in towns with populations under 5,000. The
availability of these so-called side routes did not encourage many banks to take advantage of
these options.

Capabilities Granted to Banks

The Financial Services Modernization of 1999 allowed banks, insurers and securities firms to
start offering each other’s products as well as affiliate with each other. In other words, banks
could create divisions to sell insurance policies to their customers and insurers could establish
banking divisions. New corporate structures would need to be created within financial
institutions to accommodate these operations.