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CHAPTER 25

Insurance and Pension Fund Operations

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CHAPTER 25 OVERVIEW

This chapter will:A. Describe the main uses of insurance company fundsB. Explain the exposure of insurance companies to

various forms of riskC. Identify the factors that affect the value of insurance

companiesD. Describe the common types of private pension plansE. Explain how pension funds are managed

Insurance Company

Provide various insurance and investment services to individuals and charge a fee called premium.

Life insurance, property and casualty insurance, health insurance, and business insurance.

Adverse selection problem-those who are most likely to need insurance are most likely to purchase it.

Moral hazard problem-insurance can cause the insured to take more risks because they are protected.

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Premium Determination

Premium is based on the probability of the condition under which the company will have to provide a payment to the insured (or beneficiary) and the potential size of the payment.

Competition Adverse selection problem Moral hazard problem

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Main Sources of Funds

1. Insurance premium2. Provision of annuity plans, which offer a

predetermined amount of retirement income to individuals.

3. Investment4. Equity

Exhibit 25.1 Distribution of U.S. Life Insurance Company Income

Source: 2007 Life Insurance Fact Book

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Uses of Funds

a. Government Securitiesb. Corporate Securitiesc. Mortgagesd. Real Estatee. Policy Loans

Exhibit 25.2 Assets of U.S. Life Insurance Companies

Source: 2007 Life Insurance Fact Book

Exhibit 25.4 Assets of Property and Casualty Insurance Companies

Source: Federal Reserve

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Risk Exposure

1. Interest Rate Risk

2. Credit Risk

3. Market Risk

4. Liquidity Risk

Exhibit 25.6 Participation of Insurance Companies in Financial markets

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Property and Casualty Reinsurance

Property and casualty insurance commonly obtain reinsurance, which the insurance company allocates a portion of their return and risk to other insurance companies.

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Regulation of Insurance Companies

a. Regulated by state agencies

b. Insurance company agents must be licensed

c. National Association of Insurance Commissioners (NAIC)

d. Regulation of Capital

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D. Common Types of Pension Funds

1. Background

a. Public Pension Funds

b. Private Pension Plans

1.) Defined-Benefit Plan

2.) Defined-Contribution Plan

c. Underfunded Pensions

Pension and Pension Funds

Pension plans provide a savings plan for employees that can be used for retirement, e.g. 401K. They receive premium from the employer and/or the employee.

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Common Types of Pension Funds

1. Public pension funds for example, Social Security

2. Private pension funds

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Pension Fund Management

1. Management of Insured plans

pension funds are managed by life insurance companies. Contributions are often used to purchase annuity policies. The investment concentrates on bonds and mortgages.

2. Management of Trust Portfolios

pension funds are managed by the trust department of financial institutions such as commercial banks. The investment concentrates on stocks.

Exhibit 25.10 Participation of Pension Funds in Financial Markets

Homework Assignment 15

Questions:

1 2 5 8 9 10 14 21 24

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