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Chapter 6 – Insurance

Chapter 6 – Insurance. BA 543 Financial Markets and Institutions. Chapter 6 – Insurance. Why are Insurance Companies considered Financial Intermediaries? They transfer risk from a party that does not want to bear the risk to a party that can bear the risk

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Chapter 6 – Insurance

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  1. Chapter 6 – Insurance BA 543 Financial Markets and Institutions

  2. Chapter 6 – Insurance • Why are Insurance Companies considered Financial Intermediaries? • They transfer risk from a party that does not want to bear the risk to a party that can bear the risk • Individuals transfer the risk they cannot afford and keep the risk they can afford • The process • Underwrite policies (accept or reject applicants) • Differentiate policy holders (charge different) • Invest the proceeds (financial management)

  3. Chapter 6 – Insurance • Transfer of Risk • Payment (Premium) moves risk of loss to Insurance Company • Payout at time of “event” • Premium at start of insurance period • Law of Large Numbers for Insurance Company • Insurance Company makes money • Event Payments less than Premiums • Earnings on funds prior to Event Payment

  4. Chapter 6 – Types of Insurance See Table Page 97 • Life • Term • Whole Life • Health • Medical • Dental • Property and Casualty • Property (House, Car, Boat, etc.) • Liability

  5. Chapter 6 – Insurance • Determining Premium • Based on • Event probability • Event cost • Varies across companies and policies • Demographics/Characteristics of pool • Deductibles • Taking back a portion of the risk • Reducing some of the volatility of the event • Premium Example – Insurance for Bikes

  6. Chapter 6 – Insurance Bike Example • Four Cities…North Park, South Park, East Park and West Part and insurance for theft only • NP probability of theft 20%, average cost of bike $250 • SP probability of theft 15%, average cost of bike $300 • EP probability of theft 10%, average cost of bike $400 • WP probability of theft 5%, average cost of bike $600 • Insurance Premium with no profit? • Across all cities…$41.25 one policy for all bike owners • Who self insures? (Leaves the pool voluntarily) • Who ultimately buys insurance? • Is mandatory insurance good?

  7. Chapter 6 – Insurance • Other Insurance Products • Disability Insurance • Long-Term care • Umbrella (Liability Extension) • Structured Settlements • Investment Products • GICs (Guaranteed Investment Contracts) – Like a zero coupon bond… • Annuities • Immediate • Deferred (accumulation and distribution phase)

  8. Chapter 6 – Insurance • The Industry – Separated at Glass-Steagall • Regulation • McCarran Ferguson Act 1945 - States Regulate • NAIC – National Association of Insurance Commissioners • Voluntary Association • Advocate “Best Practices” (often write proposed legislation for states) • Oversight • Rated by Agencies (Moody’s, Standard & Poor’s) • Surplus requirements

  9. Chapter 6 – Insurance • Organization • Three Companies in One… • Home Office – Writes and guarantees contracts • Investment Company – manages the investments • Distribution Company • Sells the products • Can be employees or the firm or independent agents • Bankassurance • When commercial banks distribute insurance company products

  10. Chapter 6 – Insurance • Investing by Insurance Companies • Need to match the liabilities (guaranteed products) • Life vs. Property and Casualty • Life more predictable • Property and Casualty more volatile • Internationalization • U.S. companies expanding overseas • Foreign Companies coming here • AXA, ING, Allizance, Fortis, Aegon • Less regulation here…access to U.S. markets

  11. Chapter 6 – Insurance • Hot topic of the Day - Health Insurance • Single Provider vs. Private Insurance • Medicare and VA examples of single provider • Group plans (company plans) example of private insurance • Which is better? • What are the metrics to measure for best? • Life expectancy • Infant death rates • Cost • Access • Patient Protection and Affordable Care Act 2014 • Health Insurance Exchanges

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