Transcript Class 2 - University of Southern California

Non-Bank Financial Institutions
Week 3 – September 14, 2005
J. K. Dietrich - FBE 524 - Fall, 2005
Non-Bank Financial Institutions
 Insurance-type
– Life and property and casualty
– Pension funds
 Asset
management firms and funds
 Securities firms
 Others
– Finance companies
– Mortgage bankers
– Government-sponsored agencies
J. K. Dietrich - FBE 524 - Fall, 2005
Insurance Liabilities
 Promise
to pay depending on contingency
– Life - Pay upon death, or retirement
– Property and casualty - Pay on occurrence of
accident or loss due to theft or hazard (fire,
weather, earthquake, flood)
 Differences
between life and accident
– Life probabilities known with accuracy
– Casualty has two risks: incidence and severity
J. K. Dietrich - FBE 524 - Fall, 2005
Insurance Services
 Life
and annuity contract
– Probabilities usually not influenced by insured
– Cash flows from coverage are predictable
– Cancellations, lapses, policy loans
 Casualty
contract
– Period short
– Policy-holders influence the incidence and
severity of claims
J. K. Dietrich - FBE 524 - Fall, 2005
Life Insurance Contracts
Limited Pay Life
Premiums, Benefits
Premiums, Benefits
Whole Life Contract
Retirement Death Age
J. K. Dietrich - FBE 524 - Fall, 2005
Retirement DeathAge
Life Insurance Contracts (cont’d)
Life and Annuity
Premiums, Benefits
Premiums, Benefits
Endowment Policy
Retirement Death Age
J. K. Dietrich - FBE 524 - Fall, 2005
Retirement DeathAge
Insurance Distribution
 Life
–
–
–
–
insurance
Ordinary
Group
Industrial
Credit
 Independent
agents
 Economics of insurance marketing
– Compensation of agents and brokers
– Political power in the insurance industry
J. K. Dietrich - FBE 524 - Fall, 2005
Insurance Company Income
 Revenue:
Premium income
– Earned premiums
Investment income
 Expenses:
Policy Benefits and Losses
– Direct payments to claimants
– Loss expenses (evaluation, processing)
Marketing expenses
Non-interest expense
– Labor and related expenses
– Communication, fees
J. K. Dietrich - FBE 524 - Fall, 2005
Insurance Market
J. K. Dietrich - FBE 524 - Fall, 2005
Life Insurance Assets
J. K. Dietrich - FBE 524 - Fall, 2005
Role of Insurance Equity
 Equity
in insurance is sometimes referred to
as surplus since it represents premium
collections above claims payments
 Income is approximately:
– Premiums + investment income – claims
– Income/loss adds to/subtracts from equity
 Equity
or surplus absorbs large surges in
claims as in catastrophes (e.g. Katrina)
J. K. Dietrich - FBE 524 - Fall, 2005
Insurance Balance Sheets
 Balance
sheet: liabilities are insurance
reserves, unearned premiums, and surplus
(plus equity capital)
 Assets are investments in corporate and
municipal bonds, real estate, equities,
 Balance sheet management consists of
matching asset risks to liability risks
– Many liabilities have long tails or durations
J. K. Dietrich - FBE 524 - Fall, 2005
Property-Casualty Insurance
J. K. Dietrich - FBE 524 - Fall, 2005
Contrast Life/Casualty Insurance
 Probabilities
of claims in life insurance are
well known (vital statistics yield accurate
actuarial estimates)
 Moral hazard limited in life insurance
 Dollar claims in casualty insurance are
affected by incidence and severity of
damages and may have more are affected by
incidence and severity of damages and may
have more systematic risk
J. K. Dietrich - FBE 524 - Fall, 2005
Pension Funds
 Private
versus state and local government
 Defined benefit versus defined contribution
 Self-directed pension plans
 Pensions, taxes, and responsibilities
– Corporate tax treatment
– Personal tax treatment
– Corporate responsibilities under ERISA
J. K. Dietrich - FBE 524 - Fall, 2005
Pension Fund Assets
J. K. Dietrich - FBE 524 - Fall, 2005
Asset Management
 Economics
of the industry
– Performance measurement
– Principal-agent problems
 A “temporary”
disequilibrium
– Historical perspective
 Services
provided by asset managers
 Issues in asset management
J. K. Dietrich - FBE 524 - Fall, 2005
Asset Management Firms
 Revenue:
Management Fees
– Based on assets under management
 Expenses:
Research Costs
– Analysts (labor expense)
– Data and computer expenses
Marketing expenses
Non-interest expense
– Overhead labor and related expenses
– Communication, fees
J. K. Dietrich - FBE 524 - Fall, 2005
Securities Firms
 Brokers
– Find buyers for sellers
– Organize markets
 Dealers
– Provide liquidity to market
– Hold inventories and take price risk
 Securities
originators
– Design and place financial instruments for
primary market issuers
J. K. Dietrich - FBE 524 - Fall, 2005
Brokers and Investment Banking
 Full-line
firms offer retail and institutional
trading, securities origination and financial
advisory services, and market-making
services
 Clearing brokers (e.g. Bear Stearns)
present securities for settlement
 Wire houses transmit orders to other firms
for execution
J. K. Dietrich - FBE 524 - Fall, 2005
Investment Banking
 Bulge
bracket firms (e.g. Morgan Stanley)
are largest investment banking firms
 Regional firms (e.g. Wedbush Morgan)
operate in local markets
 Boutique firms specialize in certain types of
transactions (e.g high tech or health care)
 Terms are not mutually exclusive
J. K. Dietrich - FBE 524 - Fall, 2005
Securities Firm Income
 Revenue:
Commissions
Fees - Advisory, investment banking, asset
management
Gains (and losses) and interest
 Expenses:
Labor costs
Communications and space
Clearing fees
Borrowing costs
J. K. Dietrich - FBE 524 - Fall, 2005
Finance Companies
 Three
basic types
– Captive finance companies (owned by
manufacturer, e.g. GMAC)
– Commercial finance companies and financial
firm affiliates (owned by banks or other
financial firms, e.g. Foothill Group)
– Consumer or personal finance companies
(specialized in high-risk finance, like
Household Finance)
 Funding
sources - Bank credit, commercial
paper, affiliate company financing
J. K. Dietrich - FBE 524 - Fall, 2005
Finance Company Investments
J. K. Dietrich - FBE 524 - Fall, 2005
Asset-Pools
 Origination
– Government-sponsored agencies (GSEs)
» Federal National Mortgage Association (FNMA or Fannie
May)
» Federal Home Loan Mortgage Corporation (FHLMC or
Freddie Mac)
» Student Loan Marketing Corporation (SLMC or Sallie May)
– Private originators
 Servicing
– Servicing fees and costs
– Transactions in servicing portfolios
J. K. Dietrich - FBE 524 - Fall, 2005
Other Financial Firms
 Mortgage
banks
 Information and advisory firms
 Clearing firms and depositories
 Exchanges and communication networks
 Clear differences between types are eroding,
but traditionally were due to
– Regulation, taxation, and charters
– Specialization and expertise
– Historical evolution
J. K. Dietrich - FBE 524 - Fall, 2005
Next week: Sept. 21, 2005
 Read
Chapters 4 and 17 of Money and
Capital Markets
 Read selections from trade press selected by
students and download handouts before
class
 Form a group of three or four students for
the group project and provide a tentative
choice for the group project from the list
provided or as discussed with me
 Bring a Wall Street Journal to class every
Wednesday
J. K. Dietrich - FBE 524 - Fall, 2005