Transcript Slide 1

CHAPTER 3
Financial Services: Insurance
McGraw-Hill/Irwin
Copyright © 2011 by The McGraw-Hill Companies, Inc. All Rights Reserved.
Overview
 This chapter discusses insurance
companies
– Two major groups:
 Life
 Property & Casualty
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Financial crisis and insurance companies
Size, structure, and composition
Balance sheets and recent trends
Regulation of insurance companies
Global competition and trends
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Insurance and Financial Crisis
 Insurance companies as investors in
securities
– Subprime mortgage pools fell in value
– Credit default swaps (CDS) fell
– AIG was a major writer of CDS securities
 Potential impact on other companies
used to justify AIG bailout
 Increased risk exposure
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Insurance Companies
 Differences in services provided by:
– Life insurance companies
– Property and casualty insurance
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Size, Structure & Composition
 Size, structure, and composition of the
industry:
– In 1988: 2,300 life insurance companies
with aggregate assets of $1.12 trillion
– Mid 2000s: 1,300 companies
– In early 2006: $4.5 trillion in assets
 3 largest wrote 25% of new premium business
in 2008
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Size, Structure & Composition continued:
– In 2009: $0.7 trillion in assets
– Increasing involvement of commercial
banks
 In 2008: Commercial banks sold 30.5 percent
of fixed annuity insurance contracts and 12.)
percent of variable rate insurance contracts
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Life Insurance Companies
 Significant consolidation in life
insurance industry although not to the
same extent witnessed in banking
 Competition from within industry and
from other FIs
 Conversion to stockholder controlled
companies
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Mutual vs. Stock Insurance Companies
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Biggest Life Insurers
Insurance Company
1. Metropolitan Life
2. American International Group
3. Prudential of America
4. Hartford Life
5. Teachers Insurance & Annuity
6.New York Life
7. Manulife Financial
8. Aegon USA, Inc.
9. ING Group
10. Northwestern Mutual
Ownership
Form
Assets
(billions)
Stock
Stock
Stock
Stock
Stock
Mutual
Stock
Mutual
Stock
Mutual
422.6
348.2
309.6
308.2
177.9
188.8
187.0
179.5
168.9
155.2
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Life Insurance: Issues
 Demutualization
 Adverse selection
– Insured have higher risk than general
population
– Alleviated by grouping of policyholders
into risk pools
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Life Insurance Companies
 Life insurance products:
– Ordinary life
 Term life, whole life, endowment life
 Variable life, universal life, variable universal
life
– Group life
– Industrial life
– Credit life
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Distribution of Premiums
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Other Life Insurer Activities
– Annuities
 Reverse of life insurance activities
 Topped $347.4 billion in 2008
 Ethics: Conseco, 2004
– Private pension funds
 Compete with other financial service cos.
 In 2009, managing over $2.2 trillion (43% of all
private pension plans)
– Accident and health insurance
 Morbidity insurance
 Over 167.1 billion in premiums in 2008
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Balance Sheet
– Long-term assets
 Need to generate competitive returns on
savings components of life insurance policies
 Bonds, equities, government securities
 Policy loans
– Long-term liabilities
 Net policy reserves to meet policyholders’
claims
 Separate account business 3 represented 0.1%
of total liabilities and capital in 2009
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Recent Trends
 Impact of financial crisis
– Drop in value of securities
 Capital losses from bonds and stocks
exceeded $35 billion
– Historically low short term interest rates
 Adverse impact on ability to lower rates on
new policies
 Incentive to surrender existing policies
– Dwindling reserves led to Treasury
Department extending bailout funds
– Late 2009 showed improvement
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Regulation of Life Insurance Companies
 McCarran-Ferguson Act of 1945
 Confirms primacy of state over federal regulation
 State insurance commissions
 Coordinated examination system developed by
the National Association of Insurance
Commissioners (NAIC)
 States promote life insurance guaranty
funds
 Not permanent funds (like FDIC)
 Required contributions from surviving within-state
firms
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Recent Regulatory Issues
 Fear of systemic risk posed by AIG
 2009: Proposals to create optional
federal charter
 Complaints of inconsistent regulation
and barriers to innovation
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Web Resources
 For more detailed information on
insurance regulation, visit:
NAIC www.naic.org
NY Insurance Dept. www.ins.state.ny.us
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Property and Casualty Insurance
 Size and Structure
– Currently about 2,000 companies
– Highly concentrated; Top 10 firms have
over 50% of market in terms of premiums
written
 Top 100 firms: over 95%
 M&A activity is increasing concentration
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P&C Products
Fire insurance and allied lines
Homeowners multiple peril insurance
Commercial multiple peril insurance
Automobile liability and physical
damage insurance
 Liability insurance (other than
automobile)
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Property & Casualty
 Changing composition of net
premiums written, 2008 versus 1960:
– Decline in fire insurance and allied lines:
2.4% in 2008 vs. 16.6% in 1960
– Homeowners MP: 13.3% vs. 5.2% in 1960
– Commercial MP: 7.1% vs. 0.4% in 1960
– Auto L&PD: 39.1% vs. 43% in 1960
– Other liability: 12.8% vs. 6.6% in 1960
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P&C Balance Sheet
 Similar to life insurance companies
(smaller asset base)
– Requirement for liquid assets
 Major liabilities
– Loss reserves
– Loss adjustment expense
– Unearned premiums
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Loss Risk
 Underwriting risk may result from:
– Unexpected increases in loss rates
– Unexpected increases in expenses
– Unexpected decreases in investment yields or
returns
 Property versus liability
– Losses from liability insurance less predictable
– Example: Claims due to asbestos damage to
workers’ health
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Loss Rates
 Severity versus frequency
– Loss rates more predictable on low-severity, highfrequency lines (such as fire, auto, homeowners
peril) than on high-severity, low-frequency lines
(such as earthquake, hurricane, financial
guaranty)
– Claims in high-severity, low-frequency lines may
not be independent
– Higher uncertainty forces PC firms to invest in
more short-term assets and hold larger capital
and reserves than life insurance firms
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Insurance Risks Post 9/11
 Crisis generated by terrorist attacks
forced creation of federal terrorism
insurance program in 2002
 Federal government provides
backstop coverage under Terrorism
Risk Insurance Act of 2002 (TRIA)
– Caps losses for insurance companies
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Long Tail Versus Short Tail
 Long-tail risk exposure
– Arises where peril occurs during coverage
period but claim is made many years later
– Examples: Asbestos cases and Dalkon
shield case
– Efforts to contain long-tail risks within
subsidiaries
 Example: Halliburton
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Insurance Costs: Social Inflation
 Product inflation versus social inflation
– Unexpected inflation may be systematic
or line-specific
– Social inflation: Unexpected changes in
awards by juries
 Reinsurance
– Approximately 75 percent of reinsurance
by US firms is written by non-US firms such
as Munich Re
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Underwriting Ratios
 Loss ratios have generally increased
 Expense ratios have generally decreased
 Trend toward selling directly through their
own brokers rather than independent
brokers
 Combined ratio:
− Includes both loss and expense experience
− If greater than 100, premiums are insufficient
to cover losses and expenses
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Investment Yield / Return Risk
 Operating ratio = combined ratio after
dividends minus investment yield
 Importance of investment income:
– Causes PC managers to place
importance on measuring and managing
credit risk and interest rate risk
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P&C: Recent Trends
 Several catastrophes over 1985 - 2009
– Hurricane Hugo 1989, San Francisco Earthquake 1991,
Oakland fires 1991, Hurricane Andrew 1991
– 2004, Hurricanes Charley, Frances, Ivan, Jeanne in
rapid succession generated claims comparable to
Andrew.
– Hurricane Katrina, 2005
 Trough of underwriting cycle
– September 11, 2001 terrorist attacks created an
insurance crisis (and heightened demand).
 Potential for crowding out market solutions via
government actions
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Regulation
 PC insurers chartered and regulated
by state commissions
 State guaranty funds
 National Association of Insurance
Commissioners (NAIC) provides various
services to state commissions
– Includes Insurance Regulatory Information
System (IRIS)
 Some lines face rate regulation
 Criticism over Katrina-related claims
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Global Issues
 Insurance industry increasingly global
 Worldwide, 2008 was a bad year
– 130 natural catastrophes, 174 manmade
– 2008 earthquake in China: Almost half of
worldwide insurance losses
– Global financial crisis
 Improvement in 2009 as financial
markets and economies recover
– Higher premiums and better investment
results
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Pertinent Websites
A.M. Best
Federal Reserve
Insurance Information
Institute
Insurance Services
Offices
National Association
of Insurance
Commissioners
State of NY Insurance
Guarantee Fund
www.ambest.com
www.federalreserve.gov
www.iii.org
www.iso.com
www.naic.org
www.ins.state.ny.us
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