Post on 06-May-2015
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AKM Elias Hussain ASB 1
Presentation on Life InsuranceFund & Solvency Management
AKM Elias HussainPresident,
Actuarial Society of Bangladesh
AKM Elias Hussain ASB 2
Insurance Companies
Provide contractual risk management for: Risks of insurable asset losses (auto insurance) Risks of liability claims (product liability) Risk of large medical costs (health insurance) Risk of disability (disability insurance) Risk of premature death (life insurance) Risk of longevity (annuities)
AKM Elias Hussain ASB 3
Insurance Companies, cont.
Major capital market intermediary Major investor in corporate (life) and state and
municipal bonds (property/casualty) Major long-term commercial mortgage lender
(life)
Mutual or stock form of ownershipPremium and investment revenueLosses and loss adjustment expenses
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Insurance Concepts
Pure vs. financial riskInsure fortuitous, independent risk
occurrencePremium covers losses, administrative
expenses and profitsInsured contracts for known loss
(premium) in return for protectionMoral hazard and adverse selection
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Background
Life insurance companies Provide risk management contracts for individuals and
businesses Risk areas include premature death, health maintenance costs,
and disability Life insurance provides cash benefits to the beneficiary of a
policy on the policyholder’s death Life insurance premiums reflect
Probability of making payment to the beneficiary Size and timing of the payment
Have portfolios of policies and use mortality figures and actuarial tables to forecast claims
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Cash Value Insurance
Group
Types of Life Insurance Policies
Whole Life
Variable Life
Universal Life
Term Insurance
Term
Group
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Types of Life Insurance Policies
Whole life insurance includes both a death benefit (term insurance) and a savings component that Builds a tax sheltered cash value amount for
the future for the owner of the policy Generates periodic cash flow payments over
the life of the policy for the insurance company to reinvest
Pays fixed death benefit at death
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Types of Life Insurance Policies
Term life insurance characteristics Temporary, providing death benefits only over a
specified term Premiums paid represent insurance only with
no saving component Considerably lower cost for the insured than
whole life—able to buy more insurance protection for any amount of premium
Term is for those who would rather invest their savings in other contracts or securities
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Types of Life Insurance PoliciesVariable life insurance
Whole life with variable cash value amounts Cash values invested in equities and will vary with the
investment performance Flexible premium option since 1984
Universal life insurance Combines the features of term and whole life Variable premiums over time—buys terms and invests
difference in a variety of investments Builds a varying cash value based on contributions and
investment performance
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Types of Life Insurance Policies
Group plans Employees of a corporation offered life
insurance or life insurance purchased on life of employee
Cash value or term insurance Low cost (term) because of its high volume Can cover group members and dependents
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Health Care Insurance
Health maintenance organizations or HMOs Intermediaries between purchasers and
providers of health care Annual fee or premium
Covers all medical expenses Medical staff is designated by the HMO
Losses in recent years for HMOs
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Sources of Life Insurance Company Funds Cash value reserves—accumulated cash values
owed insureds (liability) Pension reserves—accumulated “insured”
pension commitments (liability) Annuity reserves—accumulated annuity
commitments (liability) Unearned premium income—premiums
received; not yet earned (liability) Loss reserves--losses incurred, not yet paid Capital funds
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Uses of Life Insurance Company FundsMajor investor in corporate bondsGovernment securitiesCommon stockCommercial mortgageReal EstatePolicy loans to insured
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Uses of Funds—Policy Loans
Policy loans are loans to policyholders Whole life policies Borrow up to the cash value of the policy Guaranteed interest rate is stated in the policy Usually used by borrowers during periods of
rising rates to lock in the lower rate associated with their policy
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Insurance Company CapitalCapital
Build capital by issuing new stock (stock companies) or retaining earnings
Used to finance investments in fixed assets Cushion against operating losses Capital requirements vary depending on asset
risk Credibility with customers is also enhanced by
adequate capital Mutual companies owned by policyholders—
includes earnings retained over time
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Risks of Life Insurance Companies
Pure Risk of LifeInsurance Policies
PensionCommitments and
Annuities Contracts
Financial Riskincludes
Interest Rate RiskCredit RiskMarket Risk
Liquidity Risk
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Exposure to Financial RisksInterest rate risk
Fixed rate assets in company portfolios have market values sensitive to interest rate changes
Firm measures and manages risks
Credit risk Mortgages, corporate bonds and real estate
holdings can involve default Investment-grade securities Diversify portfolio among debt issuers
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Exposure to Financial Risks
Market risk Exists because events like significant market
value decreases reduce capital Economic downturn affects real estate
investments
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Exposure to Financial Risks Liquidity risk occurs because a high frequency of
claims may require the life company to liquidate assets
Life insurance companies have high cash flow from premiums to offset normal cash needs
In case of large disaster (9/11) may be forced to sell assets to generate cash even if market value is low
Companies try to balance the age distribution of their customer base
As interest rates rise, voluntary terminations of policies occur
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Threats to Solvency Poor mortality experience Poor expense experience Expense inflation Inadequate investment returns Poor lapse and surrender experience Asset default and depreciation Mismatched investments Guaranteed surrender values/investments returns Liquidity Options Change in business mix Inadequate reinsurance Operational risks
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How to handle threats to solvency
Management actions Role of the Appointed Actuary Regulations Timely intervention by regulator Conservative asset and liability valuations Risk based capital/solvency margin Holistic and integrated approach to risk
management Incentives to encourage prudent risk
management
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Assets Liability Management
It is a dynamic process of Planning, Organizing & Controlling of Assets & Liabilities- their volumes, mixes, maturities, yields and costs in order to maintain liquidity and NII.
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Asset Management
Performance is significantly affected by the performance of the assets Companies get premiums for several years
before paying out benefits Companies try to manage the risk of losses with
offsetting investment gains or diversity of assets they hold
Diversify into other businesses to offer a wide variety of financial products
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Property and Casualty Insurance
Property insurance (fire insurance)Casualty insurance (liability)Performance and financial bonding
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PC Versus Life Insurance CompaniesPC have shorter contractsPC have more varied risk areasLife companies larger due to long-term
savings and pension contractsPC has wider distribution of Occurrences
PC’s need liquid, marketable assets PC’s earnings more volatile
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Property Casualty Investment Needs
Tax sheltering--major municipal/state bond investor
Liquid, marketable assets Marketable corporate and government bonds Listed common stock
Inflation hedge--common stockReinsurance contracts--manage pure risks
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Components of a Balance sheet Contingent Liabilities
Liabilities1. Capital
2. Reserve & Surplus
3. Deposits
4. Borrowings
5. Other Liabilities
Assets1. Cash & Balances with
RBI
2. Bal. With Banks & Money at Call and Short Notices
3. Investments
4. Advances
5. Fixed Assets
6. Other Assets
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Components of Liabilities
CapitalReserves & SurplusDepositsBorrowingsOther Liabilities & Provisions
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Components of Assets
Cash & Bank Balances with RBI Balances with Banks & money at
Call & short notice
InvestmentsAdvances Fixed Asset & Other Assets
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Valuation of an Insurance Company
Value of an insurance company depends on its expected cash flows and required rate of return
V = f [E(CF), k]
V = Change in value of the insurance company
k = Change in required rate or return
Where:
E(CF) = Change in expected cash flows
+
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Valuation of an Insurance Company
Factors that affect cash flows
E(CF) = Expected cash flow
Rf = Risk free interest rate
INDUS = Prevailing industry conditions for the company
Where:
E(CF)= f (ECON, Rf , INDUS, MANAB)
ECON = Economic growth
MANAB = Management ability of company
+ +?
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Valuation of an Insurance Company
Investors required rate of return
k = f(Rf , RP)++
Rf = Risk free interest rate
Where:
RP = Risk premium
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Performance Evaluation
Common indicators of company performance are available Statistical analysis of performance Ratio analysis
Trends over time Compare to industry average
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Performance Evaluation
The higher the liquidity ratio, the more liquid the company
Liquidity
Ratio
=Invested Assets
Loss Reserves and
Unearned Premium Reserves
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Performance Evaluation
Return on net worth or policyholders’ surplus is a profitability measure
Return on Equity =Net Profits
Policyholders’ Surplus
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Performance Evaluation
Underwriting gains and losses or underwriting profitability measured by the net underwriting margin Profits include investment income, underwriting profits and realized capital gains Ratios can be calculated to focus on various sources of profits
Net Underwriting=
Premium Income - Policy Expenses
Total AssetsMargin
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Other Issues
Insurance companies interact in a variety of ways with other financial institutions
Insurance companies participate in a full range of financial markets
Multinational insurance companies Insurance companies operate in many countries Some countries lack developed markets for insurance
Multinational investments
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Thank you very much
ASB