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Insurance Insurance Companies Companies Chapter 3 © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. McGraw-Hill/Irwin
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Page 1: Insurance Companies Chapter 3 © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. McGraw-Hill/Irwin.

Insurance Insurance CompaniesCompanies

Chapter 3

© 2008 The McGraw-Hill Companies, Inc., All Rights Reserved.McGraw-Hill/Irwin

Page 2: Insurance Companies Chapter 3 © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. McGraw-Hill/Irwin.

3-2

Overview

In this segment ... Insurance Companies: Two major groups:

Life Property & Casualty

Size, structure and composition Balance sheets and recent trends Regulation of insurance companies Global competition and trends

Page 3: Insurance Companies Chapter 3 © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. McGraw-Hill/Irwin.

3-3

Insurance Companies

Differences in services provided by: Life Insurance Companies Property and Casualty Insurance

Page 4: Insurance Companies Chapter 3 © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. McGraw-Hill/Irwin.

3-4

Life Insurance Companies

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 20% of new premium business in 2005

Increasing involvement of commercial banks in insurance policy sales

2005: Nationwide sold $33.1 million via banks. 45% increase over 2004

Page 5: Insurance Companies Chapter 3 © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. McGraw-Hill/Irwin.

3-5

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

Page 6: Insurance Companies Chapter 3 © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. McGraw-Hill/Irwin.

3-6

Mutual versus Stock Insurance Companies

Page 7: Insurance Companies Chapter 3 © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. McGraw-Hill/Irwin.

3-7

Biggest Life Insurers

Insurance Company Ownership Form

Assets (billions)

1. Metropolitan Life Stock $407.8 2. American International Group Stock 341.1 3. Prudential of America Stock 331.1 4. Hartford Life Stock 204.5 5. Teachers Insurance & Annuity Stock 177.9 6. Aegon USA Inc. Mutual 172.5 7. ING Group Stock 169.9 8. New York Life Mutual 166.2 9. Axa Financial Group Stock 133.2 10. Northwestern Mutual Mutual 133.1

Page 8: Insurance Companies Chapter 3 © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. McGraw-Hill/Irwin.

3-8

Life Insurance: Issues

Demutualization Adverse selection

Insured have higher risk than general population

Alleviated by grouping of policyholders into risk pools

Page 9: Insurance Companies Chapter 3 © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. McGraw-Hill/Irwin.

3-9

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

Page 10: Insurance Companies Chapter 3 © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. McGraw-Hill/Irwin.

3-10

Distribution of Premiums

Group Life, 5.5

Accident & health, 22.2

Ordinary Life, 20.5

Other*, 0.3

Group Annuities, 20.8

Ordinary Annuities, 30.7

Page 11: Insurance Companies Chapter 3 © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. McGraw-Hill/Irwin.

3-11

Other Life Insurer Activities

Annuities Reverse of life insurance activities. Topped $272 billion in 2005 Ethics: Conseco, 2004

Private pension funds Compete with other financial service companies. Mid 2000s, managing $2.3 trillion (45% of all private

pension plans) Accident and health insurance

Morbidity insurance Effects of growth in HMO enrollment

Page 12: Insurance Companies Chapter 3 © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. McGraw-Hill/Irwin.

3-12

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 32.9% of total liabilities

and capital in 2006.

Page 13: Insurance Companies Chapter 3 © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. McGraw-Hill/Irwin.

3-13

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.

Financial Services Modernization Act, 1999

Page 14: Insurance Companies Chapter 3 © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. McGraw-Hill/Irwin.

3-14

Recent Regulatory Issues

2004: Proposals to create council of federal and state officials to oversee insurance

Complaints of costly and cumbersome state regulation

Possibility of a dual (State and Federal) system similar to bank regulatory system.

Resistance from states, consumer groups, Congress

Page 15: Insurance Companies Chapter 3 © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. McGraw-Hill/Irwin.

3-15

Web Resources

For more detailed information on insurance regulation, visit:

www.naic.org

www.ins.state.ny.us

Page 16: Insurance Companies Chapter 3 © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. McGraw-Hill/Irwin.

3-16

Property and Casualty Insurance

Size and Structure Currently about 2,700 companies. Highly concentrated. Top 10 firms have 48% of

market in terms of premiums written. Top 100 frims: over 87% M&A increasing concentration

Page 17: Insurance Companies Chapter 3 © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. McGraw-Hill/Irwin.

3-17

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)

Page 18: Insurance Companies Chapter 3 © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. McGraw-Hill/Irwin.

3-18

Property-Casualty

2005: Changing composition of net premiums written since 1960: decline in fire insurance and allied lines: 3.7%

in 2005 vs. 16.6% in 1960 Homeowners MP: 12.2% vs. 5.2% in 1960 Commercial MP: 6.8% vs. 0.4% in 1960 Auto L&PD: 42.8% vs. 43% in 1960 Other liability: 23.7% in 2005 vs. 6.6% in 1960

Page 19: Insurance Companies Chapter 3 © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. McGraw-Hill/Irwin.

3-19

P&C Balance Sheet

Similar to life insurance cos. (Smaller asset base) Requirement for liquid assets

Major liabilities: loss reserves, loss adjustment expense and unearned premiums.

Page 20: Insurance Companies Chapter 3 © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. McGraw-Hill/Irwin.

3-20

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.

Page 21: Insurance Companies Chapter 3 © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. McGraw-Hill/Irwin.

3-21

Loss Rates

Severity versus frequency: Loss rates more predictable on low-severity,

high-frequency 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.

Page 22: Insurance Companies Chapter 3 © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. McGraw-Hill/Irwin.

3-22

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 Key provisions extended in 2004

Page 23: Insurance Companies Chapter 3 © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. McGraw-Hill/Irwin.

3-23

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

Page 24: Insurance Companies Chapter 3 © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. McGraw-Hill/Irwin.

3-24

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.

Catastrophe bonds

Page 25: Insurance Companies Chapter 3 © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. McGraw-Hill/Irwin.

3-25

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 then premiums are

insufficient to cover losses and expenses.

Page 26: Insurance Companies Chapter 3 © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. McGraw-Hill/Irwin.

3-26

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.

Page 27: Insurance Companies Chapter 3 © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. McGraw-Hill/Irwin.

3-27

Recent Trends

PC industry was not very profitable during 1987 - 2006.

Succession of catastrophes 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. Trough of underwriting cycle.

September 11, 2001 terrorist attacks created an insurance crisis (and heightened demand).

Potential for crowding out via government actions

Page 28: Insurance Companies Chapter 3 © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. McGraw-Hill/Irwin.

3-28

Regulation

PC insurers chartered and regulated by state commissions.

State guaranty funds National Association of Insurance

Commissioners (NAIC) provides various services to state regulatory commissions. Includes Insurance Regulatory Information

System (IRIS). Some lines face rate regulation. Criticism regarding Katrina related claims

Page 29: Insurance Companies Chapter 3 © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. McGraw-Hill/Irwin.

3-29

Global Issues

Insurance industry becoming more global Regulatory and tax effects in Cayman

Islands and Bahamas Introduction and acceleration of insurance

market reforms cross-country mergers (insurance companies as

well as universal banks)

Page 30: Insurance Companies Chapter 3 © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. McGraw-Hill/Irwin.

3-30

World’s Largest Life Insurers

Revenues

($millions) Country

ING Group 138,235Netherlands

AXA Group 129,839 France

Assicurazioni Generali 101,404 Italy

Aviva 92,579 UK

Prudential 74,745 UK

Nippon Life 61,158 Japan

Page 31: Insurance Companies Chapter 3 © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. McGraw-Hill/Irwin.

3-31

World’s Largest P & C Insurers

Revenues

($millions) Country

Allianz 121,406 Germany

American Int’l Group 108,905 US

Berkshire Hathaway 81,663 US

Zurich Financial Svc. 67,186 Switzerland

Munich Re Group 60,256 Germany

State Farm Insurance 59,224 US

Page 32: Insurance Companies Chapter 3 © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. McGraw-Hill/Irwin.

3-32

Pertinent Websites

A.M. Best: www.ambest.comFederal Reserve: www.federalreserve.govInsurance Information Institute: www.iii.orgInsurance Services Offices: www.iso.comNational Association of Insurance

Commissioners: www.naic.orgState of NY Insurance Guarantee Fund:

www.ins.state.ny.us


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