CATEGORIES OF INSURANCE COMPANY #
Insurance company protects policy holders from specific loss events in exchange for the payments of periodic premiums.
Categories of insurance companies:
- Life insurance: Provides long term coverage & make specified payment to the policy holder’s beneficiary upon the death of the policy holder during the policy term.
(A) Term Life Insurance: Covers property losses.
(B) Whole Life insurance: Coverage for the life of the policy holders.
- Prop and Casualty: Covers property losses. Third party liability for injuries while on a policy holder’s premises or caused by the use of their vehicle.
- Medical: Third party liability for injuries while on a policy holder’s premises or caused by the use of their vehicle.
RISKS FACING INSURANCE COMPANIES #
- Insufficient funds to satisfy policyholders claims.
- Poor return on investment.
- Liquidity risk of investment.
- Credit risk
- Operational risk.
MORTALITY TABLES #
Mortality tables can be used to compute life insurance premiums. Mortality tables include information related to the probability of an individual dying within next year, the probability of an individual surviving to a specific age, and the remaining life expectancy of an individual of a specific age.
MORTALITY RISK VS. LONGEVITY RISK #
MORTALITY RISK: Risk of policyholders lying earlier than expected due to illness or disease. (earlier than expected life insurance pay out)
LONGEVITY RISK: risk of policyholders living longer than expected.( longer than expected annuity pay out period)
HEDGING MORTALITY & LONGETIVITY RISK:
- Natural hedge (or offset) that deal with both life insurance products & annuity
- Reinsurance contracts
- Longevity derivatives.
PROPERTY & CASUALTY INSURANCE RATIOS #
- Loss ratio = Payouts / premium generated.
Usually between 60%-80% & increase over time.
- Expense ratio = Expense/ premium generated
Usually between 25%-30% & decrease over time.
- Combined ratio= Loss ratio + expense ratio
- Combined ratio after dividend = combined ratio + dividend to policy holders
- Operating Ratio = Combined ratio – investment income.
MORAL HAZARD & ADVERSE SELECTION #
Moral hazard is the risk to the insurance company that having insurance will lead the policyholder to act more recklessly than if the policyholder did not have insurance.
Methods to mitigate: deductibles, coinsurance & policy limits.
Adverse selection is a situation where an insurer is unable to differentiate between a good risk & a bad risk & charges the same premium to all policy holders.
Methods to mitigate: Initial due diligence & on going due diligence.
CAPITAL REQUIREMENT FOR INSURANCE CO. #
No global requirements exist for insurance companies, however Solvency II is a set of regulations that is applicable in the European Union. Under Solvency II, there is a minimum capital requirements (MCR) and solvency capital requirements (SCR).
- If capital < SCR, capital must increase above the SCR
- If capital < MCR, business operations may become significantly restricted
- MCR is usually 25% to 45% of SCR
GUARANTY SYSTEM FOR INSURANCE COMPANY #
Insurance companies are regulated at the state level in US. Every insurer must be a member of the guaranty associates in the state(s) in which it operates. If an insurance co. becomes insolvent in a state, then each of the other insurance co. must contribute an amount to the state guaranty fund based on the amount of premium income it earns in that state.
PENSION FUNDS #
Contribution in the fund is made by both employer & employee. Upon retirement the employee will receive periodic pension payments for the remaining life.
- Defined Benefit Plan:Explicitly state the amount of the pension that the employee will receive upon retirement.
- Defined Contribution Plan:
Involve both employer & employee contribution being invested in one or more investment options selected by the employee.