Asset and Liability Management
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Insurance.pptxAsset and Liability Management
Fin6102
Ferriter – Spring 2018
Overview
This chapter discusses insurance companies
Two major groups:
Life
Property-casualty
Financial crisis and insurance companies
Size, structure, and composition
Balance sheets and recent trends
Regulation of insurance companies
Global competition and trends
Ch 6-2
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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 FIs that bought CDS from AIG used to justify the bailout
Increased risk exposure to banks, investment banks, and insurers
Ch 6-3
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Insurance Companies
Differences in services provided by:
Life insurance companies
Property and casualty insurance companies
Ch 6-4
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Size, Structure, and Composition
Size, structure, and composition of the insurance industry:
In 1988: 2,300 life insurance companies with aggregate assets of $1.1 trillion
In 2010s: 830 life insurance companies with aggregate assets of $6.5 trillion in 2015
Ch 6-5
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Size, Structure, and Composition Continued
4 largest life insurers wrote 33% of new business in 2014
Most policies sold through commercial banks
18% of all fixed annuities were sold by commercial banks in 2015
Ch 6-6
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Life Insurance Companies
Significant merger activity in life insurance industry
Not to same extent witnessed in banking
E.g., Anthem and Signa, MetLife and American Life Insurance, etc.
Competition from within industry and from other FIs
Increased conversion from mutual to stockholder controlled companies
Ch 6-7
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Mutual vs. Stock Insurance Companies
Ch 6-8
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Biggest Life Insurers
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Insurance Issues
Adverse selection
Insured have higher risk than general population
E.g., Matt has never had life insurance, but decides to buy some once he finds out he has a terminal illness
Alleviated by grouping of policyholders into similar risk pools
Problem for both life insurers and property-casualty insurers
Ch 6-10
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Types of Life Insurance
Life insurance products:
Ordinary life
Term life, whole life, endowment life
Variable life, universal life and variable universal life
Group life
Industrial life
Credit life
Ch 6-11
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Ch 6-12
Distribution of Premiums, 2015
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Other Life Insurer Activities
Annuities
Reverse of life insurance activities
Topped $325.2 billion in 2014
Private pension plans
Insurers compete with other financial service companies
In 2015, life insurers managed over $2.7 trillion (~40% of all private pension plans)
Accident and health insurance
Protects against morbidity (i.e., ill health) risk
Over 168.7 billion in premiums in 2014
Ch 6-13
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Balance Sheet
Assets
Need to generate competitive returns on savings components of life insurance policies
Focus investment on long-term assets
Bonds, equities, government securities
Policy loans
Liabilities
Policy reserves to meet policyholders’ claims
Separate account business represented 38.2% of total liabilities and capital in 2015
Ch 6-14
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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
Ch 6-15
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Regulation
McCarran-Ferguson Act of 1945
Confirms primacy of state over federal regulation
State insurance commissions
Coordinated examination system developed by NAIC
Federal Reserve
Supervises ~1/3 of U.S. insurance industry assets
States promote life insurance guarantee funds
Ch 6-16
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Recent Regulatory Issues
Fear of systemic risk posed by AIG
2009: Proposals to create optional federal life insurance charter
Proponents of federal charter argued inconsistent regulation and barriers to innovation inherent in current system
2010: Wall Street Reform and Consumer Protection Act established the Federal Insurance Office (FIO)
Ch 6-17
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Web Resources
For more detailed information on insurance regulation, visit:
NAIC www.naic.org
Ch 6-18
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Property-Casualty Insurance
Size and Structure
Currently about 2,640 companies sell property-casualty insurance
Highly concentrated
Top 10 firms have 50% of market in terms of premiums written
Top 200 firms write over 95% of total premiums
M&A activity is increasing concentration
Ch 6-19
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Types of P&C Products
Fire insurance
Homeowners multiple-peril insurance
Commercial multiple-peril insurance
Automobile liability and physical damage insurance
Liability insurance (other than automobile)
Ch 6-20
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Premium Allocation
Changing composition of net premiums written, 2014 versus 1960:
Fire: 2.3% vs. 16.6% in 1960
Homeowners MP: 15.2% vs. 5.2% in 1960
Commercial MP: 6.9% vs. 0.4% in 1960
Auto L&PD: 38.6% vs. 43% in 1960
Other liability: 12.7% vs. 6.6% in 1960
Ch 6-21
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P&C Balance Sheet
Similar to life insurance companies; long-term securities
Unlike life insurance companies; requirement for liquid assets
Major liabilities:
Loss reserves
Loss adjustment expenses
Unearned premiums
Ch 6-22
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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
Ch 6-23
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Loss Risk Continued
Severity versus frequency
Loss rates more predictable on low-severity, high-frequency lines (such as fire, auto, and homeowners) than on high-severity, low-frequency lines (such as earthquake, hurricane, and financial guaranty)
Higher uncertainty forces PC insurers to invest in more short-term assets and hold larger capital and reserves than life insurers
Ch 6-24
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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
Ch 6-25
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Long Tail Versus Short Tail
Long-tail risk exposure
Arises where loss occurs during coverage period but claim is not made until many years later
Examples: Asbestos cases and Dalkon shield case
Efforts to contain long-tail risks within subsidiaries
Example: Halliburton
Ch 6-26
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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
Ch 6-27
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Underwriting Profitability
Loss ratios have generally increased
Expense ratios have generally decreased
Attributed to change in distribution methods
Insurers have begun selling directly to consumers 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
Ch 6-28
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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 and interest rate risk
Ch 6-29
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P&C: Recent Trends
Several catastrophes over 1985 - 2015
Hurricane Hugo 1989, San Francisco Earthquake 1991, Oakland fires 1991, Hurricane Andrew 1991
2004 hurricanes (Charley, Frances, Ivan, Jeanne) occurred in rapid succession and generated claims comparable to Andrew
Hurricane Katrina, 2005
September 11, 2001 terrorist attacks created an insurance crisis (and heightened demand)
Hurricane Sandy, 2011
Potential for crowding out market solutions (catastrophe bonds) via government actions
Ch 6-30
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PC 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)
Many lines face rate regulation
Criticism over Katrina-related claims
Ch 6-31
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Global Issues
Insurance industry becoming increasingly global
Worldwide, 2011 was a bad year for both life and PC insurers
Japan’s earthquake and tsunami
Earthquakes in New Zealand
Floods in Thailand
Severe tornadoes in US
Ch 6-32
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Pertinent Websites
A.M. Best
Federal Reserve
Insurance Information Institute
Insurance Services Offices
National Association of Insurance Commissioners
Ch 6-33
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