Notesale: Turn your study into money

Document Preview

Extracts from the notes are below, to see the PDF you'll receive please use the links above

---

Insurance companies, pensions …
Monday, 7 November 2016

2:03 pm

Objectives:
- Understand the role and importance of insurance and pensions in the
financial system
- Understand he effect of their investment decision on the market
- Distinguish between the group of organisations that allocate funds to
purchase securities
Insurance and pensions:
- They play an important role in the financial system through:
○ Reducing and transferring risk
○ Hold financial securities and control enormous funds
○ Their investment decisions have effects on the market - due to the
large size of fund
Another group of organisations:
- Group that allocates funds to the purchase of securities are:
○ Mutual funds
○ Unit trusts
○ Investment trusts
○ Sovereign wealth funds
- Helps investors spread their savings across securities
Life insurance covers risk of loss of life:
- Term life - pays out on death within a set time
- Whole life - pays out when the insured dies
- Annuities - provides regular income until the death of insured
- Endowment life - pays out at a set future date on earlier death of the insured;
when the insured dies, the payment goes out after a while

Investment of surplus:
- Some contracts allow the policy holder to determine how the surplus is
invested
- There are tax deferral advantages compared to a normal investment as there
is no tax paid until the payout policy
Annuity contracts:
- Usually a lump sum is used to buy a lifetime annuity
- It can be fixed or variable
- Can start immediately or be deferred
- Accumulated value can depend in a complicated way on the value of stock
indices
- There may be penalty free withdrawals
Property-casualty insurance
- Conerned with the loss or damage to property (fire, theft accident etc)
- Concerned with legal liability exposures
- Risk of fraud etc
When do premiums change:
- For life insurance, premiums usually stay the same throughout the life of the
contract
- For property-casualty insurance, the premiums change from year to year as
risks are reassessed
- For health insurance, premiums can rise because of overall rise in cost of
healthcare but not because the health risks of policy holder increases - that
risk assessment is done when the contract is signed
Moral hazard and adverse selection:
- Moral hazard - risk that the existence of the insurance policy causes the
policy holder to take more risks
- Adverse selection - tendency for insurance company to attract bad risks
because they cannot distinguish between good and bad risks
Typical balance sheet of:
- life insurance

policy holder to take more risks
- Adverse selection - tendency for insurance company to attract bad risks
because they cannot distinguish between good and bad risks
Typical balance sheet of:
- life insurance

Note that investments are mostly long term corporate bonds
- Property casualty insurance

Investments are usually liquid shorter maturity bonds
Insurance companies and financial crisis:
- The near collapse of insurance giant AIG (American international group) was a
major moment in the financial crisis
- AIG, with 1tril assets prior to the crisis, lost 99
...
The federal
reserves stepped in with a 85bil loan to keep the company from going under
- What exactly happened is still a mystery as there were multiple moving parts
- The company's credit deault swaps played the major role in the collapse,
losing AIG 30mil
○ By selling CDS, assets that act like insurance contracts on bonds
...
5mil in 1940 to 12tril in 2011
- Open ended funds are the most common
- This means that the number of shares in the fund increases as investors buy
m

---