Insurance Insurance CompaniesCompanies

Chapter 3

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K. R. Stanton

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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

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Insurance Companies

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

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Life Insurance Companies

Size, Structure and Composition of the Industry: In 1988: 2,300 life insurance companies with

aggregate assets of $1.12 trillion In early 2000s: 1,500 companies / $3.4 trillion

4 largest wrote 19% of new premium business Increasing involvement of commercial banks in

insurance policy sales Large scale mergers

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Biggest Life Insurers

Insurance Company Ownership Form

Assets (billions)

1. Metropolitan Life Stock $245.0 2. American International Group Stock 233.7 3. Prudential of America Stock 205.7 4. Aegon USA Inc. Mutual 144.5 5. Teachers Insurance & Annuity Stock 144.5 6. Hartford Life Stock 136.8 7. ING Group Stock 125.8 8. New York Life Mutual 121.9 9. Northwestern Mutual Mutual 102.9 10. Nationwide Stock 87.4

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Life Insurance: Issues

Demutualization Adverse selection

Insured have higher risk than general population

Alleviated by grouping of policyholders into risk pools

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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

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Distribution of Premiums

Accident & health33%

Other3%

Group life22%

Ordinary life37%

Fixed annuities

2%

Variable annuities

3%

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Other Life Insurer Activities

Annuities Reverse of life insurance activities.

Private pension funds Compete with other financial service companies.

Accident and health insurance Morbidity insurance Effects of growth in HMO enrollment

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Balance Sheet

Long-term liabilities Net policy reserves to meet policyholders’ claims

Long-term assets Need to generate competitive returns on savings

components of life insurance policies Bonds, equities, government securities Policy loans

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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

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Current Regulatory Proposals

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.

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Blending of Insurance and Banking

Major insurers applying for savings bank charters

Examples: State Farm Mutual Auto Insurance / State

Farm Bank FSB TIAA / TIAA-CREF Trust Co. Allstate Insurance Co. / Allstate FSB Metropolitan Life Insurance Co. / Metlife Bank

& Trust Co. FSB

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Web Resources

For more detailed information on insurance regulation, visit:

www.naic.org

www.ins.state.ny.us

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Property and Casualty Insurance

Size and Structure Currently about 3,200 companies. Highly concentrated. Top 10 firms have 45% of market in

terms of premiums written. Top 200: over 95%

Balance sheet Similar to life insurance cos. (Smaller asset base) Major liabilities: loss reserves, loss adjustment expense

and unearned premiums.

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Property-Casualty

Changing composition of net premiums written (2002 versus 1960): decline in fire insurance and allied lines since

1960: 3.5% in 2002 vs. 16.6% in 1960 Homeowners MP: 10.5% vs. 5.2% in 1960 Commercial MP: 7.2% vs. 0.4% in 1960 Auto L&PD: 42.0% vs. 43% in 1960 Other liability: 22.7% in 2002 vs. 6.6% in 1960

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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.

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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.

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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 Key provisions extended in 2004

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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.

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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.

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Trends

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.

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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 risk and interest rate risk.

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Recent Trends

PC industry was not very profitable during 1987 - 2003.

Succession of catastrophes Hurricane Hugo 1989, San Francisco Earthquake

1991, Oakland fires 1991, Hurricane Andrew 1991 Hurricanes Charley, Frances, Ivan, Jeanne in rapid

succession generated claims comparable to Andrew. Effect on Florida PC companies yet to be discerned

Trough of underwriting cycle. More recently, September 11, 2001 terrorist attacks

created an insurance crisis (and heightened demand).

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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.

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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)

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World’s Largest Life Insurers

Revenues

($millions) Country

ING Group 88,102Netherlands

AXA Group 62,051 France

Nippon Life Insurance 61,175 Japan

Assicurazioni Generali 55,105 Italy

Aviva 53,723 UK

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World’s Largest P & C Insurers

Revenues

($millions) Country

Allianz 74,178 Germany

American Int’l Group 44,637 US

Munich Re Group 41,974Germany

State Farm Insurance 40,656 US

Berkshire Hathaway 39,962 US

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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