Chapter 3
Insurance
Companies
McGraw-Hill/Irwin
© 2008 The McGraw-Hill Companies, Inc., All Rights Reserved.
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
3-2
Insurance Companies
Differences in services provided by:
Life Insurance Companies
Property and Casualty Insurance
3-3
Life Insurance Companies
3-4
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
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
3-5
Mutual versus Stock Insurance
Companies
3-6
3-7
Biggest Life Insurers
Insurance Company
1. Metropolitan Life
2. American International Group
3. Prudential of America
4. Hartford Life
5. Teachers Insurance & Annuity
6. Aegon USA Inc.
7. ING Group
8. New York Life
9. Axa Financial Group
10. Northwestern Mutual
Ownership
Form
Assets
(billions)
Stock
Stock
Stock
Stock
Stock
Mutual
Stock
Mutual
Stock
Mutual
$407.8
341.1
331.1
204.5
177.9
172.5
169.9
166.2
133.2
133.1
Life Insurance: Issues
3-8
Demutualization
Adverse selection
Insured have higher risk than general
population
Alleviated by grouping of policyholders into risk
pools
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
3-9
Distribution of Premiums
Group Life, 5.5
Ordinary Annuities, 30.7
Accident & health, 22.2
Ordinary Life, 20.5
Group Annuities, 20.8
Other*, 0.3
3-10
Other Life Insurer Activities
Annuities
Reverse of life insurance activities.
Topped $272 billion in 2005
Ethics: Conseco, 2004
Private pension funds
3-11
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
Balance Sheet
Long-term assets
3-12
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.
3-13
3-14
Regulation of Life Insurance Companies
McCarran-Ferguson Act of 1945
Coordinated examination system developed by the
National Association of Insurance Commissioners
(NAIC).
States promote life insurance guaranty funds
Confirms primacy of state over federal regulation.
State insurance commissions
3-15
Not permanent funds (like FDIC)
Required contributions from surviving within-state
firms.
Financial Services Modernization Act, 1999
Recent Regulatory Issues
3-16
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
Web Resources
3-17
For more detailed information on insurance
regulation, visit:
www.naic.org
www.ins.state.ny.us
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
$1.4B assets versus $4.5B life insurance
Life cycle of products
3-18
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)
3-19
Property-Casualty
3-20
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
P&C Balance Sheet
Similar to life insurance cos. (Smaller asset
base)
3-21
Requirement for liquid assets
Major liabilities: loss reserves, loss
adjustment expense and unearned
premiums.
Loss Risk
Underwriting risk may result from
3-22
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.
Loss Rates
3-23
Severity versus frequency:
Loss rates more predictable on low-severity,
high-frequency lines (such as fire, auto,
homeowners peril) than on high-severity, lowfrequency 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.
Insurance Risks Post 9/11
3-24
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
Reinsurance
3-25
Reinsurance
Approximately 75 percent of reinsurance by US
firms is written by non-US firms such as Munich
Re.
Catastrophe bonds
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:
3-26
Includes both loss and expense experience.
If greater than 100 then premiums are
insufficient to cover losses and expenses.
Investment Yield / Return Risk
3-27
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.
3-28
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.
3-29
September 11, 2001 terrorist attacks created an
insurance crisis (and heightened demand).
Potential for crowding out via government actions
3-30
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
3-31
Global Issues
3-32
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)
World’s Largest Life Insurers
3-33
Revenues
($millions)
ING Group
138,235
AXA Group
129,839
Assicurazioni Generali 101,404
Aviva
92,579
Prudential
74,745
Nippon Life
61,158
Country
Netherlands
France
Italy
UK
US
Japan
World’s Largest P & C Insurers
Revenues
($millions)
3-34
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
Pertinent Websites
A.M. Best: www.ambest.com
Federal Reserve: www.federalreserve.gov
Insurance Information Institute: www.iii.org
Insurance Services Offices: www.iso.com
National Association of Insurance
Commissioners: www.naic.org
State of NY Insurance Guarantee Fund:
www.ins.state.ny.us
3-35
