insurance and pension ch 21
Fundamentals of Insurance
Although there are many types of insurance and insurance companies, there are seven basic principles all insurance companies are subject to: There must be a relationship between the insured and the beneficiary. Further, the beneficiary must be someone who would suffer if it weren't for the insurance. The insured must provide full and accurate information to the insurance company. The insured is not to profit as a result of insurance coverage.
Selling Insurance
Another problem is that most people don't purchase enough insurance. Insurance companies use a strong sales force to combat this. Independent agents may sell the insurance products of a number of different insurance companies. Exclusive agents only sell the products of one company. An underwriter reviews each policy prior to its acceptance to determine if the risk is acceptable.
Adverse Selection and Moral Hazard in Insurance
Asymmetric information plays a large role in the design of insurance products. The presence of adverse selection and moral hazard impacts the industry, but is fairly well understood by the insurance companies
Types of Pension Plans
Defined-Benefit Pension Plans: a plan where the sponsor promises the employee a specific benefit when they retire. For example, Annual Retirement Payment = 2% average of final 3 years' income years of service Defined-Contribution Pension Plan: a plan where a set amount is invested for retirement, but the benefit payout is uncertain.
Pensions
Definition: A pension plan is an asset pool that accumulates over an individual's working years and is paid out during the nonworking years. Developed as Americans began relying less on children for care during their later years. Also became popular as life expectancy increased.
Regulation of Pension Plans
Employee Retirement Income Security Act of 1974 Established guidelines for funding Allowed plan credit to transfer with employees Established vesting requirements to gain plan benefits Increased disclosure requirements Assigned regulatory oversight to the Department of Labor ERISA also established the Pension Benefit Guarantee Corporation to insure pension benefits if an underfunded pension plan is unable to meet its obligations. Accounting makes it difficult to assess funding status of a plan May be in trouble as plans appear underfunded
Health Insurance
Health insurance policies are vulnerable to the adverse selection problem - those with health problems are more likely to seek coverage. Individual policies must be priced assuming adverse selection. Most health insurance is offered through group policies.
Fundamentals of Insurance 1
If a third party compensates the insured for the loss, the insurance company's obligation is reduced by the amount of the compensation. The insurance company must have a large number of insured so that the risk can be spread out among many different policies. The loss must be quantifiable. For example, an oil company could not buy a policy on an unexplored oil field. The insurance company must be able to compute the probability of the loss's occurring.
Insurance Companies
Insurance companies assume the risk of their clients in return for a fee, called the premium. Most people purchase insurance because they are risk-averse - they would rather pay a certainty equivalent (the premium) than accept a gamble.
Growth and Organization of Insurance Companies
Insurance companies may be organized in two difference ways: A stock company is owned by shareholders and has a profit motive A mutual insurance company is owned by the policyholders and attempts to provide the lowest cost insurance At the end of 2011, only 122 of 804 insurance companies were mutual insurance companies.
Types of Insurance
Insurance is classified by which type of undesirable event is covered: Life Insurance Health Insurance Property and Casualty Insurance
Life Insurance: Company Assets and Liabilities
Life insurance companies derive funds from two sources: They receive premiums that must be used to payout future claims when the insured dies They receive premiums paid into pension funds managed by the life insurance company The next figures shows the distribution of the typical life insurance company's assets, as well as assets invested in mortgages.
Life Insurance: Company Assets and Liabilities 1
Life insurance companies have two primary liabilities: Life insurance payouts Pension fund payouts
Life Insurance
Life insurance policies come in many forms. Some of the typical policies include: Term Life: the insured is covered while the policy is in effect, usually 10 - 20 years. Whole Life: similar to term life, but allows the policyholder to borrow against the policy's cash value. When the term of the policy expires, the insured can get the cash value of the policy.
Moral Hazard in Insurance
Moral hazard occurs in the insurance industry when the insured fails to take proper precautions (or takes on more risk) to avoid losses because losses are covered by the insurance policy. Insurance companies use deductibles to help control this problem.
Social Security
Pay as you go system, where current funding is used (partially) to pay current benefits. Projected number of workers is falling while projected number of retirees is increasing, which will cause problems in years to come if not corrected. It's difficult to measure the health of the social security system. Many factors are hard to predict, such as birth rates and the rate of immigration. Although it may not fail, it would be wise for you to plan other sources for your retirement cash flows. Possible plan changes: Raise retirement age Raise amount of salary that is taxed (currently $127,200) Limit payout to wealthy - don't pay those who do not need it. Privatization
Regulation of Pension Plans 1
Pension Reform Act of 1978 authorized individual retirement accounts. Enjoy a preferential tax treatment Keogh plans are similar plans for self-employed individuals SIMPLE IRAs are simplified retirement plans for small businesses.
Types of Pensions
Private Pension Plans: any pension plan set up by employers, groups, or individuals. Public Pension Plan: any pension plan set up by a government body for the general public (e.g., Social Security).
Property and Casualty Insurance
Property Insurance: protects businesses and owners from the risk associated with ownership. Named-peril policies: insures against any losses only from perils specifically named in the policy Open-peril policies: insures against any losses except from perils specifically named in the policy Casualty Insurance - also known as liability insurance, it protects against financial losses because of a claim of negligence. Reinsurance - allocates a portion of the risk to another company in exchange for a portion of the premium
The Practicing Manager: Insurance Management
Screening Risk-Based Premium Restrictive Provisions Prevention of Fraud Cancellations of Insurance Deductibles Coinsurance Limits on the Amount of Insurance
Patient Protection and Affordable Care Act (Obamacare)
Signed into law on March 23, 2010 Access: Subsidies Limits on coverage denial Children stay on their parents' plans until age 26 Rules: Option to purchase through state-based exchanges Fines for not having insurance started in 2014
Insurance Regulation
The McCarran-Ferguson Act of 1945 explicitly exempts insurance companies from any type of federal regulation. Most insurance regulations is at the state level. Regulation is typically designed to protect policyholders from losses, or expand insurance coverage in the state.
Adverse Selection in Insurance
The adverse selection problem raises the issue of which policies an insurance company should accept: Those most likely to suffer loss are most likely to apply for insurance. In the extreme, insurance companies should turn away anyone who applies for an insurance policy.
The Future of Pension Funds
We can expect their growth and popularity as the average population continues to grow. Variety of pension fund offerings may increase as well. Pension funds may gain significant control of corporations as their stock holdings increase.