Management of Financial Institutions

Role of Insurance Companies:Life insurance and saving

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Management of Financial Institutions - MGT 604
Lecture # 36
Role of Insurance Companies
Types of insurance
Any risk that can be quantified can potentially be insured. Specific kinds of risk that may
give rise to claims are known as "perils". An insurance policy will set out in detail which
perils are covered by the policy and which is not.
Below is a (non-exhaustive) list of the many different types of insurance that exist. A single
policy may cover risks in one or more of the categories set forth below. For example, auto
insurance would typically cover both property risk (covering the risk of theft or damage to
the car) and liability risk (covering legal claims from causing an accident). A homeowner's
insurance policy in the U.S. typically includes property insurance covering damage to the
home and the owner's belongings, liability insurance covering certain legal claims against
the owner, and even a small amount of health insurance for medical expenses of guests who
are injured on the owner's property.
Automobile insurance, known in the UK as motor insurance, is probably the most
common form of insurance and may cover both legal liability claims against the
driver and loss of or damage to the insured's vehicle itself. Throughout most of the
United States an auto insurance policy is required to legally operate a motor vehicle
on public roads. In some jurisdictions, bodily injury compensation for automobile
accident victims has been changed to a no-fault system, which reduces or eliminates
the ability to sue for compensation but provides automatic eligibility for benefits.
Credit card companies insure against damage on rented cars.
Aviation insurance insures against hull, spares, deductible, hull war and liability
Boiler insurance (also known as boiler and machinery insurance or equipment
breakdown insurance) insures against accidental physical damage to equipment or
Builder's risk insurance insures against the risk of physical loss or damage to
property during construction. Builder's risk insurance is typically written on an "all
risk" basis covering damage due to any cause (including the negligence of the
insured) not otherwise expressly excluded.
Business insurance can be any kind of insurance that protects businesses against
risks. Some principal subtypes of business insurance are (a) the various kinds of
professional liability insurance, also called professional indemnity insurance, which
are discussed below under that name; and (b) the business owners policy (BOP),
which bundles into one policy many of the kinds of coverage that a business owner
needs, in a way analogous to how homeowners insurance bundles the coverages that
a homeowner needs.[7]
Casualty insurance insures against accidents, not necessarily tied to any specific
Credit insurance repays some or all of a loan back when certain things happen to the
borrower such as unemployment, disability, or death. Mortgage insurance (which
see below) is a form of credit insurance, although the name credit insurance more
often is used to refer to policies that cover other kinds of debt.
Crime insurance insures the policyholder against losses arising from the criminal
acts of third parties. For example, a company can obtain crime insurance to cover
losses arising from theft or embezzlement.
Management of Financial Institutions - MGT 604
Crop insurance "Farmers use crop insurance to reduce or manage various risks
associated with growing crops. Such risks include crop loss or damage caused by
weather, hail, drought, frost damage, insects, or disease, for instance."[8]
Defense Base Act Workers' compensation or DBA Insurance insurance provides
coverage for civilian workers hired by the government to perform contracts outside
the US and Canada. DBA is required for all US citizens, US residents, US Green
Card holders, and all employees or subcontractors hired on overseas government
contracts. Depending on the country, Foreign Nationals must also be covered under
DBA. This coverage typically includes expenses related to medical treatment and
loss of wages, as well as disability and death benefits.
Directors and officers liability insurance protects an organization (usually a
corporation) from costs associated with litigation resulting from mistakes incurred
by directors and officers for which they are liable. In the industry, it is usually called
"D&O" for short.
Disability insurance policies provide financial support in the event the policyholder
is unable to work because of disabling illness or injury. It provides monthly support
to help pay such obligations as mortgages and credit cards.
o  Total permanent disability insurance insurance provides benefits when a
person is permanently disabled and can no longer work in their profession,
often taken as an adjunct to life insurance.
Errors and omissions insurance: See "Professional liability insurance" under
"Liability insurance".
Expatriate insurance provides individuals and organizations operating outside of
their home country with protection for automobiles, property, health, liability and
business pursuits.
Financial loss insurance protects individuals and companies against various financial
risks. For example, a business might purchase cover to protect it from loss of sales if
a fire in a factory prevented it from carrying out its business for a time. Insurance
might also cover the failure of a creditor to pay money it owes to the insured. This
type of insurance is frequently referred to as "business interruption insurance."
Fidelity bonds and surety bonds are included in this category, although these
products provide a benefit to a third party (the "obligee") in the event the insured
party (usually referred to as the "obligor") fails to perform its obligations under a
contract with the obligee.
Health insurance policies will often cover the cost of private medical treatments if
the National Health Service in the UK (NHS) or other publicly-funded health
programs do not pay for them. It will often result in quicker health care where better
facilities are available.
Kidnap and ransom insurance
Home insurance or homeowners insurance:
Liability insurance is a very broad superset that covers legal claims against the
insured. Many types of insurance include an aspect of liability coverage. For
example, a homeowner's insurance policy will normally include liability coverage
which protects the insured in the event of a claim brought by someone who slips and
falls on the property; automobile insurance also includes an aspect of liability
insurance that indemnifies against the harm that a crashing car can cause to others'
lives, health, or property. The protection offered by a liability insurance policy is
twofold: a legal defense in the event of a lawsuit commenced against the
policyholder and indemnification (payment on behalf of the insured) with respect to
a settlement or court verdict. Liability policies typically cover only the negligence of
the insured, and will not apply to results of willful or intentional acts by the insured.
Management of Financial Institutions - MGT 604
Environmental liability insurance protects the insured from bodily injury,
property damage and cleanup costs as a result of the dispersal, release or
escape of pollutants.
o  Professional liability insurance, also called professional indemnity insurance,
protects professional practitioners such as architects, lawyers, doctors, and
accountants  against  potential  negligence  claims  made  by  their
patients/clients. Professional liability insurance may take on different names
depending on the profession. For example, professional liability insurance in
reference to the medical profession may be called malpractice insurance.
Notaries public may take out errors and omissions insurance (E&O). Other
potential E&O policyholders include, for example, real estate brokers, home
inspectors, appraisers, and website developers.
Life insurance provides a monetary benefit to a decedent's family or other
designated beneficiary, and may specifically provide for income to an insured
person's family, burial, funeral and other final expenses. Life insurance policies
often allow the option of having the proceeds paid to the beneficiary either in a lump
sum cash payment or an annuity.
o  Annuities provide a stream of payments and are generally classified as
insurance because they are issued by insurance companies and regulated as
insurance and require the same kinds of actuarial and investment
management expertise that life insurance requires. Annuities and pensions
that pay a benefit for life are sometimes regarded as insurance against the
possibility that a retiree will outlive his or her financial resources. In that
sense, they are the complement of life insurance and, from an underwriting
perspective, are the mirror image of life insurance.
Locked funds insurance is a little-known hybrid insurance policy jointly issued by
governments and banks. It is used to protect public funds from tamper by
unauthorized parties. In special cases, a government may authorize its use in
protecting semi-private funds which are liable to tamper. The terms of this type of
insurance are usually very strict. Therefore it is used only in extreme cases where
maximum security of funds is required.
Marine insurance and marine cargo insurance cover the loss or damage of ships at
sea or on inland waterways, and of the cargo that may be on them. When the owner
of the cargo and the carrier are separate corporations, marine cargo insurance
typically compensates the owner of cargo for losses sustained from fire, shipwreck,
etc., but excludes losses that can be recovered from the carrier or the carrier's
insurance. Many marine insurance underwriters will include "time element"
coverage in such policies, which extends the indemnity to cover loss of profit and
other business expenses attributable to the delay caused by a covered loss.
Mortgage insurance insures the lender against default by the borrower.
National Insurance is the UK's version of social insurance (which see below).
No-fault insurance is a type of insurance policy (typically automobile insurance)
where insureds are indemnified by their own insurer regardless of fault in the
Nuclear incident insurance covers damages resulting from an incident involving
radioactive materials and is generally arranged at the national level. (For the United
States, see the Price-Anderson Nuclear Industries Indemnity Act.)
Pet insurance insures pets against accidents and illnesses - some companies cover
routine/wellness care and burial, as well.
Political risk insurance can be taken out by businesses with operations in countries
in which there is a risk that revolution or other political conditions will result in a
Management of Financial Institutions - MGT 604
Pollution Insurance. A first-party coverage for contamination of insured property
either by external or on-site sources. Coverage for liability to third parties arising
from contamination of air, water, or land due to the sudden and accidental release of
hazardous materials from the insured site. The policy usually covers the costs of
cleanup and may include coverage for releases from underground storage tanks.
Intentional acts are specifically excluded
Property insurance provides protection against risks to property, such as fire, theft or
weather damage. This includes specialized forms of insurance such as fire insurance,
flood insurance, earthquake insurance, home insurance, inland marine insurance or
boiler insurance.
Protected Self-Insurance is an alternative risk financing mechanism in which an
organisation retains the mathematically calculated cost of risk within the
organisation and transfers the catastrophic risk with specific and aggregate limits to
an Insurer so the maximum total cost of the program is known. A properly designed
and underwritten Protected Self-Insurance Program reduces and stabilizes the cost of
insurance and provides valuable risk management information.
Purchase insurance is aimed at providing protection on the products people
purchase. Purchase insurance can cover individual purchase protection, warranties,
guarantees, care plans and even mobile phone insurance. Such insurance is normally
very limited in the scope of problems that are covered by the policy.
Retrospectively Rated Insurance is a method of establishing a premium on large
commercial accounts. The final premium is based on the insured's actual loss
experience during the policy term, sometimes subject to a minimum and maximum
premium, with the final premium determined by a formula. Under this plan, the
current year's premium is based partially (or wholly) on the current year's losses,
although the premium adjustments may take months or years beyond the current
year's expiration date. The rating formula is guaranteed in the insurance contract.
Formula: retrospective premium = converted loss + basic premium × tax multiplier.
Numerous variations of this formula have been developed and are in use.
Self Insurance is protection against loss by setting aside one's own money. This can
be done on a mathematical basis by establishing a separate fund into which funds are
deposited on a periodic basis. Through self insurance it is possible to protect against
high-frequency low-severity losses. To do this through an insurance company would
mean having to pay a premium that includes loadings for the company's general
expenses, cost of putting the policy on the books, acquisition expenses, premium
taxes, and contingencies.
Social insurance can be many things to many people in many countries. But a
summary of its essence is that it is a collection of insurance coverages (including
components of life insurance, disability income insurance, unemployment insurance,
health insurance, and others), plus retirement savings, that mandates participation by
all citizens. By forcing everyone in society to be a policyholder and pay premiums,
it ensures that everyone can become a claimant when or if he/she needs to. Along
the way this inevitably becomes related to other concepts such as the justice system
and the welfare state. This is a large, complicated topic that engenders tremendous
debate, which can be further studied in the following articles (and others):
o  Social welfare provision
o  Social security
o  Social safety net
o  National Insurance
o  Social Security (United States)
o  Social Security debate (United States)
Stop-loss insurance provides protection against catastrophic or unpredictable losses.
It is purchased by organisations who do not want to assume 100% of the liability for
Management of Financial Institutions - MGT 604
losses arising from the plans. Under a stop-loss policy, the insurance company
becomes liable for losses that exceed certain limits called deductibles.
Surety Bond insurance is a three party insurance guaranteeing the performance of
the principal.
Terrorism insurance provides protection against any loss or damage caused by
terrorist activities.
Title insurance provides a guarantee that title to real property is vested in the
purchaser and/or mortgagee, free and clear of liens or encumbrances. It is usually
issued in conjunction with a search of the public records performed at the time of a
real estate transaction.
Travel insurance is an insurance cover taken by those who travel abroad, which
covers certain losses such as medical expenses, lost of personal belongings, travel
delay, personal liabilities, etc.
Volcano insurance is an insurance that covers volcano damage in Hawaii.
Workers' compensation insurance replaces all or part of a worker's wages lost and
accompanying medical expense incurred because of a job-related injury.
Types of insurance companies
Insurance companies may be classified as
Life insurance companies, which sell life insurance, annuities and pensions products.
Non-life or general insurance companies, which sell other types of insurance.
General insurance companies can be further divided into these sub categories.
Standard Lines
Excess Lines
In most countries, life and non-life insurers are subject to different regulatory regimes and
different tax and accounting rules. The main reason for the distinction between the two
types of company is that life, annuity, and pension business is very long-term in nature --
coverage for
life assurance or a pension can cover risks over many decades. By contrast, non-life
insurance cover usually covers a shorter period, such as one year.
In the United States, standard line insurance companies are your "main stream" insurers.
These are the companies that typically insure your auto, home or business. They use pattern
or "cookie-cutter" policies without variation from one person to the next. They usually have
lower premiums than excess lines and can sell directly to individuals. They are regulated by
state laws that can restrict the amount they can charge for insurance policies.
Excess line insurance companies (aka Excess and Surplus) typically insure risks not covered
by the standard lines market. They are broadly referred as being all insurance placed with
non-admitted insurers. Non-admitted insurers are not licensed in the states where the risks
are located. These companies have more flexibility and can react faster than standard
insurance companies because they don't have the same regulations as standard insurance
companies. State laws generally require insurance placed with surplus line agents and
brokers to not be available through standard licensed insurers.
Management of Financial Institutions - MGT 604
Insurance companies are generally classified as either mutual or stock companies. This is
more of a traditional distinction as true mutual companies are becoming rare. Mutual
companies are owned by the policyholders, while stockholders (who may or may not own
policies) own stock insurance companies. Other possible forms for an insurance company
include reciprocals, in which policyholders 'reciprocate' in sharing risks, and Lloyds
Insurance companies are rated by various agencies such as A. M. Best. The ratings include
the company's financial strength, which measures its ability to pay claims. It also rates
financial instruments issued by the insurance company, such as bonds, notes, and
securitization products.
Reinsurance companies are insurance companies that sell policies to other insurance
companies, allowing them to reduce their risks and protect themselves from very large
losses. The reinsurance market is dominated by a few very large companies, with huge
reserves. A reinsurer may also be a direct writer of insurance risks as well.
Captive insurance companies may be defined as limited-purpose insurance companies
established with the specific objective of financing risks emanating from their parent group
or groups. This definition can sometimes be extended to include some of the risks of the
parent company's customers. In short, it is an in-house self-insurance vehicle. Captives may
take the form of a "pure" entity (which is a 100 percent subsidiary of the self-insured parent
company); of a "mutual" captive (which insures the collective risks of members of an
industry); and of an "association" captive (which self-insures individual risks of the
members of a professional, commercial or industrial association). Captives represent
commercial, economic and tax advantages to their sponsors because of the reductions in
costs they help create and for the ease of insurance risk management and the flexibility for
cash flows they generate. Additionally, they may provide coverage of risks which is neither
available nor offered in the traditional insurance market at reasonable prices.
The types of risk that a captive can underwrite for their parents include property damage,
public and products liability, professional indemnity, employee benefits, employers liability,
motor and medical aid expenses. The captive's exposure to such risks may be limited by the
use of reinsurance.
Captives are becoming an increasingly important component of the risk management and
risk financing strategy of their parent. This can be understood against the following
heavy and increasing premium costs in almost every line of coverage;
difficulties in insuring certain types of fortuitous risk;
differential coverage standards in various parts of the world;
rating structures which reflect market trends rather than individual loss experience;
Insufficient credit for deductibles and/or loss control efforts.
There are also companies known as 'insurance consultants'. Like a mortgage broker, these
companies are paid a fee by the customer to shop around for the best insurance policy
amongst many companies.
Similar to an insurance consultant, an 'insurance broker' also shops around for the best
insurance policy amongst many companies. However, with insurance brokers, the fee is
Management of Financial Institutions - MGT 604
usually paid in the form of commission from the insurer that is selected rather than directly
from the client.
Neither insurance consultants nor insurance brokers are insurance companies and no risks
are transferred to them in insurance transactions.
Third party administrators are companies that perform underwriting and sometimes claims
handling services for insurance companies. These companies often have special expertise
that the insurance companies do not have.
Life insurance and saving
Certain life insurance contracts accumulate cash values, which may be taken by the insured
if the policy is surrendered or which may be borrowed against. Some policies, such as
annuities and endowment policies, are financial instruments to accumulate or liquidate
wealth when it is needed. See life insurance.
In many countries, such as the U.S. and the UK, the tax law provides that the interest on this
cash value is not taxable under certain circumstances. This leads to widespread use of life
insurance as a tax-efficient method of saving as well as protection in the event of early
In U.S., the tax on interest income on life insurance policies and annuities is generally
deferred. However, in some cases the benefit derived from tax deferral may be offset by a
low return. This depends upon the insuring company, the type of policy and other variables
(mortality, market return, etc.). Moreover, other income tax saving vehicles (e.g., IRAs,
401(k) plans, Roth IRAs) may be better alternatives for value accumulation. A combination
of low-cost term life insurance and a higher-return tax-efficient retirement account may
achieve better investment return.
Table of Contents:
  1. Financial Environment & Role of Financial Institutions:FINANCIAL MARKETS &INSTITUTIONS
  2. FINANCIAL INSTITUTIONS:Non Banking Financial Companies
  3. CENTRAL BANK:Activities and responsibilities, Interest Rate Interventions
  4. POLICY INSTRUMENTS:Open Market Operations, Capital Requirements
  5. BALANCE OF TRADE:Balance of Payments Equilibrium, Public Policy and Financial Stability
  6. STATE BANK OF PAKISTAN:History, Regulation of Liquidity, Departments
  10. STATE BANK OF PAKISTAN - VARIOUS DEPARTMENTS (Contd.):Human Resources Department
  13. PAKISTAN ECONOMIC AID & DEBT:Macroeconomic Stability, Strengthening Institutions
  14. INCREASING FOREIGN DIRECT INVESTMENT:Industrial Sector, Managing the Debt
  15. ROLE OF COMMERCIAL BANKS:Services Typically Offered by Banks, Types of banks
  16. ROLE OF COMMERCIAL BANKS:Types of investment banks, The Management of the Banks
  17. ROLE OF COMMERCIAL BANKS:Public perceptions of banks, Capital adequacy, Liquidity
  19. ROLE OF COMMERCIAL BANKING:Private Deposit Insurance,
  20. BRANCH BANKING IN PAKISTAN:Remittances, Online Fund Transfer
  22. Mutual funds:Types of international mutual funds, Mutual funds vs. other investments
  23. Mutual Funds:Criticism of managed mutual funds, Money Market Fund
  24. Mutual Funds:Balanced Funds, Growth Funds, Specialized Funds, Measuring Risks
  25. Mutual Funds:Cost of Ownership, Redemption Fee, Reports to Shareholders
  26. Mutual Funds:Internet Fraud, The Pyramid Scheme, How to Avoid Investment Fraud
  27. Mutual Funds:Investing In International Mutual Funds, How to Pre-Select a Mutual Fund
  28. Role of Investment Banks:Recent evolution of the business, Possible conflicts of interest
  29. Letter of Credit:Elements of a Letter of Credit, Commercial Invoice, Tips for Exporters
  30. Letter of Credit and International Trade:Terminology, Risks in International Trade
  31. Foreign Exchange & Financial Institutions:Investment management firms, Exchange Traded Fund
  32. Foreign Exchange:Factors affecting currency trading, Economic conditions include
  33. Leasing Companies:Basic Purpose of Leasing, Technological Benefits
  34. The Leasing Sector in Pakistan and its Role in Capital Investment
  35. Role of Insurance Companies:Indemnification, Insurer’s business model
  36. Role of Insurance Companies:Life insurance and saving
  37. Role of financial Institutions in Agriculture Sector:What is “Revolving Credit Scheme”?
  38. Agriculture Sector and Financial Institutions of Pakistan:What is SMEs
  39. Can Government of Pakistan Lay a Pivotal Role in this Sector?:Business Environment
  40. Financial Crimes:Process of Money Laundering, Terrorist Financing
  41. DFIs & Risk Management:Managing Credit Risk, Managing Operational Risk
  42. Banking Fraud & Misleading Activities:Rogue Traders, Uninsured Deposits
  43. The Collapse of ENRON:Auditing Issues, Corporate Governance Issues, Corrective Actions
  44. Classic Financial Scandals:Corruption, Discovery, Black Wednesday