Lesson 3: Financial Services: Insurance Companies Flashcards
Q 6 & 8 missing
What is the primary function of an insurance company?
How does this function compare with the primary function of a depository institution?
The primary function of an insurance company is to provide protection from adverse events. Insurance companies accept premium payments in exchange for
compensation in the event that certain specified events occur.
The primary function of depository institutions is to provide financial intermediation for individual and corporate savers. By accepting deposits and making
loans, depository institutions allow savers with predominantly small, short-term financial assets to benefit from investments in larger, longer-term assets. These long-term assets typically yield a higher rate of return than short-term assets.
What is the adverse selection problem? How does adverse selection affect the profitable management of an insurance company?
The adverse selection problem occurs because customers who are most in need of insurance are most likely to acquire insurance. However, the premium structure for various types of insurance typically is based on an average population proportionately
representing all categories of risk. Thus, the existence of a proportionately larger share of high-risk customers may cause the premium revenue received by the insurance provider to underestimate the revenue needed to cover the insured liabilities and to provide a
reasonable profit for the insurance company.
Insurance companies deal with the adverse selection problem by establishing different pools of the population based on health and related characteristics (such as income). By altering the pool used to determine the probability of losses to a particular customer’s health characteristics, the insurance company can more accurately determine the
probability of having to pay out on a policy and can adjust the insurance premium accordingly
What are the similarities and differences among the four basic lines of life insurance products?
The four basic lines of life insurance products are: •ordinary life •group life •industrial life; and •credit life
Ordinary life is sold on an individual basis and represents the largest segment (∼79%) of the life insurance market. The insurance policy can be structured as pure life insurance (term life) or may contain a savings component (whole life or universal life).
Group life policies (∼20%) are similar to ordinary life insurance policies except that they are centrally administered, providing cost economies in evaluating, screening, selling, and servicing the policies.
Industrial life (<1%) has largely been replaced by group life since cost economies have made group life more affordable. Industrial life was historically marketed to individuals who would make small, very frequent payments and would require personal collection services.
Credit life (<1%) typically is term life sold in conjunction with some debt contract.
Explain how annuity activities represent the reverse of life insurance activities.
Whereas life insurance involves different contractual methods of building up a fund, annuities involve different methods of liquidating a fund, such as paying out a fund’s proceeds, a typical life insurance contract requires a periodic payment by one party for a promised payment of either a lump sum or an annuity if a particular event occurs, such as death or an accident.
An annuity represents a reverse contract where the party purchases the right to receive periodic payments depending on the market conditions. The contract may be initiated by investing a lump sum or by making periodic payments before the annuity payments begin
