©Christoffersen 20001

3. Insurance and Pension Funds• Three types of Insurance

» Life/health Insurance

» Property/casualty

» Reinsurance

• Insurance companies can be either mutual or stock companies. Why is there a trend to demutualize?

• Property insurance companies can sometimes have a reciprocal

exchange where each subscriber is liable for a portion of each policy.

©Christoffersen 20002

3.1 Life Insurance Companies

• Two lines of insurance. Each line of insurance differs by the way in which it is sold or marketed.

» Individual--marketed to individuals in units of $1000. Policymakers make periodic payments.

» Group--covers a large number of insured persons with one single policy.

©Christoffersen 20003

3.2 Types of Ordinary Life Insurance

• Two types of ordinary life insurance» Term life--Beneficiary receives a specified payout if

the insured dies within the coverage time. Coverage ranges from 1-5 years.

• A renewable insurance guarantees the insured the right to renew up to the age of 60 yrs without proof of insurability. Premiums tend to be higher than because of the embedded option to renew.

• A convertible insurance provides the insured with a right to convert term insurance into whole or universal life insurance. Premiums increase once the policy is converted.

©Christoffersen 20004

3.2 Types of Ordinary Life Insurance

» Whole Life--Protects the individual over their entire lifetime. The beneficiary of the individual will receive the face value of the insurance once the insured dies or reaches a specified age. Reserves need to be set aside by the insurance company to cover the face value.

• Policy loan.• Nonparticipating contracts guarantee premiums and annual

cash surrender values.• Participating contracts provide policy dividends at the end

of each year. Dividends are the investment performance less mortality experience and overhead expenses.

©Christoffersen 20005

3.2 An Example of Term Insurance

TERM INSURANCE Example 14-2Assumed Benefit $1000/holder. Assumed Interest 8%. Zero Administrative Costs.Year Age Initial Living Deaths Premiums PV (Prem) Claims PV (Claims) Reserves

1 25 97941 112 105509.10 105509.10 112000.00 103703.70 19502 26 97829 111 105388.44 97581.89 111000.00 95164.61 49253 27 97718 112 105268.87 90251.08 112000.00 88909.21 70104 28 97606 113 105148.21 83470.04 113000.00 83058.37 81315 29 97493 116 105026.48 77197.60 116000.00 78947.65 62106 40 97377 120 104901.52 71394.21 120000.00 75620.36 0

525403.92 525403.90Premium 1.077272

©Christoffersen 20006

3.2 An Example of Endowment Insurance

ENDOWMENT INSURANCE Example 14-3Assumed Benefit $1000/holder. Assumed Interest 8%.Year Age Initial Living Deaths Premiums PV (Prem) Claims PV (Claims) Reserves

1 25 97941 112 12413140.28 12413140.28 112000.00 103703.70 132941922 26 97829 111 12398945.29 11480504.90 111000.00 95164.61 276375883 27 97718 112 12384877.04 10618035.87 112000.00 88909.21 431122624 28 97606 113 12370682.05 9820246.25 113000.00 83058.37 598085805 29 97493 116 12356360.31 9082293.70 116000.00 78947.65 778221356 40 97377 120 12341658.36 8399525.30 97377000.00 61364027.76 -103

61813746.30 61813811.30Premium 126.741

What is the equivalent annuity payment promising with a future value of $1000 at the end of 6 years with payments made at the beginning of the year?

©Christoffersen 20007

3.3 Additional Life Insurance Businesses

Three additional businesses of a life insurance company:• Annuities--Opposite of life insurance

» Movement from RRSPs to RRIFs

» Movement from administered to individual Annuities» Term versus Life Annuity: Why can term annuities be sold by banks while

only life annuities are sold by insurance companies?

• Pension Plans: » sell RRSPs» compete to run trusteed pension plans

• Health Insurance

3.4 Balance Sheet of a Life Insurer

LiabilitiesAssets

Policy Reserves 73%

Policy Claims 1.7%

Policy Dividend Accumulation .8%

Other 16.8%

Total Capital/Surplus 7.7%

Separate Account Business 22%

Bonds 34%

Commercial Loans 8.1%

Common Stock 5.5%

Mortgage loans 35%

Real estate 6%

Policy Loans 3.5%

Cash 1%

Other Invt 2.5%

Life, annuity, accident premiums due .5%

Other 3.9%

Separate Account Assets 22%

©Christoffersen 20009

3.5 CompCorp

• Protects Life and Health Insurance companies• An industry association and started 1990• During the MacKay Report, there was some

discussion to joining CDIC and CompCorp to even the playing fields

• Claims against the failed institution are transferred to CompCorp Life

• OSFI regulates insurers

©Christoffersen 200010

3.5 CompCorp

• Protection» $200,000 if life insurance policy protection

» $2,000/ month in life or term annuities

» $60,000/ person in health benefits

» $60,000 on RRSPs/RRIFs

» $60,000 on surrender value of life insurance policies and annuities in accumulation stage

• Stacking covered up to $120,000

©Christoffersen 200011

3.6 Questions

» Why has group insurance become less important over the last decade?

» Does concentration in life insurance business restrict competition?

©Christoffersen 200012

3.7 Property and Casualty (Liability) Insurance

Two major product groups:» Personal Lines: Automobile, home, renter’s insurance» Commercial Lines:

• Cover fixed costs in the event of a strike,

• Crime such as steeling by employees,

• Liability from a legal suit

• Errors and omissions

• Worker’s Compensation

• PACIC insures Property and Casualty insurance upto $200,000 for 45 days after bankruptcy

3.8 Balance Sheet of Property-Casualty Insurer

LiabilitiesAssets

Unpaid Claims 46.2%

Loss expenses 4.8%

Reinsurance payable on losses .3%

Unearned premiums 22.2%

Reinsurance Funds 1.1%

OSFIs Reserve 3.3%

Policy Holder Surplus 10.9%

Capital Stock 11.4%

Bonds 47%

Preferred Stock 7.5%

Common Stock 9.7%

Mortgage loans 2.4%

Real estate 2.5%

Cash/CP/Deposits 6.8%

Other Invt 1.5%

Premium Balance 8.3%

Reinsurance recoverable 3.7%

Other 10.6%

©Christoffersen 200014

3.9 Questions on P&Cs» Why do P&C insurers hold more capital than life insurers?

» Why are there no reserves for P&Cs but there are for life insurers?

» Why do P&Cs have assets with shorter maturity than life insurers?

» Why might a P&C reinsure a substantial portion of its earthquake portfolio and not its automobile portion?

» Who regulates the capital adequacy of P&Cs and life insurers?

©Christoffersen 200015

3.10 Pension Funds

• Two major product groups:» Defined Benefit Plan: Retirement benefit is fixed

(usually as a % of average salary) but the contributions vary.

» Defined Contribution Plan: Contribution fixed but the retirement benefit is variable.

• Observe a decrease in the number of funds offering Defined Benefit Plans compared to Defined Contribution Plans.

• Contributory versus Non-Contributory

©Christoffersen 200016

3.11 Questions on Pension Funds

» Why should the employer of a contributory, defined benefit plan be allowed to withdraw surpluses?

» Who regulates pension funds in Canada?

©Christoffersen 200017

3.12 Summary

» The lines between Insurance companies and pension funds are becoming more blurred.

» Insurance companies are becoming demutualized.

» Insurance of insurers is provided by companies not by government