Insurance Regulation

Copyright © 2012 Pearson Prentice Hall.All rights reserved.

CHAPTER 21

Insurance Companies and Pension Funds

© 2012 Pearson Prentice Hall. All rights reserved. 21-2

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.


Conflict of Interest Violations

In 2004, NY Attorney General E. Spitzer charged Marsh and McLennan with insurance fraud.

Indictment cited bid-rigging and bribery. Some of the pay-for-play fees amounted to $800 million per year.

Many top execs left the firm in the wake of the incident.


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


Credit Default Swaps

A CDS is insurance against default on a financial instrument, usually some kind of securitized bond.

Market essentially non-existent before 1995. By 2008, there were about $62 trillion of CDS outstanding!

The CDS market allowed speculators to bet on the health of a company, a usual no-no in insurance.


Credit Default Swaps: The AIG Blowup

AIG’s Financial Products division insured over $400 billion of CDS securities, of which $57 billion were debt securities backed by subprime mortgages.

Creditors quickly realized the losses may bankrupt AIG – AIG could not raise any capital

The Fed organized a bailout, but took a big stake in AIG as payment. Insurance companies nationwide will now fall under federal scrutiny.


Monoline Insurance

Monoline insurance companies specialize in credit insurance and are the only insurance companies that are allowed to provide insurance that guarantees the timely repayment of bond principal and interest when a debt issuer defaults. All other insurance companies are prohibited from doing this.

Help lower required interest by providing a credit enhancement. The crisis affected them as well.


The Subprime Crisis and the Monoline Insurers

Monoline insurers did insure debt backed by subprime mortgages.

Defaults on these mortgages resulted in credit downgrades for the insurers.

This weakened the value of their insurance guarantees, which spilled over into their municipal securities insurance.

Investors reduced the value of the insurance—municipalities started seeing higher interest costs. This, in turn, resulted in lower spending on roads, schools, etc.


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.


Types of Pensions

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


Types of Pensions

Defined-Benefit Pension Plans place a burden on the employer to properly fund the expected retirement benefit payouts.─ Fully funded: sufficient funds are available to meet

payouts─ Overfunded: funds exceed the

expected payout─ Underfunded: funds are not expected to meet the

required benefit payouts


Types of Pensions

Defined-Contribution Pension Plan: a plan where a set amount is invested for retirement, but the benefit payout is uncertain.

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)


MINI-CASE: Power of the Pensions

Managers of pensions have gained the ability to exercise substantial control over corporate management.

For example, pension funds recently defeated management-sponsored antitakeover proxy proposals at Honeywell.

The stated mission of the Council of Institutional Investors is to “encourage trustees to take an active role in assuring that corporate actions are not taken at the expense of shareholders.”


Private Pension Plan Assets


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.


Social Security Assets


Social Security Assets


Social Security

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’d be wise for you plan other sources for your retirement cash flows.


Regulation of Pension Plans

A major U.S. Supreme Court decision in 1949 established that pension benefits were a legitimate part of collective bargaining. The number of plans increased from this as unions negotiated for such 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



The next slide shows the annual payments made since 1980 to failed plan participants. In 2005, the PBGC said that the plan has never been under more stress…


Participants and Beneficiaries Receiving PBGC Payments



Pension Protection Act of 2006 was passed to address the growing problem of failed pension plans. The act provides for stronger funding rules, greater transparency, and a strong pension insurance system.



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.


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.


Chapter Summary

Insurance Companies: the nature of the industry, including rationale and people employed in the industry, was presented.

Fundamentals of Insurance: the seven fundamental ideas behind all insurance were listed and reviewed.


Chapter Summary (cont.)

Growth and Organization of Insurance Companies: the changes in growth patterns over the last several decades was reviewed, including both assets and number of companies.

Types of Insurance: the variety of insurance policies available covering life, health, etc., were presented.



Pensions: the general idea and growth in pension funds was presented.

Types of Pensions: the various forms, from defined-benefit to defined-contribution, were reviewed and compared.



Regulation of Pension Plans: ERISA and other laws that govern pension funds was discussed.

The Future of Pension Funds: we should expect their popularity, size, and power to continue to grow as the population ages.

Documents

Insurance Regulation