3 - Chapter Three The Financial Services Industry:...

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Chapter Three The Financial Services Industry: Insurance Companies Chapter Outline Introduction Life Insurance Companies o Size, Structure, and Composition of the Industry o Balance Sheet and Recent Trends o Regulation Property-Casualty Insurance o Size, Structure, and Composition of the Industry o Balance Sheet and Recent Trends o Regulation Global Issues Summary 21
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Solutions for End-of-Chapter Questions and Problems: Chapter Three 1. 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. The insurance companies accept premium payments in exchange for compensation in the event that certain specified, but undesirable, 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. 2. 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 necessary revenue to cover the insured liabilities and to provide a reasonable profit for the insurance company. 3. What are the similarities and differences among the four basic lines of life insurance products? The four basic lines of life insurance products are (1) ordinary life; (2) group life; (3) industrial life; and (4) credit life. Ordinary life is sold on an individual basis and represents the largest segment ( 60%) 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 policies ( 40%) 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 (<1.0%) 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 (<2.0%) typically is term life sold in conjunction with some debt contract
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3 - Chapter Three The Financial Services Industry:...

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