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INSURANCE COMPANIES AND PENSION FUNDS CHAPTER OBJECTIVES 1. This chapter examines the contractual financial institutions: Insurance companies and pension funds. Both institutions provide risk intermediation to consumers by allowing them to make present provision for future financial need. 2. The chapter describes the operations, services, and social contributions of insurance and pension entities, highlighting financial and social issues inherent in their purposes and functions. CHANGES FROM THE LAST EDITION All tables, figures, and exhibits have been updated. CHAPTER KEY POINTS 1. Insurance transfers the burden of a “pure risk” to an entity that pools risk and pays compensation if loss occurs. “Pooling” means losses suffered by a small number of insured are spread over the entire group—an insured substitutes the small average loss for the uncertainty that they might suffer a large loss. “Pure risks” are situations with two possible outcomes, loss or no loss. Emphasize the economic benefits of insurance and how insurers determine insurance premiums. It is important to make the distinction that insurance provides financial compensation for losses but does not prevent losses from occurring. Foreshadow the pension material by describing pensions as a special kind of insurance. 2. Various types of life insurance may correspond to insurance needs of individuals during different periods of their life cycle. For example, what insurance needs would a single college student need versus a married middle manager with a family? 3. Casualty insurance is something of a vocabulary challenge for the uninitiated. While the various types of policies should be clearly compared and contrasted, the most important theme is similarities and differences in the operating characteristics of life insurers and casualty insurers. These are readily evident in their balance sheets. Emphasize that life insurers have more predictable cash outflows and can thus invest more for total return and less for liquidity. 4. Key pension concepts include: (a) insured versus noninsured pension funds, (b) fully funded versus nonfunded or unfunded pension plans, (c) vested versus nonvested pension plans, (d) defined benefit versus defined contribution pension arrangenments, and (e) portability of benefits. An important theme is portfolio management—types of investments and the reasons for selecting them. As these materials go to press, political debate is heating up over reform of the Social Security System. Accordingly, the pensions material may offer an opportunity for class discussion of several major issues affecting the economy and financial system. 5. In the context of a course in financial markets and institutions, the importance of insurance companies and pension funds as major primary market suppliers of long-term capital cannot be over-emphasized. ANSWERS TO END-OF-CHAPTER QUESTIONS
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This note was uploaded on 02/23/2011 for the course FINA 4090 taught by Professor S during the Spring '11 term at Toledo.

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