Answers_to_Chapter_15_Questions (1)

Answers_to_Chapter_15_Questions (1) - Answers to Chapter 15...

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Answers to Chapter 15 Questions 1. The primary function of a life insurance company is to protect policyholders from adverse events. Banks accept deposits from people and companies looking for a fairly safe, liquid place to put their money and make loans to people and companies who need more money. 2. A major similarity between depository institutions and insurance firms is the high degree of financial leverage incurred by both groups of firms. Both groups solicit funds (from policyholders or depositors) and use them to finance an asset portfolio predominately consisting of debt securities. A major difference between them is their composition of the liabilities, which is fixed for depository institutions but stochastic for insurance firms. While the face value of bank deposits is fixed, the insurance company's net policy reserves depend on expected future required payouts which can be highly uncertain. The other difference is that insurance companies are allowed to invest in equity instruments, which currently are prohibited for depository institutions. 3. We can see in Table 15-2 that since the 1920s and 30s, life insurance companies have increased their holdings of bonds and stocks and decreased their holdings of mortgage loans and policy loans. Government securities comprise the next largest component and have recently increased back to their earlier levels after reaching very low levels in the 60s and 70s. 4. 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 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 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 Industrial life has largely been replaced by group life since cost economies have made group life more affordable.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 typically is term life sold in conjunction with some debt contract. 5. 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
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