presentation on life insurance fund & solvency management

AKM Elias Hussain ASB 1

Presentation on Life InsuranceFund & Solvency Management

AKM Elias HussainPresident,

Actuarial Society of Bangladesh


Insurance Companies

Provide contractual risk management for: Risks of insurable asset losses (auto insurance) Risks of liability claims (product liability) Risk of large medical costs (health insurance) Risk of disability (disability insurance) Risk of premature death (life insurance) Risk of longevity (annuities)


Insurance Companies, cont.

Major capital market intermediary Major investor in corporate (life) and state and

municipal bonds (property/casualty) Major long-term commercial mortgage lender

(life)

Mutual or stock form of ownershipPremium and investment revenueLosses and loss adjustment expenses


Insurance Concepts

Pure vs. financial riskInsure fortuitous, independent risk

occurrencePremium covers losses, administrative

expenses and profitsInsured contracts for known loss

(premium) in return for protectionMoral hazard and adverse selection


Background

Life insurance companies Provide risk management contracts for individuals and

businesses Risk areas include premature death, health maintenance costs,

and disability Life insurance provides cash benefits to the beneficiary of a

policy on the policyholder’s death Life insurance premiums reflect

Probability of making payment to the beneficiary Size and timing of the payment

Have portfolios of policies and use mortality figures and actuarial tables to forecast claims


Cash Value Insurance

Group

Types of Life Insurance Policies

Whole Life

Variable Life

Universal Life

Term Insurance

Term

Group



Whole life insurance includes both a death benefit (term insurance) and a savings component that Builds a tax sheltered cash value amount for

the future for the owner of the policy Generates periodic cash flow payments over

the life of the policy for the insurance company to reinvest

Pays fixed death benefit at death



Term life insurance characteristics Temporary, providing death benefits only over a

specified term Premiums paid represent insurance only with

no saving component Considerably lower cost for the insured than

whole life—able to buy more insurance protection for any amount of premium

Term is for those who would rather invest their savings in other contracts or securities


Types of Life Insurance PoliciesVariable life insurance

Whole life with variable cash value amounts Cash values invested in equities and will vary with the

investment performance Flexible premium option since 1984

Universal life insurance Combines the features of term and whole life Variable premiums over time—buys terms and invests

difference in a variety of investments Builds a varying cash value based on contributions and

investment performance



Group plans Employees of a corporation offered life

insurance or life insurance purchased on life of employee

Cash value or term insurance Low cost (term) because of its high volume Can cover group members and dependents


Health Care Insurance

Health maintenance organizations or HMOs Intermediaries between purchasers and

providers of health care Annual fee or premium

Covers all medical expenses Medical staff is designated by the HMO

Losses in recent years for HMOs


Sources of Life Insurance Company Funds Cash value reserves—accumulated cash values

owed insureds (liability) Pension reserves—accumulated “insured”

pension commitments (liability) Annuity reserves—accumulated annuity

commitments (liability) Unearned premium income—premiums

received; not yet earned (liability) Loss reserves--losses incurred, not yet paid Capital funds


Uses of Life Insurance Company FundsMajor investor in corporate bondsGovernment securitiesCommon stockCommercial mortgageReal EstatePolicy loans to insured


Uses of Funds—Policy Loans

Policy loans are loans to policyholders Whole life policies Borrow up to the cash value of the policy Guaranteed interest rate is stated in the policy Usually used by borrowers during periods of

rising rates to lock in the lower rate associated with their policy


Insurance Company CapitalCapital

Build capital by issuing new stock (stock companies) or retaining earnings

Used to finance investments in fixed assets Cushion against operating losses Capital requirements vary depending on asset

risk Credibility with customers is also enhanced by

adequate capital Mutual companies owned by policyholders—

includes earnings retained over time


Risks of Life Insurance Companies

Pure Risk of LifeInsurance Policies

PensionCommitments and

Annuities Contracts

Financial Riskincludes

Interest Rate RiskCredit RiskMarket Risk

Liquidity Risk


Exposure to Financial RisksInterest rate risk

Fixed rate assets in company portfolios have market values sensitive to interest rate changes

Firm measures and manages risks

Credit risk Mortgages, corporate bonds and real estate

holdings can involve default Investment-grade securities Diversify portfolio among debt issuers


Exposure to Financial Risks

Market risk Exists because events like significant market

value decreases reduce capital Economic downturn affects real estate

investments


Exposure to Financial Risks Liquidity risk occurs because a high frequency of

claims may require the life company to liquidate assets

Life insurance companies have high cash flow from premiums to offset normal cash needs

In case of large disaster (9/11) may be forced to sell assets to generate cash even if market value is low

Companies try to balance the age distribution of their customer base

As interest rates rise, voluntary terminations of policies occur


Threats to Solvency Poor mortality experience Poor expense experience Expense inflation Inadequate investment returns Poor lapse and surrender experience Asset default and depreciation Mismatched investments Guaranteed surrender values/investments returns Liquidity Options Change in business mix Inadequate reinsurance Operational risks


How to handle threats to solvency

Management actions Role of the Appointed Actuary Regulations Timely intervention by regulator Conservative asset and liability valuations Risk based capital/solvency margin Holistic and integrated approach to risk

management Incentives to encourage prudent risk

management


Assets Liability Management

It is a dynamic process of Planning, Organizing & Controlling of Assets & Liabilities- their volumes, mixes, maturities, yields and costs in order to maintain liquidity and NII.


Asset Management

Performance is significantly affected by the performance of the assets Companies get premiums for several years

before paying out benefits Companies try to manage the risk of losses with

offsetting investment gains or diversity of assets they hold

Diversify into other businesses to offer a wide variety of financial products


Property and Casualty Insurance

Property insurance (fire insurance)Casualty insurance (liability)Performance and financial bonding


PC Versus Life Insurance CompaniesPC have shorter contractsPC have more varied risk areasLife companies larger due to long-term

savings and pension contractsPC has wider distribution of Occurrences

PC’s need liquid, marketable assets PC’s earnings more volatile


Property Casualty Investment Needs

Tax sheltering--major municipal/state bond investor

Liquid, marketable assets Marketable corporate and government bonds Listed common stock

Inflation hedge--common stockReinsurance contracts--manage pure risks


Components of a Balance sheet Contingent Liabilities

Liabilities1. Capital

2. Reserve & Surplus

3. Deposits

4. Borrowings

5. Other Liabilities

Assets1. Cash & Balances with

RBI

2. Bal. With Banks & Money at Call and Short Notices

3. Investments

4. Advances

5. Fixed Assets

6. Other Assets


Components of Liabilities

CapitalReserves & SurplusDepositsBorrowingsOther Liabilities & Provisions


Components of Assets

Cash & Bank Balances with RBI Balances with Banks & money at

Call & short notice

InvestmentsAdvances Fixed Asset & Other Assets


Valuation of an Insurance Company

Value of an insurance company depends on its expected cash flows and required rate of return

V = f [E(CF), k]

V = Change in value of the insurance company

k = Change in required rate or return

Where:

E(CF) = Change in expected cash flows

+



Factors that affect cash flows

E(CF) = Expected cash flow

Rf = Risk free interest rate

INDUS = Prevailing industry conditions for the company

Where:

E(CF)= f (ECON, Rf , INDUS, MANAB)

ECON = Economic growth

MANAB = Management ability of company

+ +?



Investors required rate of return

k = f(Rf , RP)++

Rf = Risk free interest rate

Where:

RP = Risk premium


Performance Evaluation

Common indicators of company performance are available Statistical analysis of performance Ratio analysis

Trends over time Compare to industry average



The higher the liquidity ratio, the more liquid the company

Liquidity

Ratio

=Invested Assets

Loss Reserves and

Unearned Premium Reserves



Return on net worth or policyholders’ surplus is a profitability measure

Return on Equity =Net Profits

Policyholders’ Surplus



Underwriting gains and losses or underwriting profitability measured by the net underwriting margin Profits include investment income, underwriting profits and realized capital gains Ratios can be calculated to focus on various sources of profits

Net Underwriting=

Premium Income - Policy Expenses

Total AssetsMargin


Other Issues

Insurance companies interact in a variety of ways with other financial institutions

Insurance companies participate in a full range of financial markets

Multinational insurance companies Insurance companies operate in many countries Some countries lack developed markets for insurance

Multinational investments


Thank you very much

ASB

presentation on life insurance fund & solvency management

Economy & Finance

universal life insurance

disability life insurance

life policies

insurance protection

corporate life

life insuranceincludes

life of employee cash

death benefit term insurance