Investment Patterns of Insurance Companies

Topics: Insurance, Investment, Life insurance Pages: 38 (11764 words) Published: April 15, 2011
Chapter 1


1.1 Introduction
Insurance, in law and economics, is a form of risk management primarily used to hedge against the risk of a contingent loss. More importantly, insurance company portfolio managers work under a different, and possibly more restrictive, set of regulatory constraints than other institutional investors (Badrinath, Kale, Ryan, & Jr, 1996). Insurance is defined as the equitable transfer of the risk of a loss, from one entity to another, in exchange for a premium, and can be thought of as a guaranteed small loss to prevent a large, possibly shocking loss. Insurance executives would like to allocate equity in such a way that risk-adjusted return on equity is maximized (Holmer & Zenios, 1995). An insurer is a company selling the insurance; an insured or policyholder is the person or entity buying the insurance. (Caillaud, Dionne & Jullien, 2000) found that, the insurance rate is a factor used to determine the amount to be charged for a certain amount of insurance coverage, called the premium. Integrated product management teams need new technical tools to determine the effects of alternative design, investment, and pricing strategies on the risk- adjusted return on the equity invested in each financial product (Holmer & Zenios et al, 1995). Insurance companies provide its customers with the assurance in return of their investment. This assurance is generally divided into two main categories i.e. life insurance and general insurance. (Carino et al, 1994). Life insurance is defined as a contract between the policy owner and the insurer, where the insurer agrees to pay a sum of money upon the occurrence of the insured individual's death or other event, such as terminal illness or critical illness. An empirical study by Hammond, Houston, and Melander (1967) and a theoretical article by Campbell (1980) both found that one of the main purposes of life insurance is to protect dependents against financial hardship in the case of the wage earner's premature death. (Browne & Kim, 1993) argues that in return, the policy owner agrees to pay a fixed amount called a premium at regular intervals or in lump sums. (Rubinstein, 1985) found that As with most insurance policies, life insurance is a contract between the insurer and the policy owner whereby a benefit is paid to the chosen beneficiaries if an insured event occurs which is covered by the policy. The only information generally disclosed in a life insurance policy is the premium, guaranteed cash values at periodic durations and un-guaranteed projected dividends for participating policies, the investment return (or the cost of insurance) can only be imputed mathematically from these data (Ferrari, 1968). Life policies are legal contracts and the terms of the contract describe the limitations of the insured events. (Merrill, Samuels, Brower& Davis, 1952) found that specific exclusions are often written into the contract to limit the liability of the insurer; for example claims relating to suicide, fraud, war, riot and civil commotion. There is a limitation with respect to the distribution of earnings to shareholders and it is noted that policyholders are credited with the entire underwriting profits of the company with the exception of nominal interest on guarantee capital and one-eighth of such profits which accrue to the account of the shareholders (Mayers & Smith, 1992). Insurance other than life insurance falls under the category of General Insurance. General insurance comprises of auto insurance, marine insurance, insurance of property against fire, burglary etc. Most general insurance policies are annual contracts. General insurers had shorter-term and much more erratic policy liabilities, limiting the scope for long-term investment (Scott, 2002). Scott, 1936) found that his content can be found on the following page: [pic]

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