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Financial Institutions Management: A Risk Management Approach

Anthony Saunders; Marcia Millon Cornett

Chapter 6

Financial Services: Insurance Companies - all with Video Answers

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Chapter Questions

Problem 1

What is the primary function of an insurance company? How does this function compare with the primary function of a depository institution?

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02:10

Problem 2

What is the adverse selection problem? How does adverse selection affect the profitable management of an insurance company?

EA
Erwin Antoni
Numerade Educator

Problem 3

What are the similarities and differences among the four basic lines of life insurance products?

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Problem 4

Explain how annuity activities represent the reverse of life insurance activities.

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Problem 5

Explain how life insurance and annuity products can be used to create a steady stream of cash disbursements and payments to avoid paying or receiving a single lump-sum cash amount.

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01:26

Problem 6

a. What is the amount of the annuity purchase required if you wish to receive a fixed payment of $$\$ 200,000$$ for 20 years? Assume that the annuity will earn 10 percent per year.
b. Calculate the annual cash flows from a $$\$ 1$$ million, 20-year fixed-payment annuity earning a guaranteed 10 percent per year if payments are to begin at the end of the current year.
c. Calculate the annual cash flows from a $$\$ 1$$ million, 20-year fixed-payment annuity earning a guaranteed 10 percent per year if payments are to begin at the end of year 5 .

Breanna Ollech
Breanna Ollech
Numerade Educator
01:41

Problem 7

You deposit $$\$ 10,000$$ annually into a life insurance fund for the next 10 years, after which time you plan to retire.
a. If the deposits are made at the beginning of the year and earn an interest rate of 8 percent, what will be the amount of retirement funds at the end of year 10 ?
b. Instead of a lump sum, you wish to receive annuities for the next 20 years (years 11 through 30). What is the constant annual payment you expect to receive at the beginning of each year if you assume an interest rate of 8 percent during the distribution period:
c. Repeat parts (a) and (b) above assuming earning rates of 7 percent and 9 percent during the deposit period and earning rates of 7 percent and 9 percent during the distribution period. During which period does the change in the earning rate have the greatest impact?

Swati Agarwal
Swati Agarwal
Numerade Educator
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Problem 8

You deposit $$\$ 12,000$$ annually into a life insurance fund for the next 10 years, at which time you plan to retire. Instead of a lump sum, you wish to receive annuities for the next 20 years. What is the annual payment you expect to receive beginning in year 11 if you assume an interest rate of 6 percent for the whole time period?

Danielle Fairburn
Danielle Fairburn
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01:57

Problem 9

a. Suppose a 65 -year-old person wants to purchase an annuity from an insurance company that would pay $$\$ 20,000$$ per year until the end of that person's life. The insurance company expects this person to live for 15 more years and would be willing to pay 6 percent on the annuity. How much should the insurance company ask this person to pay for the annuity?
b. A second 65 -year-old person wants the same $$\$ 20,000$$ annuity, but this person is much healthier and is expected to live for 20 years. If the same 6 percent interest rate applies, how much should this healthier person be charged for the annuity?
c. In each case, what is the difference in the purchase price of the annuity if the distribution payments are made at the beginning of the year?

Julie Silva
Julie Silva
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Problem 10

Contrast the balance sheet of a life insurance company (Table 6-3) with the balance sheet of a commercial bank (Table 2-5) and with that of a savings institution (Table 2-9). Explain the balance sheet differences in terms of the differences in the primary functions of the three organizations.

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Problem 11

Using the data in Table 6-2, how has the composition of assets of U.S. life insurance companies changed over time?

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Problem 12

How do life insurance companies earn a profit?

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Problem 13

How would the balance sheet of a life insurance company change if it offered to run a private pension fund for another company?

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Problem 14

How does the regulation of insurance companies differ from the regulation of depository institutions? What are the major pieces of life insurance regulatory legislation?

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Problem 15

How do state guarantee funds for life insurance companies compare with deposit insurance for depository institutions?

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Problem 16

What are the two major activity lines of property-casualty insurance firms?

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Problem 17

How have the product lines of property-casualty insurance companies changed over time?

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Problem 18

Contrast the balance sheet of a property-casualty insurance company (Table 6-5) with the balance sheet of a commercial bank (Table 2-5). Explain the balance sheet differences in terms of the differences in the primary functions of the two organizations.

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Problem 19

What are the three sources of underwriting risk in the property-casualty insurance industry?

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01:14

Problem 20

How do unexpected increases in inflation affect property-casualty insurers?

Prashant Bana
Prashant Bana
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Problem 21

Identify the four characteristics or features of the perils insured against by property-casualty insurance. Rank the features in terms of actuarial predictability and total loss potential.

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03:37

Problem 22

Insurance companies will charge a higher premium for which of the insurance lines listed below? Why?
a. Low-severity, high-frequency lines versus high-severity, low-frequency lines.
b. Long-tail lines versus short-tail lines.

Brenda Sanchez
Brenda Sanchez
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02:54

Problem 23

What does the loss ratio measure? What has been the long-term trend of the loss ratio? Why?

Sanchit Jain
Sanchit Jain
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Problem 24

What does the expense ratio measure? Identify and explain the two major sources of expense risk to a property-casualty insurer. Why has the long-term trend in this ratio been decreasing?

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02:07

Problem 25

How is the combined ratio defined? What does it measure?

Jennifer Stoner
Jennifer Stoner
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Problem 26

What is the investment yield on premiums earned? Why has this ratio become so important to property-casualty insurers?

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Problem 27

Consider the data in Table 6-6. Since 1980, what has been the necessary investment yield for the industry to enable the operating ratio to be less than 100 in each year? How is this requirement related to the interest rate risk and credit risk faced by a property-casualty insurer?

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01:13

Problem 28

a. What is the combined ratio for a property insurer that has a loss ratio of 73 percent, a loss adjustment expense of 12.5 percent, and a ratio of commissions and other acquisition expenses of 18 percent?
b. What is the combined ratio adjusted for investment yield if the company earns an investment yield of 8 percent?

Dushyant Barot
Dushyant Barot
Numerade Educator
01:23

Problem 29

An insurance company's projected loss ratio is 77.5 percent and its expense ratio is 23 percent. The company estimates that dividends to policyholders will be 5 percent. What must be the minimum yield on investments to achieve a positive operating ratio?

Hast Aggarwal
Hast Aggarwal
Numerade Educator
01:39

Problem 30

An insurance company collected $$\$ 3.6$$ million in premiums and disbursed $$\$ 1.96$$ million in losses. Expenses amounted to 6.6 percent and dividends paid to policyholders totaled 1.2 percent. The total income generated from the company's investments was $$\$ 170,000$$ after all expenses were paid. What is the net profitability in dollars?

Anand Jangid
Anand Jangid
Numerade Educator

Problem 31

A property-casualty insurer brings in $$\$ 6.25$$ million in premiums on its homeowners multiple peril line of insurance. The line's losses amount to $$\$ 4,343,750$$, expenses are $$\$ 1,593,750$$, and dividends are $$\$ 156,250$$. The insurer earns $$\$ 218,750$$ on the investment of its premiums. Calculate the line's loss ratio, expense ratio, dividend ratio, combined ratio, investment ratio, operating ratio, and overall profitability.

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Problem 32

Go to the Federal Reserve Board's website at www.federalreserve.gov and find the most recent distribution of life insurance industry assets for Table 6-2. Click on "Economic Research and Data." Click on "Financial Accounts of the United States." Click on the most recent date. Click on "Level tables." This will bring the file (Table L.116) onto your computer that contains the relevant data. How have the values of government securities, corporate securities, mortgages, and policy loans changed since 2015?

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01:37

Problem 33

Go to the Insurance Information Institute's website at www.iii.org and use the following steps to find the most recent data on the largest life insurance companies by total revenue. Click on "Facts \& Statistics." Click on "Life Insurance." This will bring the file onto your computer that contains the relevant data. What are total revenues and assets of the top 10 life insurance companies?

Anna Myers
Anna Myers
Numerade Educator