FINA 460 Exam 3

Two sources of income for insurance companies

Underwriting Income & Investment Income

What do insurance companies do?

Sell insurance policy to the policyholder to bear the risk in return for an insurance premium.

What are insurance policies?

Legally binding contracts, Policyholders expect to receive specified sums contingent on the occurrence of future events from insurance policy writers.

Two major types of expenses an insurance company faces?

1. Payments on insurance policies
2. Operating Expenses

Why do insurance companies exist?

It is because people are risk- averse. We would rather pay the insurance premium than accept the gamble that we will lose our house or car. We prefer to buy insurance and know with certainty what our wealth will be (our current wealth minus the insurance

Why do people purchase insurance?

Insurance allows us the peace of mind that a single event can have only a limited financial impact on our lives

Are we going to change our investment strategy if no insurance company exists?

In a world without insurance, we will need to save more to build up emergency funds, invest less, rent a house instead of buying it, etc.

How do insurance companies deal with adverse selection?

1. Most health insurance companies require a medical exam and may examine previous medical records before issuing a health or life insurance policy.
2. Insurance firms often offer better rates to insure a group of people, such as everyone working at a par

What is adverse selection?

Occurs when the individuals most likely to benefit from a transaction are the ones who most actively seek out the transaction and are thus more likely to be selected.

How do insurance companies combat moral hazard problem?

1. Insurance companies can combat moral hazard by requiring a deductible and /or copay as an incentive to make policyholders take proper care. A deductible is the amount of any loss that must be paid by the insured before the insurance company will pay an

What is moral hazard?

Moral hazard occurs when the insured fails to take proper care to avoid losses because losses are covered by insurance

Because policyholders transfer their risk to insurance companies, will insurance companies suffer because of the transferred risk?

No, if the insurance company has a large number of insureds so that the risk can be averaged out among many different policies. The law of large numbers says that when many people are insured, the probability distribution of the losses can be estimated mo

What is a GIC? (Guaranteed Investment Contract)

Guarantees a fixed interest income compounded over the life of the contract. It is like a zero-coupon bond issued by an insurance company, usually to pension funds. It shifts the interest rate risk from a pension fund to the issuer.

Difference between a Mutual Fund and an Annuity?

In a mutual fund, all income is taxable, and no guarantees are given in its performance.
An annuity is an investment product often called a "mutual fund is in an insurance wrapper". The wrapper is the guarantee by the insurance company. The company will p

Who regulates insurance companies?

By individual states and only the SEC regulates those insurance companies whose stock is publicly traded.

What is the self-regulatory group for insurance? What do they do?

National Association of Insurance Commissioners
They develop model laws and regulations

What is bankassurance?

Combining the activities of banking and insurance companies.

Statutory Surplus

Total Assets - Liabilities

Why are statutory surpluses important?

Due to state regulations the size of the surplus dictates the amount of common stock that an insurance company can hold and ultimately the amount of business it can write.

What are investment companies?

Financial intermediary that sell shares to the public to pool the funds of individual investors and invests these funds in a portfolio of securities.

Who are the owners of a mutual fund?

Investors

Who governs a mutual fund?

Board of directors

Who manages a mutual fund?

Investment advisor

What is NAV

Net Asset Value - the value or price of each
share of the portfolio owned by a mutual fund

How to calculate NAV

(Market Value of portfolio - liabilities) / # of shares outstanding

How many times is NAV determined per day?

Once

What factors may affect the number of shares outstanding of
a mutual fund?

All new investments into the fund will increase the number of shares, whereaswithdrawals (redemption) from the fund will decrease the number of shares.

What factors may affect the NAV of a fund? What factors may
affect the total market value of a fund?

Price

What is a closed end fund?

portfolio of pooled assets that raises an amount of capital through an initial public offering (IPO) and then lists shares for trade on a stock exchange
The number of shares remain constant, and there are no sales or purchases of fund shares by the fund c

How is the price of a closed end fund share determined?

Supply & Demand

What is an ETF? (Exchange Traded Fund)

Price is determined continuously
Traded on secondary market
Not fixed number of shares
Price = NAV

Most ETFs are _______funds so APs can easily track ETF NAVs.

index

ETFs can be____

sold short or bought on margin

What are the main costs borne by investors in
mutual funds?

Sales Charge (Load) & Annual Operating Expenses

Class A

Front?end load is deducted up front when a client invests in a fund

Class B

Back?end load is imposed at the time fund shares are redeemed. A fund may waive the back?end load if an investor holds a fund long enough.

Class C

Level load is a constant deduction each year.

Class F

No Load

Max sales charge of mutual fund?

8.5%

What does annual operating expense include for mutual funds?

1. Management Fee
2. Distribution Fee
3. Other

What are the basic categories of mutual funds?

Passive (index) vs. Active funds
Growth vs value
Stock vs bond
Domestic vs international
Target?date funds
Target?date funds based their asset allocations on a specific date, typically, the assumed date for the investor.
Target?date fund rebalances from a

What is the tax liability faced by mutual fund investors?

Mutual funds must distribute at least 90% of their net investment income earned (bond coupons and stock dividends) exclusive of realized capital gains or losses to shareholders to be considered a regulated investment company.
Regulated Investment Company: