Slide 1: Non-Bank Financial Institutions
Week 3 – September 14, 2005
J. K. Dietrich - FBE 524 - Fall, 2005
Slide 2: Non-Bank Financial Institutions
Insurance-type
– Life and property and casualty – Pension funds
Asset management firms and funds Securities firms Others
– Finance companies – Mortgage bankers – Government-sponsored agencies
J. K. Dietrich - FBE 524 - Fall, 2005
Slide 3: Insurance Liabilities
Promise to pay depending on contingency
– Life - Pay upon death, or retirement – Property and casualty - Pay on occurrence of accident or loss due to theft or hazard (fire, weather, earthquake, flood)
Differences between life and accident
– Life probabilities known with accuracy – Casualty has two risks: incidence and severity
J. K. Dietrich - FBE 524 - Fall, 2005
Slide 4: Insurance Services
Life and annuity contract
– Probabilities usually not influenced by insured – Cash flows from coverage are predictable – Cancellations, lapses, policy loans
Casualty contract
– Period short – Policy-holders influence the incidence and severity of claims
J. K. Dietrich - FBE 524 - Fall, 2005
Slide 5: Life Insurance Contracts
Whole Life Contract Premiums, Benefits Premiums, Benefits Limited Pay Life
J. K. Dietrich - FBE 524 - Fall, 2005
Retirement Death Age
Retirement DeathAge
Slide 6: Life Insurance Contracts (cont’d)
Endowment Policy Premiums, Benefits Premiums, Benefits Life and Annuity
J. K. Dietrich - FBE 524 - Fall, 2005
Retirement Death Age
Retirement DeathAge
Slide 7: Insurance Distribution
Life insurance
– – – – Ordinary Group Industrial Credit
Independent agents Economics of insurance marketing
– Compensation of agents and brokers – Political power in the insurance industry
J. K. Dietrich - FBE 524 - Fall, 2005
Slide 8: Insurance Company Income
Revenue: Premium income
– Earned premiums
Investment income
Expenses: Policy Benefits and Losses
– Direct payments to claimants – Loss expenses (evaluation, processing)
Marketing expenses Non-interest expense
– Labor and related expenses – Communication, fees
J. K. Dietrich - FBE 524 - Fall, 2005
Slide 9: Insurance Market
J. K. Dietrich - FBE 524 - Fall, 2005
Slide 10: Life Insurance Assets
J. K. Dietrich - FBE 524 - Fall, 2005
Slide 11: Role of Insurance Equity
Equity in insurance is sometimes referred to as surplus since it represents premium collections above claims payments Income is approximately:
– Premiums + investment income – claims – Income/loss adds to/subtracts from equity
Equity or surplus absorbs large surges in claims as in catastrophes (e.g. Katrina)
J. K. Dietrich - FBE 524 - Fall, 2005
Slide 12: Insurance Balance Sheets
Balance sheet: liabilities are insurance reserves, unearned premiums, and surplus (plus equity capital) Assets are investments in corporate and municipal bonds, real estate, equities, Balance sheet management consists of matching asset risks to liability risks
– Many liabilities have long tails or durations
J. K. Dietrich - FBE 524 - Fall, 2005
Slide 13: Property-Casualty Insurance
J. K. Dietrich - FBE 524 - Fall, 2005
Slide 14: Contrast Life/Casualty Insurance
Probabilities of claims in life insurance are well known (vital statistics yield accurate actuarial estimates) Moral hazard limited in life insurance Dollar claims in casualty insurance are affected by incidence and severity of damages and may have more are affected by incidence and severity of damages and may have more systematic risk
J. K. Dietrich - FBE 524 - Fall, 2005
Slide 15: Pension Funds
Private versus state and local government Defined benefit versus defined contribution Self-directed pension plans Pensions, taxes, and responsibilities
– Corporate tax treatment – Personal tax treatment – Corporate responsibilities under ERISA
J. K. Dietrich - FBE 524 - Fall, 2005
Slide 16: Pension Fund Assets
J. K. Dietrich - FBE 524 - Fall, 2005
Slide 17: Asset Management
Economics of the industry
– Performance measurement – Principal-agent problems
A “temporary” disequilibrium
– Historical perspective
Services provided by asset managers Issues in asset management
J. K. Dietrich - FBE 524 - Fall, 2005
Slide 18: Asset Management Firms
Revenue: Management Fees
– Based on assets under management
Expenses: Research Costs
– Analysts (labor expense) – Data and computer expenses
Marketing expenses Non-interest expense
– Overhead labor and related expenses – Communication, fees
J. K. Dietrich - FBE 524 - Fall, 2005
Slide 19: Securities Firms
Brokers
– Find buyers for sellers – Organize markets
Dealers
– Provide liquidity to market – Hold inventories and take price risk
Securities originators
– Design and place financial instruments for primary market issuers
J. K. Dietrich - FBE 524 - Fall, 2005
Slide 20: Brokers and Investment Banking
Full-line firms offer retail and institutional trading, securities origination and financial advisory services, and market-making services Clearing brokers (e.g. Bear Stearns) present securities for settlement Wire houses transmit orders to other firms for execution
J. K. Dietrich - FBE 524 - Fall, 2005
Slide 21: Investment Banking
Bulge bracket firms (e.g. Morgan Stanley) are largest investment banking firms Regional firms (e.g. Wedbush Morgan) operate in local markets Boutique firms specialize in certain types of transactions (e.g high tech or health care) Terms are not mutually exclusive
J. K. Dietrich - FBE 524 - Fall, 2005
Slide 22: Securities Firm Income
Revenue:
Commissions Fees - Advisory, investment banking, asset Gains (and losses) and interest
management
Expenses:
Labor costs Communications and space Clearing fees Borrowing costs
J. K. Dietrich - FBE 524 - Fall, 2005
Slide 23: Finance Companies
Three basic types
– Captive finance companies (owned by manufacturer, e.g. GMAC) – Commercial finance companies and financial firm affiliates (owned by banks or other financial firms, e.g. Foothill Group) – Consumer or personal finance companies (specialized in high-risk finance, like Household Finance)
Funding sources - Bank credit, commercial paper, affiliate company financing
J. K. Dietrich - FBE 524 - Fall, 2005
Slide 24: Finance Company Investments
J. K. Dietrich - FBE 524 - Fall, 2005
Slide 25: Asset-Pools
Origination
– Government-sponsored agencies (GSEs)
» Federal National Mortgage Association (FNMA or Fannie May) » Federal Home Loan Mortgage Corporation (FHLMC or Freddie Mac) » Student Loan Marketing Corporation (SLMC or Sallie May)
– Private originators
Servicing
– Servicing fees and costs – Transactions in servicing portfolios
J. K. Dietrich - FBE 524 - Fall, 2005
Slide 26: Other Financial Firms
Mortgage banks Information and advisory firms Clearing firms and depositories Exchanges and communication networks Clear differences between types are eroding, but traditionally were due to
– Regulation, taxation, and charters – Specialization and expertise – Historical evolution
J. K. Dietrich - FBE 524 - Fall, 2005
Slide 27: Next week: Sept. 21, 2005
Read Chapters 4 and 17 of Money and Capital Markets Read selections from trade press selected by students and download handouts before class Form a group of three or four students for the group project and provide a tentative choice for the group project from the list provided or as discussed with me Bring a Wall Street Journal to class every Wednesday
J. K. Dietrich - FBE 524 - Fall, 2005
