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MGT411 - Money & Banking - Lecture Handout 27

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  • Non-depository Institutions
  • Insurance Companies
  • Securities Firms
  • Finance Companies
  • Government Sponsored Enterprises

Non-depository Institutions

  • Insurance Companies
  • Securities Firms
  • Brokerage firms
  • Investment banks
  • Mutual fund companies
  • Finance Companies
  • Government Sponsored Enterprises

Insurance Companies

  • Insurance companies began hundreds of years ago with long sea voyages
  • The most famous insurance company, Lloyd’s of London, was established in 1688
  • Besides insuring traditional assets like airplane and ships, it also insures singers’ voices, pianists’ fingers and even food critics’ taste buds
  • Underwriting process refers to the risk assessment and loss reimbursement guarantee by the individual risk experts of the relevant field joining together to form a syndicate.
  • When an insurance contract is offered, these syndicates sign up for a certain portion of the risk in return for a portion of the risk premiums
  • Insurance process
  • Insurance companies accept premiums in exchange for the promise of compensation if certain event occurs
  • A home owner pays premium in return for the promise that if the house burns down, the insurance company will pay to rebuild it
  • So for individuals, insurance is way for transferring the risk
  • In terms of financial system as whole, insurance companies:
  • Pool small policies and make large investments
  • Diversify risks across a large population
  • Screen and monitor policyholders to mitigate the problem of asymmetric information
  • Two Types of Insurance Company:
  • Life insurance
  • Property and casualty insurance

Type of Life insurance

  • Term life insurance
  • Which makes a payment to the insured’s beneficiaries upon the death of the insured
  • Group insurance is obtained through employers
  • Whole life insurance
  • Combination of term life insurance and a savings account
  • A payment of a fixed premium over lifetime in return for a fixed benefit in case of death of policy holder
  • The cash value can be refunded if the policyholder decides to discontinue the policy
  • Over the years, the emphasis shifts from insurance to savings
  • Property and casualty Insurance
  • Auto insurance is a combination of property insurance on the car and casualty insurance on the driver
  • The policyholder pays premium in exchange for protection
  • Balance sheet
  • Liabilities
  • Promises to policyholders
  • Assets
  • Combination of bonds and stocks
  • Short term money market instruments (in case of property and casualty insurance)
  • The Role of Insurance Companies:
  • Insurance companies pool risk to generate predictable payouts
  • Adverse selection and moral hazard create problems in the insurance market that are worse than those in the stock and bond markets
  • Cancer Patients
  • Fire Insurance
  • To deal with this, insurance companies carefully screen applicants before issuing them policies
  • Medical Examination
  • Driving Records
  • Policies may also include restrictive covenants in order to reduce moral hazard
  • Fire extinguishing system and training
  • Careful
  • The future of insurance must be considered in the light of advances in medical technology, particularly with regard to the decoding of the human genome.
  • In the future, people with inherited tendencies toward certain diseases may not be able to get insurance

Securities Firms

  • The broad class of securities firms includes brokerages, investment banks, and mutual fund companies.
  • In one way or another, these are all financial intermediaries
  • The primary services of brokerage firms are accounting and the provision of access to secondary markets.
  • They also provide loans to customers who wish to purchase stock on margin, and they provide liquidity by offering check-writing privileges and by allowing investors to sell assets quickly
  • All securities firms are very much in the business of producing information; but this is truly at the heart of the investment banking business

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