Scope of Insurance Companies (Essay Sample)

Scope of insurance companies
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Abstract
Insurance companies generate income through investments and profits from the underwriting business. Insurance companies are major players in primary markets. The firms have reduced losses from challenges such as moral hazard and adverse selection through direct and indirect methods. Whole life insurance is fundamentally different from term insurance in the actual period of the cover. Different regulatory authorities regulate insurance firms globally.
Scope of Insurance Companies
The insurance industry is an important industry in every economy. Insurance products and policies provide relief for enterprises and households during distress and losses. The emergence of insurance behemoths such as Prudential Financial, AIG (American International Group) and Berkshire Hathaway has positively influenced the industry. The essay seeks to evaluate how insurance companies make money and engage in primary markets. Furthermore, the essay evaluates insulation mechanisms by insurance firms against moral hazard and adverse selection. Consequently, the essay clearly describes differences between whole and term insurance and explains the various regulatory regimes in the insurance industry.
Profit Making
Insurance companies primarily make profits through investing premiums in a mix of short and long-term ventures and underwriting proceeds. Different regulatory regimes establish how insurance firms should meet clients’ obligations and make profits. Insurance companies insure customers with similar risks as underpinned by the enterprise’s risk profile. Clients with motor cover from the same insurance company are unlikely to suffer losses at the same. The firm invests a bulk of the float on bonds, bank deposits, and Treasury bills. The short-term funds offer income and are easier to convert into cash in the short run (Andritzky, 2012). Moreover, insurance companies invest limited resources in long-term assets such as real estate and equity holdings in companies. Underwriting business is also an important income earner for insurance firms, especially in the frontier markets. Therefore, insurance companies earn profits through a mix of products sold.
Primary Markets Participation
Insurance companies involvement in primary markets is through the purchase of new stock. Primarily, fund managers employed by insurance companies invest in long-term projects. Insurance companies buy large holdings in companies selling new stock and earn dividend income and appreciation of the assets (Saunders & Cornett, 2012). British American Investments Company (Britam), a major insurer in East and Central Africa, holds significant stakes in Housing Finance and Equity bank. Primarily, insurance companies collect premiums and invest through primary markets to earn profits. Commercial banks accept deposits and convert the deposits to loans; insurance companies similarly convert premiums to investment. Insurance players in the US alone hold premiums worth more than US$100 billion. However, the bailout of AIG elaborates the negative aspects of excessively large insurance firms (Baranoff, 2012). Consequently, insurance firms are effectively major players in the primary markets.
Moral Hazard and Adverse Selection Checks
Insured clients may engage in more risky behavior after purchasing insurance cover. A motorist may tend to drive carelessly, after being insured. High-risk individuals (smokers) taking health insurance are more likely to suffer a loss, either due to health deterioration or sickness. Insurance companies charge differently depending on the level of risk. Insurance companies especially in health insurance, have different classes such as smokers and non-smokers. Insurance companies control the two through direct and indirect methods. The direct method preferred in the auto insurance category mainly implemented through deductibles (Ben-Shahar & Logue, 2012). An insured is liable for a certain amount of the occurrence of a loss. The insured is considered high risk and discourages the insured in engaging in risky behavior and high premiums, unlike other car owners. The indirect methods are appraisal and warranties. A car may provide guarantees to the insurance companies based on an independent evaluation to reduce information asymmetry. Furthermore, appraisal of the car will similarly give similar information. Therefore, the two are adequately controlled through direct and indirect ways.
Insurance Policies and Regime
Insurance is the process of hedging against uncertainties in future by a firm or individual. Insurance offers a broad range of policies such as term and whole life insurance. The two are fundamentally different. Term insurance guarantees benefits upon death within the term, unlike whole life that promises benefits upon death at any time. Moreover, premiums are expected to increase with time for term insurance, unlike whole life insurance where premiums are constant. Furthermore, term insurance pays on the occurrence of death and has no cash accumulation. Whole life insurance offers cash accumulation and eventual payment of premiums in future through interest on money accumulated in some cases (Cummins, Smith, Vance & Vanderhel, 2013). However, term policies are convertible to a permanent insurance. Different regulatory frameworks regulate the insurance sector in the world. State departments and an umbrella association of Commissioners regulate...