The Mechanism through Which Insurance Companies Influence Innovation and Investment in the Economy - Assignment Example

Insurance 2 Name: Institution: Date: Question 1 Mechanism through which insurance companies influence entrepreneurial attitude, innovation and investment in the economy The recent economic literature has documented financial intermediation promoting economic growth. Most of these empirical studies provide evidence that financial development that plays a growth-supporting role. These financial intermediaries contribute to economic realizing number of functions that do affect marginal productivity of capital, efficiency of channeling saving to investment, saving rate and technological innovation. While financial intermediation has a broader coverage with most of it linked to financial development and economic growth, which is all based on banking intermediation (Ralf, 2000). Although, other financial intermediaries are growing in importance among them insurance firms, but when compared to what is available on other financial institution. The insurance companies be part of the financial system fulfill a number of financial system’s roles, and through certain channels that are recognized due to the development of endogenous growth models this is believed to promote economic growth. The concept offered by insurance firms affect economic growth through three channels, which include changing marginal productivity of capital , proportion of saving funneled to investment and saving rate (Blum et al, 2002). The other view of these concepts is displayed through focus directed on the technological innovation as a channel through which businesses economical growth is influenced. Therefore, these channels connect financial intermediation to economic growth, since the insurance firms act as financial intermediaries. The same conduits attach their meanings with financial growth. Provision of business protection, insurers offer economic growth through channels of marginal productivity of capital, technological innovation and saving rate. Insurance firms indemnify business entities who suffer a loss and stabilize their financial position of firms and individuals. With the possibility of transferring dissimilar kind of dangers to insurance corporations, risk unfavorable economic unit are more induced t buy goods, especially those of higher values. This way, the insurance firms are able to sustain demand or consumption for goods and services, something that encourages production and employment and finally, promote economic growth (Ralf, 2000). Firms bare various hazards of their responsibility, possessions, ill health and disability of their workers among other elements, can possibly manage those risks by transferring them to the insurance firms. This helps business entities to focus their consideration and capital on core big business functions. Therefore, businesses are more willing and able to take real investments which results in higher rate of economic growth. Similarly, business owners are encouraged to take not only investments that encompass present products and production processes, but also these including technological innovation. For instance, insurance firms that involve in innovative presuppose the willingness to take the risk. Considering that insurance does not change the risk attitude of economic units, it players a key role in freeing Innovative risk which insurance part of the economic activities would not take place and hence positive effects on social welfare get to fail. Question 2 Mechanism through which casualty and property insurance and life insurance contribute to the stability of consumption and as a consequence to the stability of the economy. The role of the insurance sector and links to other financial sectors has grown in importance. While a relationship exist between the bank lending and economic growth, capital markets and economic growth, the insurance sector has not received ample attention in this sector. It is important that we consider the endogenity existing between insurance variables and economic growth. By understanding this, it is therefore possible to use other variables in explaining other influence on economic growth and insurance activity. The role of the financial sector involves channeling resources from savers to investment projects. Blum et al (2002), believes that the analogy that insurance firms hold towards other financial sectors is the link between the insurance and those of real sector, which is classified in terms of causality with respect to difference hypotheses, which may include no casual relations and demand-follow. For instance, economic growth triggers increased demand for insurance, while insurance service supply leads to growth in the insurance smoothening short-term economic volatility hence inducing economic growth at long-run. The major functionality of insurance on the client side is the risk transfer. The insured pays a premium and is secured against a specific uncertainty. This is often, measured according to the insurance premium rewarded relative to GDP, that is the significance of insurance-based danger transfer increased by one third between 1992 to 2002 in Europe, this kind of information is used to measure insurance sector’s impact on the economy. Insurance firms are place in our economy to breach the gap, by reducing uncertainty and volatility. This is often achieved, where insurance firms are involved in smoothening the economic cycle and reducing the effect created due to impact caused by crisis situations on micro and aggregate macro level. There is demand for protection against losses of property caused by natural disaster, crime, violence or accidents. Purchase, possession and sale of goods, assets and among other things are all made easy by indemnification of the insurance. Therefore, the assured safety of the property for instance, boosts trade, transportation and capital lending as many sectors heavily rely on insurance services. Besides the insurances services relieves the fear of risk-averse individuals in buying assets and thus increasing consumption, the insurances aid businesses in resisting threats accruing from business activities which represent the loss of property. Similarly, the insurance services protect businesses and individuals against possible negative outcomes on activities carried out by either individuals or firms threatening themselves, others or the future abilities of both ( Ralf, 2000). Part II Horizon Insurance Corporation Balance Sheet as at 31st December 2010 Task 1 Assets Non-current Asset Amount in $ Amount in $ Commercial Buildings $ 30,000,000 Office Equipment $ 3,000,000 $ 33,000,000 Bonds $350,000,000 Common Stock $ 115,000,000 Total investments Current Asset Cash and Money markets investments $ 18,000,000 Mortgage relates to securities $ 40,000,000 Premiums receivable $35,000,000 $ 93,000,000 Balancing figure (Suspense account) 5 $ 5,200,000 Total Assets 596,200,000 Capital Equity and Liability Capital Long-term Liabilities unassigned portion of the total surplus $ 180,000,000 Short-term Liabilities Commission payable $11,000,000 Loss adjustment expenses $ 10,000,000 Unearned Premiums $125,000,000 Loss on Reserves $170,000,000 216,000,000 Business profit for the year $ 202,200,000 Less: Dividends (Assuming this are paid dividends) $ (2,000,000) 200,200,000 Total 596,200,000 Task 2 Considering that the paid in capital represents the cash and money investments. 10% = $ 18,000,000 100% = unassigned portion of the total surplus. (100% *18,000,000)/ 10% =180,000,000 Task 3 The nature of insurance side of business is such practically all outlays are viewed as operating cost to be restricted, and the character of the defined investment side. The process of determining a fair value of investments and whether or not an investment is recoverable relies with on the projection of the future HIC business cash flows, investment operating results and market conditions. Projections are inherently uncertain and actual future cash flows may differ materially from projected cash flows. The company’s investment valuations are susceptible to risk inherent in making projections. In the normal course of business, the company assumes and codes insurance business in order to limit its maximum loss provides greater diversification of risk, reducing exposure on larger risks and expanding certain business lines. The ceding of indemnity business fails to free an insurer from its main legal responsibility to a policy holder. The life premiums for instance, are regarded as income over premium paying periods of policies. Health and accident premiums are recognized as the income over the terms of policies. Bonds and stocks are part of the HIC business investment, which can be valued, whereby bonds eligible for amortization under such rules given under the amortization cost. The business can invest in loan-backed securities are stated at a mortised cost using prospective basis. Consumer groups have alleged that property-casualty insurers are earnings. It is important to outline some certain basic principles governing monetary operations of insurance business and related purpose such as service values and guaranteeing. Insurance is a unique business in that insurers sell contracts that promise to pay claims contingent on the future that are uncertain. Volatility in the investment environment can also significantly affect insurers’ investments when it regards annual profits. Similar, to other business firms, NIC insurance has to administer their general performance as well as organizations performance in definite merchandise lines. Whereas insurer may consider economies of scope across certain lines of business and use their capital in covering higher than expected losses in any line they write, they cannot support sustained losses in one line from profits in another line. Retained earnings are the principal source of capital for NIC. Mutual firm also may issue surplus to their insurers earnings are elevated than the essential to uphold a sufficient rank of resources to support their processes. Part 2B 1. HIC Income Statement for 31st December 2009 Amount in $ Amount in $ Premium Earned $ 185,000,000 Premium Written $ 180,000,000 Interest income $ 12,000,000 Rental Income $ 400,000 Capital gain from Securities $ 8000,000 Total income $ 378,200,000 Less: Net loss incurred $(115,000,000) Gross Profit $ 263,200,000 Less: Expenses General expenses $35,000,000 Taxes $ 4,000,000 Commissions $ 12,000,000 Loss adjustment expenses $ 10,000,000 Total expenses $ 61,000,000 Net profit for the year $ 202,200,000 2. The essence of managing risk is making good decisions. Correct decision making, is influenced by the exactness of the information given and proper analysis. Comparing the HIC general asset and liability obligation the firm financial position reveals a positive result. This makes the business well placed to support both long term and short term obligations. On a short term basis the business is able to make profit importantly for boosting increased service to the business customers through increased investment. 3. Distinguish between class rating and merit rating. Illustrate your answer with one example for each. In business merit rating is referred to as the appraisal of an employee’s performance. It is often used to determine promotions and raises. According to Bailey (2005), private passengers’ automobile insurance uses multiple classification system. Under merit rating, one can classify by use of age for instance, within each age classification can be achieved by looking at occupation and within each age classify by use of gender. For insurance firms, a class plan involving the use of age, sex and occupation fails to precisely identify each risk as per the value. In Canada, the underwriters have long recognized this, which is further covered comprehensively by the meriting experience identifying risks that are accident free for three or more years than their class. Michelle (2010), the Canadian merit rating experience reveals that cars that qualify for best merit rating have different accident frequency in regard to the kind of rank they are identified to be in. for instance, the private automobile passenger risks vary considerably from each other, while the class plan and the merit plan are both attempts use to separate better risks from poorer risks. In actual sense, neither of the plans is perfect. Thus far it is evident that both merit rating and class rating are of equal effectiveness and if used in combination a substantial improvement can be realized, both leave unanalyzed considering the number of variation among risks. 4. Suppose that HIC insured 100,000 homes in one of the provinces it operates. The company expects to pay $20,000,000 in incurred losses and loss-adjustment expenses to these 100,000 homes. Determine for HIC’s home insurance (a) the pure premium (b) the gross rate per unit of coverage a) Calculating pure premium Pure premium = (Actual loss + Loss-adjusted expenses)/ Number of Exposure Units = (20,000,000 + 10,000,000)/ 100,000 = 10,000,000/100,000 =$ 100 per unit b). the gross rate per unit coverage Gross rate = Pure premium + load = 100 + 1000 =$ 1100/100,000 units = $ 0.011 per unit Load = home units covered / pure premium = 100,000/ 100 = 1000 5. Explain why an insurance company can lose money from its underwriting operations and yet report profits on its income statement. Illustrate your answer with an example. The indemnity market has lengthy been question to pricing cycle. Insurance market pricing may produce breakeven point profitability results or even operating losses for some companies. The soft markets for instance occurs when with the economic tendency of commodity business operate at either breakeven point or closer to that (Michelle, 2010). Since one underwriter may fail to meet his premium target without lowering price, there is need to price below the market price. Eventually other under writers follows suit, or risk filing to meet their premium targets. This results to a downward spiral of insurance prices. A delay in filling rates decreases slowing the process further. On the contrary, the price never same as the field rates, for instance, a commercial insurance rate has to be filed, but for different firms that are a fraction of a business group often has different rates, and a choice of the firm to place a risk in is underwriter. In addition, price deterioration causes many insurance businesses prices are below discounted losses and expenses (Baldwin, 2001). On the contrary, the surplus and discount inherent in the loss reserves still earns investment income. If we consider this the firm may eventually generate profits through their investment departments. At a certain stage, many companies started to reduce adequacy of their loss reserves creating a semblance of profitability (Michelle, 2010). Similarly, some firms may choose to lay off their securities and buy others at the point, as long as the stock or bond market is priced at a higher price, sufficient to generate a capital growth on securities sold hence generating more of a semblance of profitability. The economic theory indicates that for companies that survive in a commodity business are those that have lower cost structure. This has to be one way in lowering the cost structure, and which is important with a particular national accounts responsible for paying their own actual losses rather than projected losses, in having lower expenses. References Baldwin, B. G. (2001). advisor, The new life insurance investment. New York: McGraw-Hill Professional. Blum et al (2002). The Financial-Real Sector Nexus: Theory and Empirical Evidence, IEF Working Paper . Research Institute for European Affairs, University of Economics and Business Adminstration . Michelle A. Green, J. A. (2010). Understanding Health Insurance: A Guide to Billing and Reimbursement. London: Cengage Learning. Ralf, Z. (2000). Does Insurance promote economic growth – evidence from OECD Countries. The Journal of Risk and Insurance , Vol.67(4): 489-506 Read More