1203AFE Lecture Notes - Lecture 11: Timeshare, Income Tax, Corporations Act 2001
30 May 2018
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Week 11 Money, Bank and Finance Lecture Notes
Topic 9: Insurance, Investments and superannuation
Why Insurance, Investments and Super?
• Insurance: taken for granted, important for risk management, important contributor
of capital.
• Iestet Cos: Thei performance influences national wealth significantly.
• Superannuation: Source of capital, important for national savings, wealth and
expenditure
Insurance
• Insurance is the transfer of a pure risk to an entity that pools the risk of loss and
provides payment if a loss occurs.
• Pure risks are risks in which there are two possible outcomes: loss or no loss.
• Insurance policies are contracts between the insurer and the insured to cover the
loss that may be suffered.
• In return, the insurer receives a fee called the insurance premium.
Objective Risk
• The risk that insurers face once they have accepted the risk from the insurance
purchasers is called objective risk.
• This is the deviation between actual losses and expected losses.
• Insurance is priced to cover expected losses and expenses.
• If loss levels are as predicted, the insurance mechanism works well.
Reducing Objective Risk
• Insurance companies reduce objective risk in a number of ways:
o Using the law of large numbers
o Careful underwriting
o Co-insurance
o Careful pricing
o Restrictive covenants
o Reinsurance
Privately Insurable Risk
• Certain conditions must be met before a private company can insure risk:
o There must be many similar exposure units so that risk can be predicted
using the law of large numbers.
o Losses that occur should be accidental and unintentional.
o Losses must not be catastrophic.
o Losses should be determinable and measurable.
o Chance of loss should be calculable.
o The premium for insurance must be affordable.
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Regulation
• In Australia, insurance companies are regulated by APRA.
• APRA is responsible for the prudential regulation of insurance companies and
monitors capital requirements and liquidity management.
Insurance Company Profits
• Insurance companies collect premiums and make payments when losses occur.
• If the premiums that are collected exceed the value of total claims, the insurance
company has made an underwriting profit.
• In addition, the insurance company earns investment income on the pooled
premiums.
Pricing Insurance
• The insurer must charge a premium that is high enough to cover claims and
administrative expenses and make a profit.
• The premiums must also be competitive or the insurance company will lose business.
• Essentially, pricing is a mathematical-statistical exercise that relies on the
measurement of the probability of insured events occurring.
The Relevance of Interest Rate Risk
• Interest rates are important in insurance pricing, especially for commercial property
and liability insurance.
• When interest rates are high, insurance companies tend to write a lot of business to
invest premium dollars at high rates.
• However, if interest rates fall unexpectedly, insurance companies may get into
trouble.
Types of Insurance
• Life Policies
o The purpose of life insurance is to provide financial support to dependents in
the case of premature death.
o There are a number of different types of life policies:
▪ Term life insurance
▪ Whole of life insurance
▪ Business overhead insurance
General Policies
• General insurers insure a variety of risks.
• General policies provide a predetermined payment should some event occur.
• There are many different types of general policies:
o Property
o Liability insurance
o Motor vehicle insurance
o Travel insurance
find more resources at oneclass.com
find more resources at oneclass.com
Health Insurance Policies
• Health insurance policies insure against the medical costs associated with illness and
injury.
• The Australian government has encouraged private health insurance to extend the
coverage provided by the taxpayer funded Medicare program.
• There is a very large array of health insurance policies available to the consumer.
Important Issues
• There are a number of issues faced by the insurance industry:
o Adverse selection: this refers to a situation where those most likely to suffer
a loss are most likely to insure.
o Moral hazard: this is a situation where the coverage of risk may lead to
complacency or inappropriate activities by the insured.
• Other important issues include:
o The viability of insurance companies
o The complexity of insurance contracts
o Redlining: the refusal by insurance companies to issue insurance in particular
geographic areas.
o Patents: the patenting of insurance products to protect them from
competitors.
o Securitisation of risk: the transfer of risk to capital markets through the
creation of a financial instrument.
Investment Companies
• Investment Funds
o Investment funds are collective investment vehicles.
o They gather funds from savers for investment in capital markets, money
markets or real estate.
o Investors pay a variety of fees in return for enjoying the opportunity to use
investment products that otherwise may not be available.
o This form of investment has the advantage of providing investors with risk
intermediation by investing in a diversified portfolio of assets.
Categories of Funds
• The main categories of funds are:
o Statutory funds of life insurance offices
o Superannuation funds
o Public unit trusts
o CMTs
o Common funds
o Friendly societies
find more resources at oneclass.com
find more resources at oneclass.com
Document Summary
Week 11 money, bank and finance lecture notes. Insurance: taken for granted, important for risk management, important contributor of capital. I(cid:374)(cid:448)est(cid:373)e(cid:374)t co(cid:859)s: thei(cid:396) performance influences national wealth significantly: superannuation: source of capital, important for national savings, wealth and expenditure. Insurance policies are contracts between the insurer and the insured to cover the loss that may be suffered. In return, the insurer receives a fee called the insurance premium. Objective risk: the risk that insurers face once they have accepted the risk from the insurance purchasers is called objective risk, this is the deviation between actual losses and expected losses. Insurance is priced to cover expected losses and expenses. If loss levels are as predicted, the insurance mechanism works well. Insurance companies reduce objective risk in a number of ways: using the law of large numbers, careful underwriting, co-insurance, careful pricing, restrictive covenants, reinsurance.
