FNCE 4102 Week 10 Financial Institution Profile Example

Profile of a Life Insurer's Promises and the Assets Behind Them: Policy Types and Claim Timing, Why Mortality Tables Let It Promise What No Individual Can, a Bond-Heavy Portfolio and How the Two Sides Are Matched

Student Name

Walden University

FNCE 4102: Financial Institutions and Markets

Instructor Name

Month Day, Year

Profile of a Life Insurer's Promises and the Assets Behind Them: Policy Types and Claim Timing, Why Mortality Tables Let It Promise What No Individual Can, a Bond-Heavy Portfolio and How the Two Sides Are Matched

The Institution

Meridian Life is a composite listed U.S. life insurer with about $90 billion in invested assets, built from the kinds of disclosures a life insurer's annual report contains. It sells three main products: term and whole life insurance, fixed annuities and group retirement plans for employers. Its business is to make long promises and invest the premiums until the promises come due (Mishkin & Eakins, 2018).

The Promises

Term life policies pay a death benefit if the insured dies within a set period, usually ten to thirty years. Whole life policies pay whenever the insured dies and build a cash value the owner can borrow against or surrender. Fixed annuities promise a stated interest rate on deposits and, for those who annuitize, a stream of payments for life. Group retirement contracts promise employers a guaranteed return on employee contributions.

No individual can know when they will die, but an insurer covering a million lives can predict, within a narrow range, how many will die each year. Mortality tables, built from decades of population and insured-life data, give the probability of death at each age. The law of large numbers turns individual uncertainty into a predictable total. That is why an insurer can promise a 40-year-old a $500,000 benefit for a premium of a few hundred dollars a year: it is not betting on one life but pricing a pool. The same tables, applied to annuitants, let it promise lifetime income, though longer lifespans have made that promise more expensive over time.

The Assets

The portfolio is dominated by investment-grade corporate bonds and mortgages, which pay a steady income above Treasury yields and have maturities long enough to match the company's obligations. Life insurers as a group are among the largest holders of U.S. corporate bonds for exactly this reason (National Association of Insurance Commissioners, n.d.).

Table 1

Meridian Life Invested Assets by Category

Composite insurer; shares typical of U.S. life insurer portfolios as reported in industry data.

How the Insurer Earns

Meridian earns in three ways. On annuities and retirement contracts it keeps a spread: if its portfolio yields 5.0 percent and it has promised policyholders an average of 3.5 percent, the 1.5-point difference pays expenses and profit. On life insurance it earns a mortality margin when deaths come in at or below what the tables predicted, plus investment income on premiums held before claims are paid. On some products it also charges fees. All three depend on the assets earning what the company expected and the promises costing what it priced, which is why the matching described next matters so much.

Matching the Two Sides

The average liability, weighted by when payments are expected, comes due in about 12 years; the asset portfolio's duration is about 11 years. Matching duration means that when interest rates change, the values of assets and liabilities move by similar amounts, protecting the insurer's surplus. The small gap of about one year means a fall in rates would reduce liability values slightly more than asset values, a modest exposure. Insurers also match cash flows: bond coupons and maturities are timed to cover expected claims in each year.

Where the Match Is Weakest

Three risks remain. First, interest rates: a long period of very low rates, as in the 2010s, squeezes the spread between what the insurer earns on new investments and what it has promised on older annuities. Second, credit: a recession that raised corporate defaults would hit the 55 percent corporate bond allocation. Third, longevity: if annuitants live longer than the tables assume, payments run longer than planned. Koijen and Yogo (2015) showed that during the 2008 crisis some life insurers sold policies at prices below the actuarial value to raise capital quickly, a sign of how stress on the asset side can feed back to the promises. Regulators address these risks through risk-based capital requirements that charge more capital for riskier assets.

References

Koijen, R. S. J., & Yogo, M. (2015). The cost of financial frictions for life insurers. American Economic Review, 105(1), 445-475. https://doi.org/10.1257/aer.20111496

Mishkin, F. S., & Eakins, S. G. (2018). Financial markets and institutions (9th ed.). Pearson.

National Association of Insurance Commissioners. (n.d.). Capital markets special reports. https://content.naic.org/capital-markets-bureau