4.1 Insurance companies

Figure 4.1(a) shows the assets held at the end of 2004 by rms conducting general

insurance business. The two most conspicuous features are the large holdings of

UK shares, amounting to nearly 17 per cent of total assets, and of overseas shares,

accounting for another 16 per cent. Given that the purpose of a general insurance

company is to provide a pool of funds from which to meet claims which are by their

nature uncertain: and given also that their policies are mainly short term – clients can

terminate or renew annually – this proportion of long-term assets may be surprising.

However, this overlooks two points. Firstly, while it may be true that individual clients

can and do terminate contracts frequently, they do this to move from one company

to another: every year each company loses existing customers but gains new ones.

Rather like banks, in the aggregate, premium income is fairly stable. Secondly, during

the 1980 and 90s it became common for rms to make ‘underwriting losses’. That is

to say that their premium income was insufcient to meet claims and the difference

has therefore had to be met from investment income. This has made the protability

of investment very important. Thus the companies’ approach to investment has been

to ensure that there is sufcient availability of short-term assets to meet unforeseen

contingencies and then to maximise holdings of long-dated, higher-yielding assets.

If we were to look at both stocks and ows together for the most recent years,

say 2000 to 2004, insurance companies have tended to dispose of UK ordinary com-

pany shares and government securities (a trend now reversed). What the gures

obscure, however, is a switch from ordinary company shares into preference shares

and corporate bonds. This is a useful reminder that stock gures are a snapshot of

the position at a particular moment: the ow gures will often reveal that the stock

is in the course of changing. Notice, though, that while ow gures are useful in

telling us the directions in which companies channel the funds they most recently

received, they do not tell us how active those companies are in any particular market.

In Chapter 6, for example, we shall see from turnover data that insurance companies

can be very important traders of company securities even if their netacquisitions

(positive or negative) are small.

Figure 4.1(b) shows the aggregate portfolio for long-term insurance companies.

The conspicuous features are like those for general insurance companies. There is a

very heavy concentration on securities of all types, amounting to 72 per cent of the

whole portfolio. However, they have larger holdings of land and property. There is

also a difference when we come to consider ‘short-term assets’. At 5 per cent of total

assets for long-term funds, they form a smaller proportion than they do for general

insurance companies and this suggests that the latter are more liquid. In fact, the

difference is even larger than it appears since ‘other assets’ is a much larger category

for general insurance companies and this too is made up largely of short-term and

fairly liquid assets (agents and reinsurance balances, for example). The message is

that long-term insurance funds hold a much higher proportion of longer-term assets

than do general funds. To understand why they do so, it is necessary to consider the

nature of a long-term fund’s liabilities.

As we said earlier, long-term insurance contracts enable people to insure against

such events as death or permanent illness or disablement. For obvious reasons, life

(i.e. death)-related contracts dominate. These may be of various forms. A person can

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Chapter 4 • Non-deposit-taking institutions

insure against death within a specied period, the policy paying nothing if the insured

survives. This is known as term insurance. Alternatively a whole-of-life policy insures

against death at any time. An endowment policy pays a capital sum to the insured at

a specied time in the future, or on death if earlier. This sum may be a guaranteed

absolute amount, in which case the insured has a policy ‘without prots’, or there may

be a guaranteed minimum plus an entitlement to share in the company’s annual

prots. On this ‘with prots’ type of policy the shares accrue as annual bonuses and are

paid with the guaranteed minimum on termination of the policy. Under an annuity

policy the company pays a regular income to the insured for a specied period up

until death, in return either for a lump sum payment or regular contributions earlier

in life. This cannot be an exhaustive list (see Box 4.2) since, like other nancial inter-

mediaries, insurance companies are continually developing new products. Nonetheless

it makes two features of long-term insurance policies very clear.

Box 4.2

Types of life assurance product

Annuity: A policy which provides the holder with a regular stream of payments from

some specied date until death. An annuity is purchased by a large lump sum payment

(often at the point of retirement) though the lump sum may be accumulated by regular

payments into a fund previously established for the purpose.

Endowment: A policy requiring regular contributions which pays a specied sum on a

specied date or on the death of the insured if this should occur earlier. This is a long-

term savings product, with an element of insurance, often sold in conjunction with some

xed-term loan (e.g. a mortgage) in order that the specied sum will pay off the loan.

Term assurance: A policy requiring regular contributions which makes a payment to a

named survivor if the insured dies within a specied period. If the insured lives beyond

the specied date, nothing is paid. The only life assurance product which provides no

element of saving.

Whole of life: A policy, normally requiring regular contributions, which makes a payment

to a named survivor only on the death of the insured.

The rst is that they are contractual. People taking out policies of the kind just

described are committing themselves to paying premiums as part of a long-term

contract. They can, of course, cease payment at any time, but they break the contract

and forgo virtually all the benets since very little compensation is usually available

for the premiums which have already been paid. Secondly, unlike general insurance,

the motivation behind many life-related policies is essentially a desire to save for the

future, either for one’s own benet or for the benet of dependants. This means,

of course, that life insurance companies, while obviously offering products that are

distinct by virtue of their pure insurance element, are to some extent in competition

with other intermediaries whose function is mainly to attract long-term savings.

The nature of these policies determines the risks to which long-term funds are

exposed. Actuarial predictions of a country’s mortality record are now very reliable,

but it is at least a theoretical risk that the record could deteriorate unexpectedly. A bit

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