Output of the U.S. Financial Sector: Measuring the services of banks and insurance companies

1. Output of the U.S. Financial Sector: Measuring the services of banks and insurance companies Brian C. Moyer Deputy Chief National Income and Wealth Division 10th OECD-NBS Workshop on National Accounts Paris, France November 6-10, 2006

2. Output of the financial sector • Financial sector includes: • commercial banks • credit unions • savings and loans • regulated investment companies • insurance companies • Output can be either priced or “implicit”

3. I. Implicit output of commercial banks • Current measure introduced in the 2003 NIPA comprehensive revision • Based on the 1993 System of National Accounts— Financial intermediation services indirectly measured (FISIM) • FISIM of commercial banks recognized for both depositors and borrowers

4. Implicit output of commercial banks • Implicit output of depositors’ and borrowers’ services calculated by type of liability and asset, respectively • Implicit output of depositors’ services YiD = (r – average rate paid) * average liability balance • Implicit output of borrowers’ services YiB = (average rate received – r) * average asset balance • Total implicit output of commercial banks Yi = YiD +YiB

5. Calculation of average rates • Based on “book value” calculations • average rate paid = (interest expense / average liability balance) • average rate received = (interest income / average asset balance) • Data available from commercial banks’ balance sheet and income statements

6. Calculation of the reference rate (r) • Pure cost of borrowing funds; does not include risk premiums or intermediation services • Ratio of interest income on U.S. Government Treasury and Agency securities (excluding mortgage- backed securities) to their value on balance sheets of commercial banks

7. Average rates and the reference rate average rate received percent reference rate average rate paid

8. Average rates and the reference rate • Spread between the reference rate and the average rate paid represents: • for depositors, foregone interest income • for banks, equilibrium cost of supplying services to depositors • Spread between the average rate received and the reference rate represents: • extra cost paid by borrowers for financial services received • extra revenue earned by banks as compensation for financial services supplied

9. Sector allocations of implicit output • Consumption of implicit output allocated to persons, government, rest of world, and businesses (corporations, sole proprietors, and partnerships) • Allocations estimated by asset and liability • Assets allocated based on sector distribution of loan/lease balances • Liabilities allocated based on sector ownership of deposit balances • Data available from the U.S. flow of funds accounts

10. Constant-price implicit output • Steps in the calculation Reference year total output (both priced and implicit) extrapolated with: volume index of banking output equals: constant-price total output less: constant-price output of priced services equals: constant-price implicit output • Sector shares of constant-price implicit output same as current-price sector shares

11. II. Output of insurance companies • Output of property and casualty (P&C) insurance companies includes: • transfer of risk • financial intermediation • administrative services, such as handling claims • Current measure introduced in the 2003 NIPA comprehensive revision • Similar treatment recommended by the Advisory Expert Group for the upcoming revision to the 1993 System of National Accounts

12. BEA’s previous measure of output • Output = net premiums – dividends paid to policy holders – actual losses • However, disasters often cause large swings in measured output of insurance companies

13. Consumption of household insurance premiums actual losses Sept 11 consumption=premiums– actual losses Hurricane Andrew

14. BEA’s current measure of output • Output = direct premiums earned + premium supplements – dividends paid to policy holders – normal (expected) losses incurred • More consistent with the behavior of insurance companies

15. Consumption of household insurance premiums normal losses consumption=premiums –normal losses

16. Output of P&C insurance companies • Direct premiums earned include transactions related to reinsurance • Premium supplements • Expected income earned by insurance companies from investing policyholder reserves • Used to supplement revenue from premiums to pay claims or purchase reinsurance services

17. Output of P&C insurance companies • Normal losses • Represent claims that insurance companies expect to pay in a period • Insurance companies determine premiums for a future period based on the claims they expect to pay; that is— Normal lossest = direct premiums earnedt * {0.3 * (direct losses incurredt-1 / direct premiums earnedt-1) + 0.7 * E[(direct losses incurredt-1 / direct premiums earnedt-1)]}

18. Adjusting for disasters • Effect of disasters on normal losses is “smoothed”; a portion of the disaster is added to normal losses for a 20-year period following the disaster • “Net insurance settlements” is the difference between actual and expected losses; it is recorded as a current transfer payment to policyholders from insurance companies

19. Constant-price insurance output • Currently based on a “single-deflation” technique using consumer price indexes and producer price indexes • Research underway to consider constant-price estimates based on “double-deflation” techniques