INSURANCE AND PENSION FUND OPERATIONS

1. INSURANCE AND PENSION FUND OPERATIONS CHAPTER 25 Dr David P Echevarria

2. TYPES OF LIFE INSURANCE POLICIES • Term Life • Whole-Life • Group Plans • Annuities Dr David P Echevarria

3. SOURCES AND USES OF INSURANCE COMPANY FUNDS • Principal Source: Premiums • Secondary Sources: Sale of Bonds, Equity • Uses of Funds • Government Securities (Treasuries) • Corporate Securities (legal list) • Mortgages (Residential Loans) • Commercial Real Estate Loans • Policy Loans Dr David P Echevarria

4. REINSURANCE,REGULATION& PERFORMANCE • Insuring against extra-ordinary losses • Lloyds of London one of the first major players • State regulation predominates • A.M. Best ratings Dr David P Echevarria

5. PENSION FUNDS • Federal Legislation; • Employment Retirement Security Act (1974); ERISA • Regulation of pension plans • Eligibility, vesting, funding • Fiduciary responsibilities • Reporting and disclosure • Plan termination insurance; Pension Benefit Guaranty Corp Dr David P Echevarria

6. PENSION FUNDS • Determining the required level of Funding: • Determining the Earnings rate of the Fund • Present Value of Benefits = Market Value of Fund • OVER-Funded = PV of Benefit liabilities < MV of Fund UNDER-Funded = PV of Benefit liabilities > MV of the Fund unfunded deficits are liabilities of the firm • Defining Benefits: • ACCRUED: based on years of service for all employees • PV of Benefits fro past service regardless of vested • VESTED: based on employees that reach vested status. Benefits to be paid if all employees who are vested retired when expected to do so. Dr David P Echevarria

7. PENSION FUNDS • Types of Plans: • Defined Contribution Plans: • Benefit levels determined by the investment experience of the fund • Both employer and employee contribute to plan (typ. pre-tax dollars) • Defined Benefit Plans: A contractual benefit (an annuity) payouts based on actuarial tables and length of service. Under ERISA, these are corporate liabilities enforceable by law • Vesting Schedules (1989 revision) • 100% after 5 years of service • Graded vesting: 20% after 3 years, then 20% each additional year until 100% vested • Pension formulas vary; (base % + add-ons * years) * MAX salary Dr David P Echevarria

8. PENSION FUND MANAGEMENT • Insured Vs. Trust Portfolios • Insured; insurance annuity plans with guaranteed returns • Trust; the atypical stock investment plan via mutual fund portfolios • Insured funds sensitive to interest rate risk, trust portfolios to acumen of fund managers and the vagaries of the market • Risk management is essential • Stock funds manage risk by selecting sectors or particular stocks • May also use derivatives to hedge rate-sensitive investments Dr David P Echevarria

9. PENSION PORTFOLIO EVALUATION & REGULATION • Expense ratios versus performance • Academic Measures • Sharpe Index: excess return to risk • Jensen's Alpha: the ability to earn return independent of the market • Pension Benefit Guarantee Corporation (PBGC) • The FDIC of pension plans • Pension Funds Must be Prudently Managed; role of Fiduciaries Dr David P Echevarria

10. HOMEWORK QUESTIONS • What is the importance of determining the under- or over-funding of a pension fund? • How do accrued benefits differ from vested benefits? • Why might corporations prefer defined contribution plans? • Why might employees prefer defined benefit plans? • In your estimation, which plan is better and why? • Why are insured plans easier (or harder) to manage? • What role does the PBGC play with regard to pension plans? • How is the PBGC funded? Dr David P Echevarria