Insurance company:
Because death rates for the population as a whole are predictable with a high degree of certainty, life insurance company can accurately predict what their payouts to policyholders will be in the future. Consequently, they hold long term assets that are not particularly liquid.
Insurance companies use the premiums paid on policies to invest in assets such as bonds, stocks, mortgages and other loans; the earnings from these assets are then used to pay out claims on the policies.
Ways to reduce moral hazards and adverse selection:
(1) information collection (reduce adverse selection)
(2) risk-based premiums, risk classification (reduce adverse selection)
(3) restrictive provisions (reduce moral hazard)
(4) prevention of fraud (reduce moral hazard)
(5) deductibles: the fixed amount by which the insured's loss is reduced when a claim is paid off. A 250$ deductible on an auto policy means that if you suffer a loss of 1000$ because of an accident, the insurance company will pay you only 750$. (reduce moral hazard)
(6) coinsurance: works exactly the same as deductible
(7) limits on the amount of insurance
Pension funds:
Because the benefits paid out of the pension fund each year are highly predictable, pension funds invest in long term securities,with the bulk of their asset holdings in bonds, stocks, and long term mortgages.
Private pension funds are administered by a bank, a life insurance company or a pension fund manager.
Public pension plans: social securities. Unlike a private pension plan, paid-out benefits are not tied closely to a participant's past contributions, so typically they are paid out from current contributions. This "pay-as-you-go" system can leads to great underfunding, which means that a person's contribution and earnings do not cover what he gets from the pension fund.
Mutual funds:
financial intermediaries that pool the resources of many small investors by selling them shares and using the proceeds to buy securities. Mutual funds allow the small investors to obtain the benefits of lower transactions costs in purchasing securities and to take advantage of the reduction of risk by diversifying the portfolio of securities held.
Federal Credit Agency:
Housing sector: Ginne Mae, Fannie Mae, Freddie Mac
Farm: Farmer Mae
Student loans: Sallie Mae
Government loan guarantees; acts like insurance: it insures the lender from any loss if the borrower defaults.
Housing: FHA, Veterans Administrations, Urban Development
Farm and education
Securities market institutions:
Investment banks: When a corporation wishes to borrow funds, it hires the services of an investment bank to help sell its securities.
(1) They advise the corporation whether it should issue bond or stock
(2) underwriters--investment banks that guarantee the corporation a price on the securities and then sell them to the market
Securities brokers and dealers: conduct trading in secondary market.
Brokers: match buyers with sellers (don't own securities themselves)
Dealers: link buyers and sellers by standing ready to buy and sell securities at given prices, They hold inventories of securities and make their living by selling these securities for a slightly higher price than they paid for them.
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