Financial innovation and standards for the capital of life insurance companies

New England Economic Review, Jan-Feb, 1995 by Richard W. Kopcke

Annuities and GICs

Life insurance companies also offer other financial services to their customers, including guaranteed investment contracts and annuities. Guaranteed investment contracts (GICs) are similar to medium-term notes. A saver might be offered a return of 9 percent for three years. These contracts most frequently are sold to pension and retirement plans sponsored by employers. The appeal of GICs rests on their high yields combined with their guarantee of principal, and their maturities force purchasers to review these investments comparatively frequently.

Annuities promise to pay their beneficiaries an income for a specific interval of time, often from retirement until death. Annuities may be funded by making installment payments over several years or by making a single payment (often by transferring funds from other investments, such as balances in permanent insurance policies or employers' thrift and pension plans). The value of annuities depends very much on the return that an insurer earns on its assets. The greater the yield, the smaller are the installments required to fund a given annuity, and the greater are the income payments resulting from any given investment in an annuity. Annuities often allow policyholders the option to withdraw all or a portion of their cash values before the beneficiary begins receiving income payments from the contract. Though not so common in the past, annuities today generally impose redemption fees for early withdrawals, and the assets backing the annuities may be marked to current prices to value customers' withdrawals.

III. The Composition of Insurance Companies' Liabilities

During the first half of this century, the main business of life companies was the selling of life insurance, and the whole life policy was their most popular contract. By the mid-1950s, reserves against life insurance contracts accounted for almost three-quarters of the total reserves of life companies, and term insurance represented one-sixth of ordinary life insurance in force. The commitment to whole life insurance was sufficiently great that life insurance companies managed about one-fifth of all financial assets held by financial intermediaries, a share second only to that of commercial banks. Mutual life insurance companies, in turn, managed most of the industry's assets, having written nearly two-thirds of the life insurance in force.

Between the 1950s and the 1980s, the competition that accompanied rising interest rates reshaped the life insurance industry. Today, as measured by reserves, the selling of annuities has supplanted the selling of permanent insurance policies. Reserves backing life insurance account for only about three-tenths of the total reserves of life companies, and term insurance accounts for just under one-half of ordinary life insurance in force. Although the assets backing annuities and other products have grown much more rapidly than life insurance reserves, life companies now manage only about one-eighth of all financial assets held by financial intermediaries, a share exceeded by those of commercial banks and pension fund advisors. Furthermore, stock companies, which currently manage about three-fifths of the life insurance industry's assets, have overtaken the mutual companies.