Page 532 - Introduction to Business

506 PART 5 Finance

and consumers. Unlike depository institutions, they are not major participants in
the money market but do play a major role in the capital market. They pool together
the long-term savings of the country and allocate these funds to capital investments
in land, buildings, and equipment. Since these long-term savings are not insured by
the government, nondepository institutions are not as heavily regulated as deposi-
tory institutions. Exhibit 14.9 gives the sizes of different nondepository financial
institutions. Here we see that private pension funds are the largest nondepository
institution, followed by life insurance and mutual funds, which are similar in size.
Securities firms and other insurance companies like property-casualty insurance
firms are relatively small compared to the other types of nondepository institutions.

insurance companies Financial Insurance Companies. Historically, insurance companies are one of the
institutions that offer various kinds of most successful financial institutions. Their success proves that people and busi-
protection from financial losses to ness firms are risk averse and are willing to pay money to protect themselves from
individuals and business firms
financial losses. There are two types of insurance companies: life insurance com-
panies and property-casualty companies. Together, they represent the third largest
group of institutions, behind banks and pension funds.
Life insurance companies offer three basic types of financial protection to their
customers: death, old age or retirement, and medical. In each case an insurance pol-
icy is sold to customers that promises specific benefits to the individual or their ben-
eficiaries. Policyholders must pay monthly premiums to maintain their insurance
coverage. Premiums are invested by the life insurance company in bonds, stocks,
and real estate. The largest share of funds is invested in bonds. The reason for this
investment strategy is that life insurance companies are able to use actuarial science
to accurately predict such items as death rates. While it is difficult to predict when a
single person will die, for large groups of people it is possible to estimate the num-
ber of individuals who will die in any given year. With this knowledge in hand, the
life insurance company seeks to invest its funds in capital market instruments that
term insurance An insurance policy that
offers a lump sum death benefit to offer predictable cash flows over time to meet policyholder death benefits. In this
policyholders regard, bonds paying fixed interest payments over time are clearly superior to stocks
whole life insurance An insurance and real estate. Given relatively stable liabilities in the form of death benefits, in
policy that offers both a term policy plus addition to stable cash flows from bonds, life insurance companies are able to con-
a type of savings account that
increases in cash value over time as sistently earn fair profits and, therefore, tend to have low failure rates.
premiums are paid Three of the most popular life insurance policies are term insurance, whole life
annuity A type of savings plan offered or permanent insurance, and an annuity. Term insurance offers a lump sum death
by insurance companies that offers benefit to policyholders and is quite inexpensive to obtain. Whole life insurance
either a lump sum death benefit or a
steady stream of cash payments to offers both a term policy plus a type of savings account that increases in cash value
beneficiaries over time over time as premiums are paid. An annuity is a savings plan that offers either a

EXHIBIT 14.9
Total Asset Sizes of Different Kinds of U.S. Nondepository Institutions, 2003

Type of Nondepository Institution Total Asset Size (billions of dollars)

Private pension funds $7,936
Mutual funds $3,587
Life insurance $3,358
Securities firms $1,376
Other insurance $ 925

Source: “Flow of Funds Statements,” Board of Governors of the Federal Reserve System, Washington, DC,
http://www.federalreserve.gov/releases/Z1/Current.

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