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CHAPTER 14 Understanding the Financial System, Money, and Banking 507

lump sum death benefit or a steady stream of cash payments to beneficiaries over
time. Many times group life insurance policies are sold to business firms and gov-
ernment agencies to offer to their employees at more competitive premium rates
than an individual could negotiate with the life insurance company. Additionally,
life insurance companies offer medical insurance that covers most costs associ- medical insurance An insurance policy
ated with doctor, hospital, and pharmacy drug expenses. Because the cost of med- that covers most costs associated with
doctor, hospital, and pharmacy drug
ical insurance can be high, most people co-insure through their employer under
expenses
group insurance plans; for example, your employer would pay $1000 of your
monthly premium and you would pay $400, for a total of $1400. You can see that
purchasing medical insurance on your own would be much more expensive.
Property-casualty insurance companies provide policies to protect property, property-casualty insurance Insurance
such as homes, buildings, vehicles, and other capital assets. Auto insurance, fire policies to protect property, such as
homes, buildings, vehicles, and other
insurance, theft insurance, workers’ compensation insurance, crop and hail
capital assets
damage insurance, and environmental insurance are some of the most popular
property-casualty policies.
Life insurance and property-casualty companies can be classified as stock versus
mutual organizations. Stock organizations have separate owners and policyholders. In
mutual organizations there are no stockholders, so the policyholders are considered
the owners. Whereas dividends are paid to stockholders in stock organizations, they
are paid to policyholders in the form of lower premiums in mutual organizations.

Pension Funds. Pension funds are a relative newcomer among financial insti- pension funds Financial institutions that
tutions, but their growth since 1950 has been phenomenal. Most individuals seek to offer various kinds of retirement savings
plans to individuals
retire from work later in life. A typical retirement age is 65. On retirement, one must
live on savings accumulated during one’s working years. Pension funds are the pri-
mary source of savings for most people.
Many firms have matching programs in which, for every dollar saved by a per-
son in the pension fund, the firm will put a second dollar in the fund. Another
incentive to save in pension funds is that the contributions to the plan are not tax-
able. If a person made $1000 before taxes, and then put $50 in her or his pension
fund, the firm would put another $50 into the fund, and the taxable income for the
person would now be $950. The reduction in taxes is $50 times the tax rate of the
person; a 30 percent tax rate would mean a $15 tax savings.
Pension funds take the savings of individuals and invest them in stocks, bonds,
and real estate. This brings up a further incentive to save in pension funds; namely,
earnings on the investments are not taxed by the government. When funds are
eventually taken out of the pension plan on retirement, individuals must pay
income taxes. However, because taxes are deferred for so long, the tax burden on
retirement savings is quite small. If you do not like to pay taxes, put your money in defined contribution plan A type of
a retirement account. pension plan in which the employee
sets aside a portion of her or his
What kinds of retirement plans are there? The example above is a defined
paycheck in a savings plan and the
contribution plan, which is the most common type of pension plan in the United employer provides matching funds in
States today. Historically, the most popular pension plan was the defined benefit many cases
plan. In this plan the employer promises to pay out a specified amount of monthly defined benefit plan A type of pension
plan in which the employer promises to
pay to an employee on his or her retirement. For instance, the firm might pay 70
pay out a specified amount of monthly
percent of the average of the employee’s last 10 years’ annual wages and salary. pay to an employee upon his or her
These so-called public pension plans are often offered by government entities at retirement
the federal, state, and local level. Because they are backed by the taxing power of public pension plans Pension plans
government, they are relatively safe. However, private firms that offer these plans offered by federal, state, and local
government that are backed by the
expose their employees to the risk that they will fail and be unable to meet defined taxing power of the government
benefit payments to retirees. For this reason, private pension plans offered by firms private pension plans Pension plans
are normally defined contribution plans. offered by private firms to employees

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