2-Financial Markets Page 41 Wednesday, February 4, 2004 1:15 PM
Overview of Financial Markets, Financial Assets, and Market Participants 41From our discussion of asset/liability management and the manage-
ment of funds in the absence of liabilities, we can see that the invest-
ment strategy of one institutional investor may be inappropriate for
another. As with investment strategies, a security or asset class that may
be attractive for one institutional investor may be inappropriate for the
portfolio of another.
In the remainder of this section we look at the investment objective
of the major institutional investors. For each entity, the nature of the
liabilities and the strategies they use to accomplish their investment
objectives are also reviewed, as well as regulations that influence invest-
ment decisions.Insurance Companies
Insurance companies are financial intermediaries that, for a price, will
make a payment if a certain event occurs. They function as risk bearers.
There are two types of insurance companies: life insurance companies
(“life companies”) and property and casualty insurance companies
(“P&C companies”). The principal event that the former insures against
is death. Upon the death of a policyholder, a life insurance company
agrees to make either a lump sum payment or a series of payments to
the beneficiary of the policy. Life insurance protection is not the only
financial product sold by these companies; a major portion of the busi-
ness of life companies is in the area of providing retirement benefits. In
contrast, P&C companies insure against a wide variety of occurrences.
Two examples are automobile insurance and home insurance.
The key distinction between life and P&C companies lies in the dif-
ficulty of projecting whether a policyholder will be paid off and, if so,
how much the payment will be. While this is no simple task for either
type of insurance company, from an actuarial perspective it is easier for
a life company. The amount and timing of claims on P&C companies
are more difficult to predict because of the randomness of natural catas-
trophes and the unpredictability of court awards in liability cases. This
uncertainty about the timing and amount of cash outlays to satisfy
claims affects the investment strategies used by the managers of P&C
companies’ funds.Pension Funds
A pension plan is a fund that is established for the payment of retire-
ment benefits. The entities that establish pension plans—called plan
sponsors—are private business entities acting for their employees, state
and local entities on behalf of their employees, unions on behalf of their
members, and individuals for themselves. In the United States, corporate