BUAD 808: Business & Company Law
What is the primary function of an insurance company? How does this function compare with the primary function of a depository institution?
Dawari Ete Akobo – DP17MBA0967
Ozigi Abubakar – ABUMBA02015007508
Samsu Aaron Gombwer – DP17MBA008381
Okpa Eze Jeremiah – ABUMBA2017012222
Philip Chijioke Annie – ABUMBA02015004371
Financial institutions are businesses which offer multiple services in banking and finance. These are divided into depository and non-depository institutions. They serve as financial intermediaries between savers and borrowers and direct the flow of funds between the two groups (Hamouda, 2018). Insurance companies belong to the category of financial institutions known as non-deposit institutions such as life insurance which is involved in annuities and pensions products, while the other non-life insurance which sells other types of insurance (Dusan, et al, 2015). This assignment discusses the primary function of an insurance company and compares the function of the insurance company with a commercial bank a depository institution.
Financial institutions serve as financial intermediaries between savers and borrowers and direct the flow of funds between the two groups. To do so, savings accounts are pooled to mitigate the risk brought by individual account holders in order to provide funds for loans (Hamouda, 2018). Those that accept deposits from customers are depository institutions including commercial banks, savings banks, and credit unions; those that don’t are nondepository institutions like finance companies, insurance companies, and brokerage firms (ibid).
Depository Institutions and Non-Depository institutions
Depository institutions are those financial institutions that accept deposits from customers including commercial banks, savings banks, and credit unions; and those that don’t are nondepository institutions like finance companies, insurance companies, and brokerage firms. Insurance can be defined as a financial device whose main aim is to mitigate financial risk or provide protection in the event of an adverse occurrence (Dusan, et al, 2015).
Figure 2: A tabular representation of differences and similarities in Financial Institutions
Non depository institution Depository institution
Commercial Banks Insurance Company
Financial intermediary Savers Deposits = Loans Client Premium = investment
Interest Rate Risk Interest Rate volatility Interest rate fluctuations
Asset-Liability Mismatch Liabilities > Assets in short run Liabilities ? insurance long-run
Systemic Interconnection Central Banking System Lacks systemic contagion
Money creation Deposits = Money creation Premiums ? Money creation
regulatory authority Subject to regulatory control Less susceptible to regulation
From the table above decision on the primary function of the insurance company is majorly providing protection through premiums, while the banks provide funds from pooled deposits for customers with short term to long term investment appetite from deposits. In this it is shown from the above table that insurance and banks act as financial intermediaries as they both utilize funds gathered through deposits and premiums to other investments in securities, real estate, bonds and other financial intermediaries.
Secondly, the insurance company in their distribution of risk among the insured, investing the pooled funds suffer the same interest rate risk in their choice of low or high yield investment because interest rate tends to be volatile depending on the central banks intended policy.
Thirdly there is a difference from the primary functions of insurance companies compared to the banking firm when it comes to asset matching the table shows us that some time the banks liabilities exceed its asset match compared to insurance companies whose clients might not request payments until there exists a disaster like fire burn of property or otherwise, hence banks are in a dilemma if depositors request funds at once which in all instances might not be the case.
Fourthly, banks are different from insurance companies based on systematic integration. The Central Bank which is the lender of last resort provides funds among the financial stream for the commercial banks and ensures smooth system balances to foster monetary policy. However this is not the case for the insurance houses.
Fifthly, the commercial banks tend to create money due to the deposit from customers in the long run, but that of the insurance is different because it might only be able to raise premiums patterned to risk aversion through spreading risk amongst clients, provision of certainty and protection from adverse circumstances.
Finally the insurance companies are perceived not to be highly regulated as the commercial banks. Though we have the Central Bank of Nigeria, Nigeria Deposit Insurance Corporation who scrutinize and penalize the commercial banks the insurance companies are supervised and regulated by the National insurance company . Nevertheless scholars have pressed for more scrutiny in the Nigerian insurance industry to avoid the calamity of American Insurance Group a world class insurance firm with subsidiaries spread all over the world which failed for sake of invalid insurance promises.
This work has looked at financial institutions consisting of a non- depository institution with special emphasis on the insurance company and a depository institution, the commercial bank. In all selecting the primary functions of the insurance company and that of the commercial bank, it was discovered that haven reviewed the functions of the regulatory bodies that the similarity between insurance and the bank are as follows, both are financial intermediaries, insurance companies and banks suffer interest rate risk, never the less the differences lie in the asset mismatch, money creation capabilities, systematic integration and regulation. The banks have mismatches in assets compared to the insurance firms, also insurance companies cannot create money like the banks do; lastly there tends to be more stringent regulation in the banking system which forms some sort of systematic integration as compared to the insurance regulators. We concluded that despite these similarities and differences the financial institutions are the bedrock for the financial systems drive toward economic growth and development enhanced by top notch regulation.