CHAPTER 12 Nonbank Financial Institutions 291 The investment policies of these companies are affected by the fact that property losses are very uncertain In fact, because property losses are more uncertain than the death rate in a population, these insurers are less able to predict how much they will have to pay policyholders than life insurance companies are Natural disasters such as the ice storm of 1998 and the Calgary hailstorm of 1991 exposed the property and casualty insurance companies to billions of dollars of losses.1 Therefore, property and casualty insurers hold more liquid assets than life insurers: cash, due and accrued investment income, money market instruments, and receivables amount to over a third of their assets, and most of the remainder is held in bonds, debentures, and stocks Their largest liability relates to unpaid claims and adjustment expenses, followed by unearned premiums (premiums representing the unexpired part of policies) Property and casualty insurance companies will insure against losses from almost any type of event, including fire, theft, negligence, malpractice, earthquakes, and automobile accidents If a possible loss being insured is too large for any one firm, several firms may join together to write a policy in order to share the risk Insurance companies may also reduce their risk exposure by obtaining reinsurance Reinsurance allocates a portion of the risk to another company in exchange for a portion of the premium and is particularly important for small insurance companies You can think of reinsurance as insurance for the insurance company The most famous risk-sharing operation is Lloyd s of London, an association in which different insurance companies can underwrite a fraction of an insurance policy Lloyd s of London has claimed that it will insure against any contingency for a price Credit Insurance In recent years, insurance companies have also entered into the business of supplying credit insurance There are two ways they have done this One way insurance companies can in effect provide credit insurance is by selling a traded derivative called a credit default swap (CDS) in which the seller is required to make a payment to the holder of the CDS if there is a credit event for that instrument such as a bankruptcy or downgrading of the firm s credit rating (Credit derivatives are discussed more extensively in Chapter 14.) Issuing a CDS is thus tantamount to providing insurance on the debt instrument because, just like insurance, it makes a payment to the holder of the CDS when there is a negative credit event Major insurance companies have entered the CDS market in recent years, sometimes to their great regret (see the FYI box, The AIG Blowup) CREDIT DEFAULT SWAPS Another way of providing credit insurance is to supply it directly, just as with any insurance policy However, insurance regulations not allow property/casualty insurance companies, life insurance companies, or insurance companies with multiple lines of business to underwrite credit insurance Monoline insurance companies, which specialize in credit insurance MONOLINE INSURANCE For example, the freezing rains of January 1998 triggered about 840 000 insurance claims As a result, Canadian P&C insurers paid out over $1.44 billion Similar disasters in the United States, such as the Los Angeles earthquake in 1994, Hurricane Katrina, which devasted New Orleans in 2005, Hurricane Ike, which devastated Galveston in 2008, and the September 11, 2001 destruction of the World Trade Center, exposed the U.S property and casualty insurance companies to billions of dollars of losses