FIN 3310 Module 7 Written Assignment: Insurers, Pension Funds and Other Nonbank Institutions Example

Where the Rest of the Money Goes: Insurers, Pensions and Other Nonbank Institutions

Student Name

B.S.B.A. in Finance, Thomas Edison State University

FIN-3310: Financial Institutions and Markets

Mentor Name

Month Day, Year

Where the Rest of the Money Goes: Insurers, Pensions and Other Nonbank Institutions

Insurance Companies

Insurers collect premiums, invest them and pay claims. The two main types differ because their liabilities differ (Mishkin & Eakins, 2018). Diamond and Dybvig (1983) showed that institutions funding illiquid assets with short-term claims are exposed to runs, a risk that applies to some nonbanks as well as banks.

Insurers face the same asymmetric information problems as lenders. Adverse selection, people most likely to suffer losses being most eager to insure, is managed through screening and risk-based premiums; moral hazard, insured people taking less care, is managed through deductibles, coinsurance and restrictive provisions. Insurance is regulated mainly by the states, through capital requirements and guaranty funds that pay claims when an insurer fails.

Pension Funds

A traditional pension pays a set income tied to pay and service, and the employer must fund it whatever markets do. A defined contribution plan, such as a 401(k) or 403(b), specifies only what goes in; the employee bears the investment risk and the risk of outliving savings. Many credit union members are teachers with state defined benefit pensions, while their spouses in private jobs often have only 401(k) plans.

As private employers swapped pensions for 401(k)-style plans, the market risk of retirement passed to families. Benartzi and Thaler (2001) found that many participants spread contributions naively across whatever funds a plan offers, so plan design strongly shapes outcomes. Underfunded public pensions, including New Jersey's, raise a different risk: that promised benefits depend on future taxpayers and legislators.

Investment Banks and Securities Firms

Investment banks help firms and governments issue securities, underwriting new offerings and advising on mergers, and act as brokers and dealers in secondary markets. Unlike commercial banks, they traditionally did not fund themselves with insured deposits but with short-term borrowing such as repurchase agreements, which made them vulnerable to runs in 2008, when Lehman Brothers failed and the remaining large investment banks became bank holding companies under Fed supervision.

Mutual Funds

Mutual funds pool investors' money to buy diversified portfolios, offering small investors diversification, professional management and liquidity. Money market mutual funds, which hold short-term securities and seek a stable value, compete directly with bank deposits; two runs on such funds, in 2008 and 2020, led to reforms aimed at making them more resilient.

Finance Companies

Finance companies lend to consumers and businesses, such as auto and equipment loans, but fund themselves by issuing commercial paper, bonds and bank loans rather than taking deposits. Because they do not hold insured deposits, they face lighter regulation, focused mainly on consumer protection.

Comparing the Institutions

Conclusion

Each institution transforms funds and manages a particular risk. For credit union members, the most important change is the one in their pensions: as defined contribution plans spread, households bear risks once carried by institutions, which raises the value of sound financial advice and well-designed plans.

References

Benartzi, S., & Thaler, R. H. (2001). Naive diversification strategies in defined contribution saving plans. American Economic Review, 91(1), 79-98. https://doi.org/10.1257/aer.91.1.79

Diamond, D. W., & Dybvig, P. H. (1983). Bank runs, deposit insurance, and liquidity. Journal of Political Economy, 91(3), 401-419. https://doi.org/10.1086/261155

Mishkin, F. S., & Eakins, S. G. (2018). Financial markets and institutions (9th ed.). Pearson.