Financial Insurer: Investing Essentials

You can get insurance for just about anything. And as it turns out, there are a number of companies that offer insurance for things found only in the financial landscape of both individuals and companies.

What are financial insurers?

Financial insurance refers to policies written by companies to cover things like the mortgages people use to buy homes, or the bonds and other various forms of debt companies issue. In the event the payments stipulated in the contracts are unable to be maintained, the insurer the policy is with will step in and fulfill the parameters of the agreement.

How big is financial insurance?

Unlike some industries, figuring the true size of financial insurance is surprisingly difficult. While the companies that operate exclusively in it are somewhat small, the size and scope of the things insured is large.

For example, in the mortgage insurance industry, in 2013, more than 10% of all mortgages originated -- worth $1.9 trillion -- had PMI policies attached to them. And at last count, one of the largest financial insurers for bonds and the like had nearly $350 billion worth of bonds and structured products it insured.

How do financial insurers work?

Like all forms of insurance, the foundational principles of financial insurance are relatively straightforward.

One of the most well-known forms of this is private mortgage insurance, or PMI. If an individual buys a home with a down payment of less than 20%, the lender may require them to purchase this insurance. As a result, if the borrower is unable to continue to make payments on the mortgage, the company that wrote the PMI policy will in turn pay the lender for the amount of the loan.

This type of insurance benefits the borrowers because while they have to pay between $30-$70 a month for every $100,000 borrowed, it in turn allows them the ability to buy a home they would have to wait years to purchase as they saved up for the 20% down payment. In addition, it also gives lenders the willingness to write more policies, but also gives them security knowing that if the worst situations occur, they are protected.

Similarly, when companies or governments issue bonds that are in turn bought by investors, financial insurance can be purchased to insure the bonds. This way, the buyers know even if the company defaults and is unable to pay its obligations, they will still receive payments from the insurance company. 

At times, the companies issuing the bonds purchase insurance on the debt they put on the market to lower the interest costs they pay. In addition, companies purchasing the bonds on the open markets can buy insurance policies to protect themselves in the event the institution or municipality they are purchasing the bond from goes bankrupt, or is unable to make payments. 

What are the drivers of financial insurance?

As you might imagine, financial insurers faced a perilous stretch as a result of the financial crisis. As both the mortgage industry collapsed and the broader economy spun downward, the insurers were forced to cover massive losses. So, broadly speaking, the macroeconomic landscape is key in this industry. 

In addition, like more standard policies, the insurer's ability to appropriately price and structure the insurance it has written is critical to its success. So too is the success it exhibits in its investing of what is known as the "float," which is the money it holds that will eventually be paid out to its policy holders.

The bottom line on financial insurers

At its core, insurance can be a wildly profitable and successful business. However the struggles and difficulties these financial insurers faced is a stark reminder of how dangerous the sector may be.

 


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