Are Insurance Companies and Pension Funds Considered Financial Instruments?

Insurance companies and pensions funds are not really financial instruments holistically. However, components of their businesses may be and can be worth taking a closer look at for deeper financial instrument investigation.

Key Takeaways

• Holistically, insurance companies and pension funds are not usually considered to be financial instruments.
• Insurance companies offer insurance policies and annuities, which can be financial instruments.
• Pension funds use a variety of different financial instruments to invest across different asset allocations.

Financial Instruments

First, it can be helpful to understand what a financial instrument is actually. Financial instruments are generally securities that can be traded. As such, a financial instrument and a security can be synonymous. Legal jurisdictions may have varying codification for a financial instrument, which can be important for registrants.

Financial instruments have a range of characteristics. Tradability is usually core. Financial instruments usually represent some amount of ownership. They are usually based on a contract between two parties. They also usually have a specified carrying value.

Financial instruments generally are tools that money managers use when seeking different types of allocations. The most basic financial instruments are:

• Stocks
• Treasury bonds
• Municipal bonds
• Corporate bonds

Financial instruments can also be more complex, such as in the form of derivatives or structured products. More complex financial instruments can include:

• Call options
• Put options
• Swaps
• Mortgage-backed securities (MBS)
• Collateralized loan obligations (CLO)

Insurance Companies

While insurance companies themselves are not necessarily financial instruments (unless considering their tradeable stock or debt in the secondary market), they produce a couple of different types of alternative financial instruments. Insurance companies are known for providing insurance policies. Another one of their products may also include annuities. Insurance policies and annuities can potentially be thought of as alternative types of financial instruments.

Insurance Policies

Traditional and online insurance offerings are becoming broader and easier to obtain. Online technologies are expanding the way policyholders apply and obtain policies, as well as receive payouts. This pertains to both individuals and commercial policies. For individuals, some of the top categories for insurance include medical, dental, vision, auto, home, life insurance, short-term disability, and long-term disability. Companies also take out policies in these categories and may also get coverage for real estate, workers’ compensation, and more.

Insurance, in its simplest form, is a written protection against uncertain risk. Policyholders pay a specified premium for the promise of a payout if a claim is filed and approved.

Comprehensively, there is no secondary public trading market for insurance policies. However, they have many characteristics of a financial instrument. Insurance policy liabilities may also be packaged and/or covered by reinsurance companies, similar to the structuring of standard securitized products.

For the policyholder, an insurance policy is a contract with the insurance company. It involves ownership. Insurance policies also have a specified value. Thus, while most insurance policies are not securities per se, they can possibly be viewed as an alternative type of financial instrument.

Annuities

Insurance companies also manage annuities. Annuities are a more traditional type of financial instrument but still may be considered an alternative investment. Most variable annuities and indexed annuities must register as a security with the Securities and Exchange Commission (SEC). Fixed annuities are usually also considered to be financial instruments, though they are not required to register.

An annuity requires an investor to make either a lump sum or systematic investment over time. The annuity manager then promises to pay the investor a disbursement based on the terms of the annuity. Insurance companies are most well-known for offering and managing annuities, but some financial institutions also offer them as well.

Pension Funds

Holistically, a pension fund could be viewed alongside mutual funds, exchange-traded funds (ETFs), and even hedge fund portfolios. Pension funds are a collection of pooled assets managed with an organized asset allocation that seeks to earn a return over time that is used to meet pension payout obligations. Pension funds are becoming less popular because of their management complexities. However, many government employers still use pension schemes.

A pension fund manager uses a variety of financial instruments to meet the goals of the fund. Just like mutual funds, ETFs, and hedge funds, pension funds make investments in stocks, bonds, and possibly structured products.

Pension fund managers have a liability matching responsibility that increases the complexity of their job. Pension funds promise to pay a specified amount to their employees in retirement. This can lead to the use of more conservative financial instrument securities for funds needed to meet immediate obligations. Pension funds also invest in higher-risk financial instruments with higher expected returns, like stocks, to accumulate more capital for their future obligations. Overall, a pension fund manager has the authority to invest in all types of financial instruments in order to meet their goals. However, managers may be bound by some standardized investment policy constraints established by the fund itself.

Read the original article on Investopedia.