Michael Taillard - Corporate Finance For Dummies

Have you ever passed by a savings bank or savings association? Those are both forms of savings institutions, which have a primary focus on consumer mortgage lending. Sometimes savings institutions are designed as corporations; other times they’re set up as mutual cooperatives, wherein depositing cash into an account buys you a share of ownership in the institution. Corporations don’t use these institutions frequently, however, so I don’t cover them throughout the rest of the book.

Credit unions are mutual cooperatives, wherein making deposits into a particular credit union is similar to buying stock in that credit union. The earnings of that credit union are distributed to everyone who has an account in the form of dividends (in other words, depositors are partial owners). Credit unions are highly focused on consumer services, so I don’t discuss them extensively here or elsewhere in this book. However, their design is important to understand because this same format is very popular among the commercial banks in Muslim nations, where sharia law forbids charging or paying traditional forms of interest. As a result, the structure of a credit union in the U. S. is adopted by commercial banks in other parts of the world, so a basic awareness of this structure can be useful for international corporate banking.

Insurance companies are a special type of financial institution that deals in the business of managing risk. A corporation periodically gives them money and, in return, they promise to pay for the losses the corporation incurs if some unfortunate event occurs, causing damage to the well-being of the organization. Here are a few terms you need to know when considering insurance companies:

Deductible: The amount that the insured must pay before the insurer will pay anything

Premium: The periodic payments the insured makes to ensure coverage

Co-pay: An expense that the insured pays when sharing the cost with the insurer

Indemnify: A promise to compensate one for losses experienced

Claim: The act of reporting an insurable incident to request that the insurer pay for coverage

Benefits: The money the insured receives from the insurance company when something goes wrong

You’re probably thinking to yourself right now, “Wait. You pay the insurance company to indemnify your assets, but then it makes you pay a premium, deductible, and co-pay and caps your benefits? What’s the point?” Yeah, I know. Insurance companies can calculate the probability of something happening and then charge you a price based on the estimated cost of insuring you. They generate profits by charging more than your statistical cost of making claims.

Think of it like this: As a nation, people in the United States overpay for everything that’s insured by an amount equal to the profits of the insurance companies. Originally, this setup allowed corporations and individuals to share the risk of loss; each person paid just a little bit so no person had to face the full cost of a serious disaster. Unfortunately, this is decreasingly the case, as insurance companies grow in profitability and incur unnecessary overhead costs. That’s precisely why many nations require their insurance companies to operate as nonprofit organizations.

You can insure just about anything on the planet. (Consider that Lloyd’s of London will insure the hands of a concert pianist or the tongue of a famous wine taster!) The following sections outline three of the most common (and relevant) types of insurance companies as far as corporations are concerned.

Corporations deal a lot with health insurance companies because their employees often demand health insurance — not to mention healthy employees tend to be more productive. Health insurance is a very popular benefit for employees because being insured as a part of a large group is generally less expensive than trying to find individual insurance:

Group insurance is cheaper than individual insurance because the probability of large groups of people being rewarded more than they pay in premiums is lower than that of individuals.

Group insurance was frequently the only option that allowed for coverage on preexisting conditions (conditions people developed before receiving insurance); however, under the Patient Protection and Affordable Care Act, insurance companies can no longer deny coverage to people.

Health maintenance organizations (HMOs) are a popular, and often cheaper, insurance option for both corporations and individuals because they require everyone insured to go through a general physician, who acts as a kind of gatekeeper by determining whether a referral to a specialist is required.

Life insurance companies work similarly to other types of insurance companies, except that the only time they pay benefits is when you die. Corporations sometimes take life insurance policies on critical employees who have specialized skills or knowledge that can’t be easily replaced without significant financial losses. Many corporations also offer group life insurance which, like health insurance, is cheaper than individual insurance. Life insurance comes in two basic flavors: whole and term. Each one has a wealth of variations and additional options. The types have many differences, but the primary distinction is that term life insurance is paid for a set period and is only valid as long as it is being paid, while whole life insurance is considered permanent and will build value over time.

Property-casualty insurance is the most critical type of insurance for corporations to have. It covers the potential harm that can befall a company or anyone on property owned by the company should an accident occur. Did a meteor fall from the sky and smash your headquarters? That’s insurable!

Securities firms provide transaction services related to financial investments, which are quite distinct from the services provided by traditional depository institutions. However, many commercial banks have separate departments that offer the services of securities firms, and others merge or partner with securities firms. (For example, Bank of America is a commercial bank that bought the securities firm known as Merrill Lynch.) Still other securities firms are completely independent of any depository institution. Exactly which types of services a securities firm provides depends on the type of institution it is.

Investment banks deal exclusively in corporations and other businesses as clients as well as products. In other words, they offer a wide range of services, including underwriting services for companies that issue stock on the primary market, broker-dealer services for both buyers and sellers of stock on the primary and secondary markets, merger and acquisitions services, assistance with corporate reorganization and bankruptcy procedures, general consulting services for corporations large enough to afford them, and other such services related to raising or transferring capital.

In case you couldn’t tell from their name, broker-dealers perform the services of both brokers and dealers:

Brokers are organizations that conduct securities transactions on the part of their clients — buying, selling, or trading for the investment portfolio of their clients.

Dealers are organizations that buy or sell securities of their own portfolio and then deal those securities to customers who are looking to buy them.