4 - Introduction to financial products and customer needs

Question 1

Summarise the three main principles of insurance and pensions

Answer 1

1. Insurable interest - in most countries, an insurance contract is only valid if the person taking out the contract has a financial interest in the insured event, to prevent moral hazard, fraud and other crime
2. Pre-funding - putting money aside in advance of a risk event, which is uncertain in terms of whether it will happen, its timing and amount.
3. Pooling of risk - protects a group of individuals who pool their finances, against uncertainty in financial costs, which then leads to more cost-efficient provision.

Question 2

Define an Insurance contract

Answer 2

In return for a single payment (or a series of payments) the provider will pay an individual or any heirs an agreed amount (or series of amounts) that start or end on a pre-specified event.

This event may happen to the individual, the individual’s property or a third party.

Question 3

Define Reinsurance contract

Answer 3

An insurance contract for providers of insurance, which allows the transfer of risk taken on to a third party

Question 4

Define Pension scheme

Answer 4

A pension scheme involves the accumulation of funds paid out on a later event, for example retirement, death or withdrawal from the scheme

Question 5

Define Investment scheme

Answer 5

Investment schemes involve an individual paying a single payment or a series of payments to a provider with the expectation that a higher amount will be paid back at a later date

Examples include:
> Savings products
> CIS

Question 6

Define Derivative

Answer 6

A financial instrument whose value depends on the value of underlying investments or variables

Question 7

Explain how attitude to risk affects an individual’s financial decisions

Answer 7

A risk-averse individual will prefer protection against future events even at the expense of a worse immediate lifestyle.

A high-risk individual will prefer to work on the assumption that rare events will not happen to them, and will prefer to address such events when they occur. In the meantime they will use the money saved by bot making provision to enhance their immediate lifestyle.

Question 8

Current needs

Answer 8

A current need is one that has an immediate effect on an individual’s circumstances.

For example:
- Protection, e.g. against death, loss, illness, accident

Question 9

Future needs

Answer 9

Future needs relate to future aspirations.

For example:

• Accumulation for a known purpose, e.g. retirement income, mortgage repayment
• Accumulation for a purpose yet unknown out of any remaining disposable income or capital

Question 10

How can Logical needs be identified?

Answer 10

Logical needs are determined after a careful analysis and prioritisation, followed by fitting products to those needs.

The needs may be identified as:

• Maintaining a current lifestyle
• Protection
• Accumulation for a known purpose
• Accumulation for a purpose as yet unknown from remaining disposable income or capital

This may involve taking advantage of tax-efficient arrangements.

Question 11

How can Emotional needs be identified?

Answer 11

Emotional needs are identified by considering an individual’s feelings. This may result in an individual getting what they want rather than what they truly need.

For example:

• to generate more income in retirement than is actually needed
• to avoid the guilt if not protecting dependents

Question 12

List the main types of Social security benefits that may be offered by the State

Answer 12

1. Retirement pensions including survivor benefits
2. Medical care
3. Income support due to unemployment, illness or disability
4. Housing support due to low income
5. Long-term care support
6. Child support

Question 13

List 5 types of financial needs that individuals may have

Answer 13

1. To pay off any debts owing
2. To save for retirement
3. To save for a house purchase or to pay off a mortgage
4. To protect yourself /dependants against sickness, death, unemployment etc
5. To protect against theft/damage of your property etc

Question 14

List 5 categories of financial benefits available to individuals

Answer 14

1. Benefits on events that are unpredictable - both whether and when they might occur
2. Benefits on events certain to occur, but unpredictable in time
3. Benefits for immediate consumption
4. Benefits on events predictable in time
5. Benefits from the accumulation of disposable income and capital

Question 15

List the needs met by pension schemes

Answer 15

1. To accumulate assets to provide an income in retirement
2. To increase this income in real terms to maintain standard of living
3. To protect against the financial impact of death of the member, both pre and post retirement
4. To accumulate assets for other reasons (eg lumpsum at retirement to pay off mortgage)

Question 16

What is Micro-insurance

Answer 16

These are insurance products that offer coverage to low-income households ie

1. Protection to individuals with little savings
2. Tailored specifically for lower valued assets and compensation for illness, injury or death

Question 17

When identifying customer’s needs, what are the 4 key things to consider?

Answer 17

1. Logical vs emotional needs
2. Current vs future needs
3. Attitude to risk
4. Vulnerability

Question 18

Who is a Vulnerable consumer?

Answer 18

Someone who, due to their personal circumstances, is especially susceptible to detriment, particularly when a firm is not acting with appropriate level of care

Question 19

What characteristics make one a Vulnerable consumer?

Answer 19

1. Low levels of education/limited knowledge of financial markets and products
2. Low levels of income
3. Poor health status
4. Limited access to advice
5. Limited financial security due to low earnings and low savings/assets

Question 20

What can financial providers do in order to protect Vulnerable consumers?

Answer 20

1. Adjusting benefit designs
2. Adjusting pricing basis
3. Adjusting entry criteria etc