4. Introduction to financial products and customer needs Flashcards
What are the 5 categories of product benefits?
- Benefits on events that are unpredictable - when and ehther they might occur
- Benefit on events that are certain to occur - but unpredictable in time
- Benefits for immediate consumption
- Benefits for events predictable in time
- Benefits from the accumulation of disposable income and capital
What are the types of social security benefits that may be offered by the state?
- Retirement pensions including survivor benefits
- Medical care e.g. NHI
- Income support due to unemployment illness or disability
- Housing support due to low income
- Long term care support
What is an insurance contract?
- In return for a single premium or series of payments, the provider will pay the individual or any heirs an agreed amount or series of amounts based on the start or end of a prespecified event. Individual, property or third party.
What is a reinsurance contract?
- Insurance contract for the providers of insurance, which allows for the transfer of direct risk taken onto a third party
What is a pension scheme?
- A vehicle=> the accumulation of funds
- Paid out on a later event=> usually retirement
- Event may be death or early withdrawal from the pension scheme
What is an investment scheme?
- A vehicle involving a single payment or series of payments
- To a provider with the expectation
- A higher amount will be paid back at a later date
What is a derivative?
- Financial instrument
- Value depends on the value of an underlying
- Investment or variable
What are the three main principles of insurance and pensions that impact the design of financial products and the benefits that they can provide?
- Insurable interest=> Person taking out an insurance contract must have a financial interest in the insured event=> prevent moral hazard and fraud
- Pre-funding=>Putting money aside in advance for a risk event which is uncertain in terms of whether it will happen or timing and amount. Investment returns and risk tolerance need to be considered
- Pooling of risk=>Protects groups of individuals who pool their finances, against uncertainty in financial costs. Which Leads to more cost effective provision.
Explain the operation of a current account, including its payment methods and main features
- Current account is a flexible bank account allowing both saving and borrowing
- Payment methods are Cash withdrawals, debit cards, regular payments to third parties, online and mobile payments and cheques
Current accounts may:
- give flexibility to pay into account or withdrwa anytime
- palce a limit on withdrawals (notice accounts)
- Have an overdraft facility
Explain the operation of a secured loan and an unsecured loan
- A secured loan is backed by some form of financial asset (collateral).
- This asset can be taken by bank if loan is not paid back in line with terms of the loan
- An unsecured loan is not secured against other assets, and therefore is more risky from the banks’ perspective
Expain the operation of a mortgage, including three examples of types of mortgage
- Mortgage is a loan to purchase a property and is secured on that property
- Interest charged is usually varaible, but a fixed rate is possible
- Capital is paid over mortgage term
- Some interest-only mortgages are available
Examples:
- Residential mortgages
- Buy-to-let mortgages
- Commercial real estate mortgages
Describe the operation of an asset-based security (ABS)
- ABS is a bond backed by a ring-fenced pool of assets, normally loans (mortgages, car loans)
- The payments due from customers on these loans are repackaged into the form of a bond, which is then sold to investor
- Investors are repaid through capital and interest payments from the pool os assets
- ABSs are issued in tranches (A,B,C) with different yields and different levels of risk. Tranch A is most secure and attactive to institutional investors
How can logical and emotional customer needs be identified?
Logical needs are determined after careful analysis and prioritisation followed by fitting products to those needs. The needs may be identified as:
* Maintaining current lifestyle
* Protection against death, liss, illness, accident
* Accumulation for a known purpose
* Accumulation for a purpose as yet unknown
May involve tacking advantage of tax efficient investment
Emotional needs=> identified by considering an individual’s feelings
* Results in individuals getting what they want rather than what they truly need
Examples of emotional needs:
- Generate more income in retirement than is actually needed
- Avoid guilt of not protecting dependents
What ‘current’ customer needs?
- Immediate effect on individuals’ circumstances
- E.g. Protection against death, loss, illness or accident
What is ‘future’ customer needs?
- Future needs relate to future aspirations. Examples:
- Accumulation for a known purpose e.g. Retirement income, mortgage repayment
- Accumulation for a purpose as yet unknown=> out of any remaining disposable income
How does attitude towards risk affect an individual’s financial decisions?
- Risk averse individual=> Prefer protection against future events at the expense of a worse immediate lifestyle.
- High risk individual=> work on the assumption that rare events will not happen to them and will deal with them when they occur
- In the meantime, they will use the money saved (by not making provision for future adverse events) to enhance their immediate lifestyle
