Ch 4: Introduction to financial products and customer needs

Question 1

Summarize 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

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

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

Pension scheme

Answer 4

A vehicle that involves the accumulation of funds, which are paid out on a later date, usually retirement. The event may also be death, withdrawal, or illness

Question 5

Investment scheme

Answer 5

A vehicle that involves 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 on a later date

Question 6

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 prioritization, 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