CH2 - External Environment

Question 1

List the factors to consider in relation to the external environment

Answer 1

Legislation and Regulation
Tax
State Benefits
Accounting Standards
Risk Management requirements, capital adequacy and solvency
Corporate Governance
Corporate Structure
Competitive Advantage and commercial requirements
Changing cultural and social trends
Demographic Changes
Climate change and other environmental factors
Lifestyle considerations
International Practice
Technological changes

Question 2

What is legislation

Answer 2

This is law that has been formally declared by a parliament or congress or governing body

Question 3

What is Regulation

Answer 3

This is a form of secondary legislation that is used to implement a primary piece of legislation appropriately or take into account particular circumstances or factors

Question 4

How do state benefits influence benefit providers

Answer 4

Where the state benefits are low, then additional non-state benefits will be sought after and they include either an employer providing them through a retirement benefit scheme or the individual themselves

Question 5

What two aspects of state benefits should be taken into account when planning the financial needs of an individual?

Answer 5

1) Individuals may need to provide less for themselves where the state provides to a large extent. And employers may feel less of a need to contribute much to a benefit scheme
2) There may be no savings incentive - Where state benefits are provided, those that have lower income will find it beneficial for them to not save at all

Question 6

What are the in which benefits can be taxed?

Answer 6

• The benefits may be free from tax
• The excess of the benefit over the contributions paid may be taxed as income or capital gain
• The benefit is taxed as income

Question 7

What products are heavily focused around a particular tax system

Answer 7

Pensions provision and lump sum benefit on retirement
Tax Free savings vehicles
Some investment Vehicles e.g exchange traded funds
Retail savings bonds
Qualifying life insurance products

Question 8

How would accounting standards influence the products provided

Answer 8

The way that a product is accounted for in the company’s accounting records will have an impact on the way that the product is sold and it’s desirability
The way that benefit schemes have to be reported will influence the type of benefits that employers are prepared to provide for their employees

Question 9

What is capital adequacy

Answer 9

It is either the difference between, or the ration of , the assets that the company has and the sum of the liabilities and minimum capital requirements

Question 10

What is the likely aim of the regulatory requirements relating to capital adequacy and solvency for insurers

Answer 10

To reduce the risk of them being unable to pay claims
To reduce the losses suffered by policyholders in the event that an insurer is unable to meet claims
To provide an early warning system so that regulators can intervene if capital is not adequate
To ensure confidence in the insurance sector

Question 11

What us corporate governance?

Answer 11

The high level framework within which the managerial decisions are made

Question 12

What is the aim of corporate governance

Answer 12

The aim is to ensure that the business is managed effectively to meet the needs of the stakeholders.

Question 13

How could good corporate governance be enhanced

Answer 13

By ensuring that the remuneration incentivises management to act in the interest of stakeholders

Question 14

What role do non executive directors play in a structure aimed at good corporate governance

Answer 14

• They provide an impartial view and represent shareholders interests
• They play a leading role in setting the remuneration for executives pay
• They play a leading role in the audit committee

Question 15

What were mutual societies originally established for

Answer 15

They were originally established to benefit a certain group of individuals
Most were founded by benefactor groups that were concerned about the welfare of a defined group of people
- They only start by an altruistic gesture that involves someone lending the capital without the requirement to be repaid unless profits are made

Question 16

What are the features of mutual societies

Answer 16

• They have no shareholders and any of the profits that are made belong to the policyholders
• The main disadvantage is that they aren’t able to raise finance easily from the capital markets which will restrict their products offered

Question 17

What are the two ways that mutual’s price their products

Answer 17

1) Surplus distribution - Offer a specific distribution of their surplus to their members
2) Pricing at cost - The products are designed with the lowest margins in the price consistent with the risks undertaken and benefits members that they write

Question 18

What are the two types of proprietary company

Answer 18

Public Proprietary
Private Proprietary

Question 19

What advantages to public proprietaries have

Answer 19

They benefit from their access to capital markets and they have greater economies of scale and more dynamic management than mutual societies

Question 20

What is the limitation of private companies

Answer 20

They are just as restricted as mutual’s at raising capital but they benefit from the close involvement of their owners who have access to significant capital

Question 21

Describe the Underwriting cycle

Answer 21

The profitability in insurance will go up and down due to the market forces of demand and supply, combined with the actual claims experience and economic climate

1) When business is profitable then more insurers enter the market, supply increases and premiums decrease
2) Decreased premiums will reduce profitability and result in losses being made and the cycle going into depression
3) At the bottom of the cycle, the insurers will either leave the market or their involvement in the classes will reduce since premiums are too low to be profitable. Supply in the market then decreases
4) Premium rates then increase again and cover the losses made and the cycle returns back to the top with more insurers entering the market

Question 22

What does the inability to make profits at the bottom of the cycle lead to ?

Answer 22

The inability to make profits leads to :
- Loss of business : Putting pressure on the ability to recoup fixed expenses and future growth
- Reduced Solvency : Requires additional capital support or other remedial action

Question 23

Why would a company decide to stay in the market even if it was making losses?

Answer 23

• They may believe that the accumulated losses at the bottom of the cycle are outweighed by the expected profits during the anticipated upswing
• The cycles of two or more insurance markets may be out of phase. Therefore a company working in these markets may use losses in one to offset the losses in another
• The costs of withdrawing from the market and then re entering when it picks up may be prohibitive
• The insurer may need to offer such a product to attract the sale of other more profitable products that it sells

Question 24

How does the business cycle work for banks?

Answer 24

-The equivalent business cycle is largely driven by interest rates and the economic activity over the wider economic cycle
- Where interest rates are high, there is greater demand for savings products and therefore reduces borrowing and creates deflationary pressure
-Where there is strong economic growth, there may be increased demand to borrow

Question 25

What are examples of changing cultural and social trends that can have an impact on the financial products, schemes, contracts and transactions

Answer 25

• Home ownership becoming more widespread leads to greater demand for products such as mortgages
• Increasing incomes give people the sense that they have more ‘spare’ income and so the demand for savings products is likely to increase
• Due to increased awareness of environmental and ethical issues among customers, an insurer may face reduced demand for products if it fails to convince customers that it’s contributing towards a lower carbon economy
• Increased telematics allow the risk factors of an individual to be assessed.

Question 26

What are the two sources of an ageing population

Answer 26

• Rising Life expectancy
• Declining fertility

Question 27

What are the effects of an ageing population

Answer 27

• Older people are more likely to be saving money than they are to be spending it, this will lead to lower interest rates and deflationary pressures
• Social welfare systems may experience problems. Some pay as you go systems become unsuitable
• Cost of healthcare systems increase
• Education expenditure reduces

Question 28

How does climate change influence demographics

Answer 28

• Mass Migration from high risk areas
• Increased morbidity and mortality
• Increased incidence of diseases in some areas
• Increased conflict and wars

Question 29

How does climate change bring opportunities and risks to the provider of benefits?

Answer 29

• Possibility for products that protect against the risk of climate change
• Due to the effects of climate change, some risks will become uninsurable
• Insurance companies will need to adapt risk selection and manage the potential wider social and reputational challenges from withdrawing cover from high risk areas

Question 30

What does international Practice entail

Answer 30

Providers may look at other countries in the international market to see if the products sold in the other countries could be replicated in their own country
- This is subject to the difference in legislative requirements and tax

Question 31

How has technology changed the way that financial products are provided for individuals?

Answer 31

• Financial products used to be sold by intermediaries finding the best product for their customers, but now with many products sold over the internet, clients are able to obtain a range of quotations for themselves without having to physically meet anyone.
• There are price comparison websites for commodity products therefore customers don’t have to go to multiple sites
• Banking and savings products are now provided over the internet and mobile apps along with the traditional bank branches. It removes the need to visit branches
• Insurance companies are using websites increasingly to capture enquiries from their clients, record the changes in clients personal details, register claims and perform other administrative tasks
• Financial product providers are establishing presence on social media not only for advertising, but also to provide links to product sales and customer enquiry websites.