CH2: The External Environment Flashcards
List the factors to consider in relation to the external environment.
Corporate structure
Regulation and legislation
Environmental issues and climate change
Accounting standards
Tax
Economic outlook (eg interest rates, inflation, growth and exchange rates)
Governance
Risk management requirements
Adequacy of capital and solvency
New business environment
Demographic trends
Lifestyle considerations
International practice
State benefits
Technology
Social and cultural trends
What are the key features of mutual and proprietary financial providers?
Mutuals – no shareholders:
-Better benefits as profits belong entirely to with-profit policyholders
-Restricted access to new capital, which may restrict product offerings
-Specific distributions of profit made, or contracts priced at cost
Proprietaries – shareholders:
-Public proprietary companies – easier access to capital, possible benefits from economies of scale and more dynamic management
-Private proprietary companies – restricted access to capital, possible benefits from close involvement of the owners
-Profits may be shared between shareholders and with-profit policyholders, eg in a with-profit proprietary life insurance company
Which two forms of general insurance cover are compulsory, ie required by legislation, in many countries?
- Employers’ liability
- Motor third party liability
Give two examples of how regulation may help ensure that a customer enters into a contract that is suitable to their financial needs.
- Limits on charges levied by the provider, eg on unit trusts or unit-linked contracts
- Regulation of the sales process, eg on advice given and disclosure of information
Give four examples of how climate change may influence population demographics
- Mass migration from areas at high risk of flooding and rising sea levels
- Increased morbidity and mortality
- In some areas, increased risk of disease
- Increased conflicts and wars
Describe how accounting standards may affect employer benefit provision and the financial products brought to market.
The way that benefit schemes need to be reported in company accounts may influence the types of benefits that employers are prepared to provide for their employees.
The presentation of financial instruments in the accounts of product providers also impacts on the range of products that is brought to market.
For example, the different accounting requirements for setting the provisions for different types of insurance contract in different territories can influence the design of contracts.
Similarly, whether a fund manager brings investments to market within an insurance wrapper in a subsidiary company, or through a collective investment scheme, might depend on the presentation and results shown in the company’s accounts
List four examples of how benefits arising from financial products and schemes can be taxed
- Benefits can be received free of tax.
- The excess of benefits over contributions can be taxed as income or as capital gains.
- Benefits can be taxed entirely as income.
- A portion of the benefit can be tax-free, with the balance being taxed.
Normal or special tax rates can be used where benefits are taxed.
Explain how items other than benefits may be treated for tax.
Some arrangements may offer tax relief on contributions, normally coupled with tax on the resulting benefits.
Alternatively, contributions may be paid from taxed income, normally coupled with tax relief on the resulting benefits.
Income and gains may be taxed during the accumulation phase, normally coupled with no tax on the policyholder’s gain.
Tax may be payable on inheritance. Insurance may be available to cover this tax liability.
Define corporate governance and outline the features of a good corporate governance framework
Corporate governance is the high-level framework within which a company’s managerial decisions are made.
A good corporate governance framework:
- encourages managers to act in the best interests of stakeholders, rather than in their own personal interests
- incentivises managers in a way that achieves the first aim
- utilises non-executive directors.
Explain the broad approach of banking and insurance regulation to ensuring the capital adequacy and solvency of a provider.
Capital adequacy and solvency form part of banking and insurance regulation which sets a framework on how financial institutions measure their capital adequacy and solvency.
Financial institutions need to determine the minimum capital that they are required to hold. Capital adequacy is then measured as the excess of assets over the sum of liabilities and capital requirements.
This might be expressed as a monetary amount but is more commonly stated as a percentage of liabilities plus capital requirements or a multiple of the capital requirements.
Increasingly, and largely driven by the availability of computing power, States are moving towards risk-based capital requirements such as the structures behind the EU Solvency II regime. Earlier simple formulae-based approaches are becoming outdated.
Describe the underwriting cycle.
Profitability in the various insurance classes tends to go in cycles, driven by market forces of supply and demand combined with actual claims experience and economic climate.
When business is profitable, more insurers enter the market. Premium rates reduce as insurers compete for market share.
This leads to reduced profits or to losses, loss of business and reduced solvency, and the cycle goes into depression. The position may be accentuated by catastrophes or by the economic climate.
At the bottom of the cycle, insurers leave that market or reduce their involvement in the classes concerned. Eventually premium rates increase to cover the losses being incurred and in light of reduced competition.
Which two key factors drive the business cycle for banks
- Variations in interest rates
- Economic activity
Explain how age affects lifestyle considerations when it comes to the need for financial products
Young people demand loans and mortgages, but few create a demand for savings.
Slightly older people pay off their loans and start to save. They may also need protection for dependants. Longer working lifetimes and increases in life expectancy will increase the need for savings, life assurance and the age to which it is required. There will be a move away from volatility towards security prior to retirement.
Older still (in retirement), and demand for savings diminishes, but is replaced with demand for post-retirement income plans and long-term care products. Children are less (or no longer) dependent.
Many countries in the developed world are experiencing significant demographic changes.
Give four examples of the effects of an ageing population on the economy or State.
- Older people tend to spend less and save more. This leads to lower interest rates and deflationary pressures on the economy.
- Some pay-as-you-go State pension systems are becoming unsustainable as the income received from the working population falls short of that needed to pay the retired population.
- Increasing costs of healthcare systems lead to either higher levels of tax to be paid or reduced healthcare provision by the State.
- The cost per capita of educating the population will tend to fall.
Give four examples of how climate change may influence population demographics.
- Mass migration from areas at high risk of flooding and rising sea levels
- Increased morbidity and mortality
- In some areas, increased risk of disease
- Increased conflicts and wars
Give four examples of how State benefits can influence an individual’s needs for benefit provision.
- If State benefits provide only a minimum standard of living, individuals may want to supplement this with benefits such as employer-sponsored pension schemes, individual savings and insurance.
- State benefits can reduce the need for individual provision, eg by providing free emergency medical treatment, or a basic State pension.
- State benefits can act as a disincentive to save, eg if State benefits are means-tested, an individual may be better off by not saving at all.
- If the State compels individuals to save, this may reduce the amount that individuals are prepared to save voluntarily in individual arrangements.
Give seven examples of technological advances that can have an impact on the availability of financial products, schemes, contracts and transactions
- Internet quotations and sales
- Price comparison websites
- Banking over the internet and telephone
- Some banks only providing services online
- Insurance companies increasingly using websites to capture customer enquiries and register claims and administration
- Social media for advertising and links to sales / enquiry websites
- Email as a fully accepted and widely used means of communication
Give six examples of changing cultural and social trends that can have an impact on the financial products, schemes, contracts and transactions available.
- Increased home ownership increases the demand for mortgages. 2. Cuts in State healthcare increase the demand for private health insurance.
- Increasing prosperity increases the demand for savings products.
- Increased awareness by consumers of environmental and ethical issues affects the demand for insurance products if the insurer’s investments are not viewed as meeting environmental criteria.
- Increased use of telematics for motor insurance, in many countries, allows the risk factors for an individual, the policyholder’s driving behaviour and other factors to be monitored through a device installed in the insured vehicle or a smart phone app.
- Greater ‘social inflation’, the rate at which increases in claims exceed general inflation, eg driven by higher jury awards.
