Chapter 1: South African general business environment

Question 1

List 7 areas of the general business environment for life insurance companies in South Africa: (7)

Answer 1

1. New business
2. The wider competitive environment
3. Operational risk
4. Corporate finance and securitisation
5. Mergers and acquisitions
6. Demutualisation
7. Cell captives.

Question 2

The two main ways for companies to grow are: (2)

Answer 2

1. “Organic growth” - selling business to new clients

2. Mergers or acquisitions.

Question 3

Factors affecting new business: (7)

Answer 3

1. Regulation
2. Policyholder tax
3. Economic conditions
4. Publicity
5. Technology
6. Target markets
7. Micro-insurance

Question 4

Regulation plays a significant role in the new business environment and affects: (3)

Answer 4

1. Product design
2. Marketing
3. Commission and regulation of the sales force.

Question 5

Outline the main requirements by the Financial Advisory and Intermediary Services (FAIS) Act: (2)

Answer 5

1. The FAIS Act requires that a needs analysis be performed by the broker to ensure that the products sold are suitable for the policyholder.
2. The Act also requires that brokers and agents pass the FAIS exam before they are permitted to sell life insurance products.

Question 6

In the past, the life insurance industry has suffered reputational damage from certain practices. Some examples are: (4)

Answer 6

1. Poor surrender values were paid even in the event of surrenders close to maturity.
2. Brokers promoted living annuities instead of life annuities, exposing policyholders to the risk of running out of retirement savings.
3. Policy quotations were produced showing benefits that would be achieved with unrealistic high investment returns.
4. Financial advisers encouraged policyholders to surrender one policy in favour of another, to the detriment of policyholder value.

Question 7

Insurance products currently have some tax advantages over non-insurance equivalents, such as: (3)

Answer 7

1. High net worth individuals have the advantage of being taxed at the rate applicable to the Individual Policyholder Fund (IPF), which is most likely lower than their marginal rate.
2. Some companies have an Excess E (XSE) position in their IPF due to relatively low reserves (and hence low investment income) compared to expenses. This means that they can provide tax-free investment income on savings products.
3. Retirement annuities (RA’s) allow policyholders to save tax-free for retirement. In addition, RA premiums are tax-deductible (up to a certain level), and although the income purchased with the RA are taxable, a portion can be taken as a tax-free lump sum at retirement.

Question 8

Factors resulting in higher expense loadings on products sold by insurance companies: (3)

Answer 8

1. The need to hold regulatory reserves and capital
2. Training and regulation of the sales force
3. Additional regulatory requirements. For example, the requirement for the HAF to review the premium rates.

Question 9

Some examples of non-life savings options are:

Answer 9

1. Unit trusts
2. Fixed term and call deposits
3. Money market accounts
4. Exchange traded funds
5. Guarantee investment products
6. Direct investment in the market

Question 10

Operational risks can include: (7)

Answer 10

1. Product mis-selling
2. Mis-pricing
3. Administrative errors
4. IT failures
5. Data issues
6. Poor standards of policy service, which can lead to reducing new business
7. Staff retention

Question 10

Operational risks can include: (7)

Question 11

Define Financial reinsurance:

Answer 11

Financial reinsurance is where a reinsurer provides reinsurance which, in addition to some element of risk transfer, provides relief against new business strain through payment of initial commission from the reinsurer to the insurer.

Question 12

The consolidation of the large number of life insurers has been driven by: (3)

Answer 12

1. The increased cost of regulation
2. More focus on efficiencies and economies of scale
3. Life insures not meeting capital requirements due to poor performance

Question 13

What are cell captives?

Answer 13

Cell captives are a mechanism by which companies (the cell owner) can perform the business of an insurer without obtaining their own insurance license.

An insurer (the cell captive) “rents out” their insurance license to different cell owners in exchange for a fee.

Question 14

Cell captives are separated into: (3)

Answer 14

1. First part cell business, where the cell owner and the policyholder of the insurance sold is the same.
2. Third part cell business, where the cell owner and the policyholder are different.
3. Promoter cell business, which is insurance sold directly to the public by the cell captive insurer without going through any of the cells.

Question 15

Cell owners are typically (with examples): (2)

Answer 15

1st Party Cells:

• Large corporates who are looking to self-insure their risks
• Pension Funds where the Pension Fund can self-insure and access the reinsurance market.

3rd Party Cells:

• Underwriting managers, who can design, price and administer products, but can’t sell products directly.
• Intermediaries
• Other insurers (e.g. a short term insurer looking at writing a small amount of long-term business)
• Other companies

Question 16

As a minimum, the cell captive provides the cell owner with the following services: (2)

Answer 16

1. Accounting

2. Regulatory reporting services

Question 17

The additional specialized services a cell captive can provide to the cell owner: (6)

Answer 17

1. Start-up assistance
2. Pricing
3. Underwriting
4. Claims management
5. Reinsurance
6. Investment management

Question 18

Challenges for cell captives: (4)

Answer 18

1. They need to ensure that third-party cell owners abide by the relevant regulations in the FAIS Act, the Insurance Act and the Long-term Insurance Act.
2. The solvency position of each cell needs to be monitored to ensure that remedial action (such as recapitalization) can be taken when necessary.
3. The cell captive needs to decide how to allow for risk diversification benefits across cells when calculating statutory and internal capital, and fully understand the potential implications of any allowance for diversification for the cell owners.
4. Tax calculations are done at the company level and ignore the internal division of the company into cells.

Question 19

List the Factors that a company would need to take into account when deciding whether to enter into a cell captive agreement or to apply for their own insurance license: (4)

Answer 19

1. Whether the company needs to insure itself, in which case a first-party cell may be best, or whether it is insuring third parties, in which case either a cell captive or an insurance license could be used.
2. Whether they have the expertise required to perform the underlying function of an insurer, such as accounting, regulatory services, pricing, underwriting, claims management etc.
3. Whether the company is expected to quickly grow to sufficient scale to support the required administration functions.
4. Whether they have sufficient capital to meet the minimum capital requirements of a life insurer.