Chapter 2 - External environment

Question 1

What is legislation?

Answer 1

Law that has been formally declared by a governing body.

Question 2

What is regulation?

Answer 2

Secondary legislation used to implement a primary piece of legislation, or to take account of particular circumstances.

Question 3

What are some of the main affects regulation has on the products offered by the financial industry?

Answer 3

May influence what types of financial products are most suited to a consumer’s needs.

Regulation of the sales process may influence what types of products are brought to the market.

Reduces information asymmetries by ensuring the providers of financial products demonstrate their consumers fully understand their products and risks.

More complex products may not be marketed due to regulation and the emphasis on information asymmetry.

Question 4

How would the existence of state benefits affect the products offered by the financial industry?

Answer 4

Individuals may need to provide less for themselves and dependents

May not be a savings incentive (means-tested benefits)

Change in legislative structure presents significant unquantifiable risk.

Question 5

What are the main areas which can be taxed on financial products and what is the effect of theses taxes?

Answer 5

Tax on benefits
- Can be free of tax, excess of benefit over contributions can be taxed, or entire benefit can be taxed. (other hybrid options)

Contributions

Accumulation phase

Inheritance tax

When benefits are taxed will affect the suitability of the product for the specific consumer and therefore the types of products which are offered. Generally double taxation will be avoided.

Question 6

How do accounting standards influence the products offered by the financial industry?

Answer 6

Reporting methods may influence the types of benefits employers are prepared to offer.

Will impact the range of products offered, due to different requirements for setting reserves for different products.

Question 7

What is a wrapper?

Answer 7

The form in which a product is bought to the market.

Question 8

What do risk management requirements involve?

Answer 8

Minimum standards for risk governance

Requirements for risk management roles within a firm

Question 9

What is capital adequacy? Who regulates solvency in South Africa? What are two other important frameworks?

Answer 9

Excess of assets over liabilities and capital requirements. This can be stated as a monetary amount, or more commonly a percentage of the liabilities and capital requirements, or a multiple of the capital requirements.

Solvency assessment and management (SAM), which was developed by the Financial Sector Conduct Authority (FSCA)

Basel accords (Basel III - Banking)
Solvency II

Question 10

What is corporate governance?

What is the aim of CG and some strategies which could be followed to implement effective CG?

Answer 10

High-level framework within which a company’s managerial decisions are made.

The aims is efficient management to meet requirements of stakeholders.

There may be concern for regulators if CG incentivises managers to make decisions in their own interest rather than that of stakeholders. A strategy could be to ensure remuneration incentivises management to act in the interests of the policyholders.

Non-executive directors can be brought in to :

• Provide an impartial view
• Represent stakeholders
• Set remuneration for executive directors
• Play a role in the audit committee

Question 11

Discuss the two main types of corporate structure.

Answer 11

Mutual societies:

• Founded by benefactor/group concerned about welfare of defined group of people
• Have no shareholders and profits belong entirely to policyholders
• Theoretically should be able to provide better benefits at lower costs, since no dividends are paid.
• In practice a lack of financing can restrict products and reduce profits.
• Two methods of pricing products: Pricing at cost and surplus distribution
• Medical schemes and mutual banks are mutual societies in South Africa

Public and Private proprietaries/corporations:

• Easier access to capital markets through equity financing
• May benefit from greater economies of scale and more dynamic management
• Private companies may benefit from close involvement of owners, but may be as restricted as mutuals in terms of financing, unless owners have access to significant additional capital
• Apportionment of surplus between shareholders and policyholders is important decision.

Question 12

Discuss the underwriting cycle

Answer 12

Result of the competitive nature of insurance and other business.

Cycle is driven by:
- Market forces
- Claims experience
- Economic climate
(see p. 14 for diagram and explanation)

Question 13

Outline some of the main miscellaneous external issues?

Answer 13

Changing cultural and social trends
- Influence types of products

Demographic changes
- Influences provider of products (ageing population)

Climate change and other environmental issues

• Ethical issues and emissions trading
• Physical, transition and liability risks for insurance companies

Lifestyle considerations
- Risk appetite and product need

International practice
- International products may be brought into the country

Technological changes

• Product distribution and claims capture
• Micro-insurance