Chapter 2-External environment Flashcards
- State two forms of insurance that are compulsory in some countries.
Examples include:
• employers’ liability insurance
• motor third party liability insurance.
- Give an example of how regulations may influence the type of product most suited to a customer’s needs.
For example, limitations on charges for certain types of collective investment scheme may make that type of contract more suitable than another without the charge limitation, even though there are other disadvantageous features.
- Give an example of how regulation of the sales process for different products may influence the type of financial products brought to market.
Requirements for detailed explanation to consumers may mean that complex products, in particular those involving benefit smoothing processes or derivative investment strategies, are not marketed however suitable they might be for consumers’ needs.
- Why don’t State benefits alone necessarily meet the needs of citizens?
Where the State provides benefits to its citizens these are often at a low level which may only be sufficient to keep individuals just out of poverty. Many individuals will want have a higher level of benefit.
- Give two exampels of how an individual may achieve a higher level of benefits than those provided by the State.
An employer may provide this through a retirement benefits scheme or membership of a private health arrangement. Alternatively the individual may wish to provide personal benefits either through saving or through the purchase of insurance.
- Explain how State benefits should be taken into account when considering the financial planning needs of individuals.
There are two aspects to this:
• Individuals may need to provide less for themselves. For example, in the UK where emergency hospital treatment is free, very few individuals will take insurance out against this, but they may take out private medical insurance against the need to have non-urgent treatment such as a hip replacement or dental care. Another example is an employer sponsoring a benefit scheme. When considering the total benefit needed by employees, the employer may deduct any State benefits in order to minimise the cost of the scheme.
• There may not be a savings incentive. Where State benefits are means-tested, individuals on a low income who only have a limited ability to save may find that it is better value for them not to save at all, as any savings they have will be offset against the benefits that they are entitled to from the State and result in a lower level of income. For example, the amount of long-term care or housing benefit provided by the State may be reduced for those with assets worth more than a certain value.
- Give an example of significant State involvement in controlling benefit provision by describing Singapore’s Central Provident Fund.
An example of significant State involvement in controlling benefit provision is Singapore’s Central Provident Fund. This was set up in 1955 to provide financial security for workers in their retirement or when they were no longer able to work. It requires compulsory contributions from employees and employers. Since 1955, it has evolved into a comprehensive social security savings scheme, which not only covers members’ retirement needs but also their needs for:
• home ownership
• healthcare
• education of their children
• financial protection through insurance.
- How will State requirements for individuals to save affect an individual’s savings?
If the State requires individuals to save for their retirement or other benefits, this will reduce the amount that individuals feel they can or need to invest in individual arrangements.
- Describe how tax can affect an individual’s financial planning.
The tax treatment of benefits arising from financial products and schemes can have an impact on the needs of individuals.
• Benefits can be received free of tax.
• The excess of the benefit received over the contributions paid can be taxed, either as income or as a capital gain.
• The benefit can be taxed entirely as income.
There are common hybrid options where a portion of the benefit can be taken tax-free, with the balance being taxed. In these cases, the portion can be a monetary amount, a percentage of the total benefit or a combination of these approaches. Where benefits are taxed, the normal or special tax rates can be used.
Some territories use all these options, depending on the legislation under which the product or scheme is written.
The impact of tax on contributions towards financial products should also be considered. Some arrangements may offer tax relief on contributions paid. These would normally be coupled with tax on the resulting benefits. Other types of arrangement require contributions to be paid from taxed income. These arrangements normally offer some relief from tax on the ultimate benefit.
Governments also have the option of taxing the income and gains of products and schemes during the accumulation phase.
In developed countries, to provide an incentive to save, the general principle is that double taxation is avoided. Therefore if a provider is taxed on income and gains in the accumulation phase of a product, there is unlikely to be a charge to tax on the policyholder’s gain.
Tax may also need to be considered when considering the inheritance that an individual will pass on. If tax is payable on the individual’s estate on death, it may be possible to take out insurance to cover this tax liability.
- Describe how accounting standards may affect both employer benefit provision and the financial products brought to market by providers.
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 through a subsidiary company, or through a collective investment scheme, might depend on the presentation and results shown in the company’s accounts.
- Explain what capital adequacy and solvency requirements are and outline the capital requirements imposed on banks.
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.
- How may capital adequacy be measured?
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. Capital requirements for financial product providers are discussed in more detail later in the course.
- Whay type of capital requirement are states moving to, driven largely by the availability of computing power?
Increasingly, and largely driven by the availability of computing power, states are moving towards risk-based capital requirements such as the structures behind the European Solvency II regime. Simple formulae-based approaches are used in some countries, but the general global trend is towards a more risk-based capital framework.
- Define the term ‘corporate governance’ and state its main aim.
Corporate governance refers to the high-level framework within which a company’s managerial decisions are made. The aim of good corporate governance is that a company should be managed efficiently in order to meet the requirements of its stakeholders - the shareholders, employees, pensioners, customers, suppliers and others who may be affected by the company’s operations.
- Give an example of how good corporate governance can be used to alleviate a particular concern regarding the bhaviour of a company’s management.
One concern of regulators is that management might make decisions based more on their own personal interests than on those of other stakeholders.
Good corporate governance can be enhanced by ensuring that remuneration incentivises management to act in the interests of stakeholders. Share options may be part of this, though the lack of sufficient downside for management can limit how well share options achieve this objective. Non-executive directors are also often part of a structure aimed at good corporate governance.
