Chapter 2: External Environment Flashcards
List the factors to consider in relation to the external environment
CREATE GRAND LISTS
Competetive structure Regulation and legislation Environmental issues and climate change Accounting standards Tax Economic outlook
(Corporate) Governance Risk management requirements Adequacy of capital and solvency New business environment Demographic trends
Lifestyle considerations International practice State benefits Technological changes Social and cultural trends
Mutual Societies
- Founded by a benefactor or group who were concerned about the welfare of a defined group of people
- Mutual societies have no shareholders and profits belong entirely to policyholders
- Mutuals should be able to provide better benefits for the same cost than proprietaries because no funds are diverted to provide a dividend stream to shareholders
- The disadvantage of mutuality is that finance cannot be readily raised from capital markets. This is likely to restrict the products that a mutual might be prepared to offer. In particular, products that are capital intensive will be less attractive to mutuals and may be priced accordingly
2 Ways in which mutuals approach product pricing
Surplus distribution
- Mutuals may offer specific distributions of surplus to their members. With profit insurance companies, friendly societies and co-operative organisations tend to do this
Pricing at cost
- The alternative is to design products with the lowest margins which are price consistent with the risks undertaken and benefit members receive
Proprietaries (compared to mutuals)
Public proprietary companies benefit from easier access to capital markets for finance, and may also have greater economics of scale and more dynamic management than mutuals
Private companies may be as restricted as mutuals for raising capital, but often benefit from the close involvement of the owners, which is a management advantage. The owners of private companies may have access to significant additional capital, providing an edge over both mutuals and public proprietary companies
Legislation
Law that has been formally declared by a parliament or congress or other governing body
Regulation
A form of secondary legislation that is used to implement a primary piece of legislation appropriately or to take account of particular circumstances or factor
- Require compulsory insurance in certain circumstances
- Influence the types of product most suited to a consumer’s needs - for example limitations on charges on a CIS may make the product more suitable than another without the limitation
- Regulation the sale process may influence the types of product that are brought to the market by product providers
- Due to information and knowledge asymmetries, regulation often places responsibility on product providers to demonstrate that consumers fully understand the product and risks. This may prevent complex products, such as those involving derivatives, are not marketed however suitable they are to consumers needs
What two forms of insurance cover are compulsory in many countries?
- Employer’s liability insurance
Explain the concept of emissions trading
This is a market-based approach to address pollution, with the aim of minimizing the cost of meeting an emissions target set by the government.
The government issues permit to emit up to the overall limit. Permits are sold or are equal to historical trading emissions for each polluter. A participant can use permits exactly, or emit less and sell the excess permits, or emit more and buy permits from other polluters.
The usual aim is for the government to lower the overall limit over time.
Accounting Standards
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
For example, if the company provides large extra benefits to the staff in retirement, they might choose not to this anymore as it would look bad in the balance sheets.
The presentation of financial instruments in the accounts in the accounts of product providers also impacts the range of products that is brought to the market
List four examples of how benefits 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 benefits can be tax-free, with the balance being taxed
Explain how items other than benefits can be taxed
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 gains.
Tax may be payable on inheritance. Insurance can be available to cover this tax liability.
Describe the underwriting cycle
Profitability in the various insurance classes tend 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 the market or reduce their involvement in the classes concerned. Eventually, premium rates increase to cover the losses being incurred and in the light of emerging experience.
Explain why an insurer might stay in a market that was loss-making
An insurer may believe that the accumulated losses, during the bottom of the cycle, are outweighed by the expected profits during the anticipated subsequent upswing in the market
The cycles of two or more insurance markets may be out of phase. A company working in these markets may use losses in one to cross-subsidise the others
The cost of withdrawing from a market and subsequently re-entering that market when it picks up might be prohibitive
The insurer may need to offer such a product in order to attract sales of other more-profitable products that it sells (loss-leading)
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 to achieve the first aim
- Utilises non-executive directors
- Influences the way in which stakeholders’ needs are met
Suggest likely aims of regulator requirements relating to capital adequacy and solvency for insurance
- to reduce the risk of insurers being unable to meet 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
