Chapter 2: External Environment Flashcards
List the factors to consider in relation to the external environment
CREATE GRAND LISTS
Corporate structure
Regulation and Legislation
Environmental issues and climate change
Accounting Standards
Tax
Economic outlook
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
External Environment:
Legislation and regulation, definitions and explanation
Legislation: Law formally declared by the governing body.
Regulation: a secondary form of legislation, used to implement the primary legislature.
- Require compulsory insurance in some cases
- Influence the types of product avialable
- Regulate the sale process
What 2 forms of GI cover are compulsary in many countries?
- employers’ liability insurance
- motor 3rd party liability insurance
External Environment:
State Benefits
State benefits should be taken into account when considering the financial planning needs of an individual. There are two aspects to this:
- Individuals may need to provide less for themselves (e.g. an employer sponsoring a benefit scheme).
- There may not be savings incentive (e.g. when state benefits are means-tested).
List 4 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 capital gains.
- Benefits can be taxed entirely as income.
- A portion of benefits can be tax-free, with the balance being taxed.
Explain how other items other than benefits can be taxed
Contributions:
* Some arrangements may offfer tax relief on contributions, normally coupled with tax on the resulting benefits.
* Alternatively, contributions could be paid from taxed income, normally coupled with tax relief on the resulting benefits.
Accumulation of return:
* Income and gains may be taxed during the accumulation phase, normally coupled with no tax on the policyholder’s gains.
Inheritance tax:
* Tax may be payable on inheritance. Insurance can be avialable to cover this tax liability.
Give 6 examples of products that are heavily focused around a particular tax system
- pension provision and lump sum benefits payable upon retirement
- tax-free savings vehicles
- tax-free government savings schemes
- retail savings bonds in SA
- some types of investment vehicles (e.g. certain exchange trade funds, unit trusts or fixed deposits)
- “qualifying life insurance products (e.g. endowment policies that benefit from reduced tax rates)
External Environment:
Accounting Standards
- The way that benefit schemes need to be reported in company accounts may influence the type 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.
External Environment
Adequacy of capital and solvency
Capital adequacy is measured as the excess of assets over the sum of liabilities and capital requirements.
Aims of requlatory requirements:
* 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
External Environment:
Corporate Governance, define and outline features
High-level framework for managerial decisions in a company
Framework:
* Encourages managers to act in the best interests of stakeholders
* Incentivises managers in a way to achieve the first aim
* Utilises non-executive directors
* Influences the way in which stakeholders’ needs are met
External Environment:
Corporate structure: Mutuals and Proprietaries
Mutuals- no shareholders:
* Better benefits as profits belong entirely to with-profit policyholders
* Restricted access to capital, which may restrict product offerings
* Product pricing approuch: Surplus distribution, Pricing at cost
Proprietaries: Shareholders:
-Public
* easier access to capital markets for finance
* economies of scale
* more dynamic management
-Private
* Restricted access to capital
* possible benefits of close envolvement of owners (owners may have access to significant additional capital, edge over mutuals and public proprietaries)
* Profits may be shared between shareholders and with-profit policyholders
External Environment:
New business Environment: 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 provitable, 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 cycles go into depression. This possition is emphasized 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 losses being incurred and in the light of emerging experience.
External Environment:
Cultural and social trends
- Increased home ownership increases the demand for mortgages
- Cuts in state healthcare increases the demand for private healthcare insurance
- Increased prosperity increases the demand for savings products
- Increase in the use of telematics for motor insurance allows the risk factors of the 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
- Owing to increased awareness of environmental and ethical issues amongs consumers, an insurer may face reduced demand for products if it fails to satisfy customers that is contributing towards the transition of a lower-carbon economy
External Environment:
Demographical changes
Two main sources of demographical changes leading to population ageing:
* rising life expectancy
* declining fertility
Give 4 examples of the effects of an ageing population on the economy or state
- Older people tend to spend less and safe more. This leads to lower interest rates and deflationary pressures on the economy
- Some pay-as-you-go State pension schemes are becoming unsustainable as income received from the working population falls short of that needed to pay retired population
- Increasing level 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
List potential imapcts of climate change on population trends:
- Mass migration from areas at higher risk of flooding due to heavy rainfall and rising sea levels
- Increased mortality and morbidity
- Increased incidence of diseases in some areas
- Increased conflict and wars
Emissions Trading
- This is a market based approuch to address pollution, with the aim of minimizing the cost of meeting an emmisions target set by the government.
- The government issues permits 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 for the government is to lower the overall limit over time.
External Environment:
Lifestyle considerations
- younger people have preferences for loans rather than savings
- people with children may have a need for life insurance protection products
- older people may have a need for annuities and long-term care products
External Environment:
International practice
- Providers may look at suitablity of replicating overseas products in the domestic market
- differences in tax and legislature must be considered
External Environment:
Technological changes
- impacts the distribution of financial products
- easier to reach specific target markets
- better pricing and may reduce costs
Give 6 examples of technological advances that have an impact on the avialabilty of financial products, schemes, contracts and transactions
- Internet quotations and sales
- Price comparison websites
- Banking over the internet and phone
- Social media for advertising links to sales / enquiry websites
- Insurance companies increasingly using websites to capture customer enquiries and register claims and transactions
- Email as the main source of communication
Capital is required to cover which 3 risks?
- market risk
- credit risk
- operational risk
