Chapter 2: External environment Flashcards
List 15 external environment considerations
C - Competition & Underwriting Cycle R - Regulation & Legislature E - Environmental Issues A - Accounting Standards T - Tax E - Economic Outlook
G - Governance R - Risk Management Requirements E - Experience from Overseas A - Adequacy of Capital and solvency T - Trends (Demographic)
L - Lifestyle Considerations I - Institutional Structure (mutual or proprietary) S - Societal Trends T - Technological Changes S - State Benefits
External Environment:
Legislation and regulations, 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 certain circumstances
- Influence the types of product available
- Regulate the sale process
External Environment:
State benefits
For an individual:
- Less need for self-provision
- Discourages saving if mean tested
Employers and Employees:
- Raise employers’ awareness of the need to top up State benefits
- Introduce moral hazard, ie the risk of individuals relying on the State and not purchasing their own cover
- Reduce levels of additional savings if benefits are means-tested
- If benefits are contributory, make individuals feel less wealthy and thus less able to purchase their own cover.
External Environment:
Tax
- Tax treatments will have an impact on the needs of individuals
- Affects the type and form of products offered by the financial service industry
- Means that product innovations may be designed to avoid paying tax
- Inheritance tax will change the amount of money passed down
- Directs savings towards the most tax-effective forms of tax shelters
External Environment:
Accounting Standards
- May influence an employer’s provision of employee benefits
- Influence the range of products marketed and their wrappers
- Wrapper: How the product is brought to the market
External Environment:
Capital adequacy and solvency
- forms part of banking and insurance regulation
- is carried out using a complex capital adequacy framework, Basel II, for banks
Aims of the regulator:
- Reduce the risk of insurers being unable to meet claims
- Reduces losses suffered by policyholders when insurers can’t meet claims
- Early warning system for regulators to intervene when capital is not adequate
- Ensure confidence in the insurance sector
External Environment:
Corporate governance
High-level framework for managerial decisions in a company
Aims:
- encourages managers to act in the best interests of stakeholders
- incentivises managers accordingly
- should be monitored for effectiveness
- may utilise non-executive directors
- influences the way in which stakeholders’ needs are met
External Environment:
Risk management requirements
- are concerned with measuring, monitoring and controlling the impact of risks on a firm’s balance sheet
- Implemented by regulators to safeguard against systemic failure
Capital is required to cover which 3 risks?
- market risk
- credit risk
- operational risk
External Environment:
Mutuals
- No shareholders, profits belong to policyholders
- Better benefits for the same cost
- Can’t readily raise finance by usual methods
- Certain products may be restricted or more highly-priced
- Products are either priced “at cost” or for allowance of surplus distribution to with-profits policyholders
External Environment:
Public proprietary company
- easier access to capital markets for finance
- economies of scale
- more dynamic management
External Environment:
Private proprietary company
- may find some difficulties raising capital
- benefit from the close involvement of the owners
The underwriting cycle
Business is profitable => new entrants, greater competition, lower premium rates => reduced profits (depression)
=> insurers leave the market or reduce involvement => increased premium rates => profitable business
At the bottom of the cycle: loss of business is possible or reduced solvency (will increase the need for capital)
- Long term: Profit and losses even out
- Short term: Profitable classes may subsidise losses in other classes
External Environment:
Demographic changes
- can have a major impact on main benefit providers, eg State
- include increasing longevity and falling birth rates
- may result in the ageing population
Results of the ageing population
- less spending, as older people more likely to save
- the strain on social welfare systems
- the increased cost of healthcare
- cost of education falling
