Chapter 3 - External Environment Flashcards

1
Q

List 19 external environment considerations

A
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
T - Trends (Demographic)
L - Lifestyle Considerations
I - Institutional Structure
S - Societal Trends
T - Technological Changes
S - State Benefits

P - Physical Environment (climate & natural perils, pandemics)
G - Globalization
C - Convergence of financial institutions

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2
Q

External Environment:
Legislation and regulations, definitions and explanation

How do they affect the financial services industry?

A

Legislation: Law formally declared by governing body

Regulation: secondary form of legislation, used to implement primary legislature

  • Require compulsory insurance in certain circumstances
  • Influence the types of product available and best suited for customer needs (tax)
  • Competition & barriers to entry
  • National control vs Privatisation
  • Court judicial decisions (affects average future liab. claims)
  • Crime & Punishment
  • Financial Reporting
  • Solvency/liquidity reqs.
  • Ts & Cs of insurance contracts e.g. compulsory unlimited cover for liability products
  • Regulate the sale process / providers required to fully explain products i.e TCF which is expensive
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3
Q

External Environment:

State benefits

A

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 (social assistance)
  • If benefits are contributory (social insurance), individuals may feel less wealthy and thus less able to purchase their own cover.
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4
Q

External Environment:

Tax

A
  • Tax treatments will have an impact on the needs of individuals/running of financial services businesses
  • Affects pricing/valuations/profit calculations
  • Affects individual need & ability to provide private benefits
  • 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
  • Encourages/discourages investment in products e.g. tax advantages for pension products
  • Affects govt. ability to be a provider of benefits & enforcer of regulations
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5
Q

External Environment:

Accounting Standards

A
  • May influence an the types of benefits offered by employers to employees
  • Influence the range of products marketed and their wrappers
  • Accounting reqs. for reserving can influence contract design of products
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6
Q

External Environment:

Capital adequacy and solvency

A
  • 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 risk of insurers being unable to meet claims
  • Reduces losses suffered by p/h when insurers can’t meet claims
  • Early warning system for regulators to intervene when capital is not adequate
  • Ensure confidence in insurance sector
  • Reduce financial crime
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7
Q

External Environment:

Corporate governance

A

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
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8
Q

External Environment:

Risk management requirements

A
  • are concerned with measuring, monitoring and controlling the impact of risks on a firm’s balance sheet e.g. perhaps by reinsurance
  • Implemented by regulators to safeguard against systemic failure
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9
Q

Capital is required to cover which 3 risks?

A
  • market risk
  • credit risk
  • operational risk
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10
Q

External Environment:

Mutuals

A
  • No shareholders, profits belong to p/h
  • 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-profit policyholders
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11
Q

External Environment:

Public proprietary company

A
  • easier access to capital markets for finance
  • economies of scale
  • more dynamic management
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12
Q

External Environment:

Private proprietary company

A
  • may find same difficulties raising capital

- benefit from a close involvement of the owners

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13
Q

The underwriting cycle

A

Business is profitable => new entrants, greater competition, lower premium rates => reduced profits
=> 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 need for capital)

  • Long term: Profit and losses even out
  • Short term: Profitable classes may subsidise losses in other classes
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14
Q

External Environment:

Demographic changes

A
  • mortality/fertility/unemployment/immigration
  • can have major impact on main benefit providers, eg State
  • Affordability of pension plans affected by longevity
  • Increasing longevity and falling birth rates may result in ageing population
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15
Q

Results of ageing population

A
  • less spending, as older people more likely to save
  • strain on social welfare systems
  • increased cost of healthcare
  • cost of education falling
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16
Q

External Environment:

Environmental issues

A
  • influence the ways in which Government, advocacy groups and individual participants act, and hence the behaviour of financial markets
  • has led to providers offering products that promote environmental and ethical issues
  • affects how providers communicate with customers, eg reducing the amount of paperwork
17
Q

External Environment:

Lifestyle considerations

A
  • younger people have preferences for loans rather than savings
  • people with children look towards life insurance protection products
  • older people may have a need for annuities and long-term care products
  • longevity => more saving and for longer, so assets aren’t exhausted before death
18
Q

External Environment:

International practice

A
  • Providers may look at the suitability of replicating overseas products in the domestic market
  • differences in tax and legislature must be considered
19
Q

External Environment:

Technological changes

A
  • impacts distribution of financial products
  • easier to reach specific target markets
  • better pricing and may reduce costs
20
Q

External Environment:

Climate & Natural Perils

A
  • Catastrophes can cause large claims/ acc. claims
  • Sometimes difficult to obtain cover in certain areas => govt. might have to step in
  • After a catastrophe reinsurance might be very expensive (burning cost) or unavailable in the mkt.
21
Q

External Environment:

Social Factors & Trends

A
  • Common values/attitudes of population
    This affects:
  • Underwriting practices e.g. no discrimination based on sex allowed, no DNA testing allowed
  • This affects how products are priced
22
Q

External Environment:

Economic & Social Environment

A

Economic assumptions include:

  • interest rate
  • inflation
  • investment returns
  • Exchange rates
  • tariffs on imported goods

Influence insurance sales/claims:

  • theft, fraud, arson, crime rates
  • business failure/unemployment rates
  • willingness to buy insurance
  • cost of repairs & replacement parts