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Actuarial Risk Management > Chapter 3: Regulation > Flashcards

Chapter 3: Regulation Flashcards

1
Q

Name reasons why regulation is needed

Fully explain each reason

A

Information asymmetry
* Usually between the product designer and the end customers
* At least one party to a transaction has information that the other does not .
* The less informed party might end up making sub-optimal decisions as a result.

Confidence
* A failure in one part of the system could lead the whole system to fail

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2
Q

State reasons why financial markets need more regulation than other markets

A
  • Long term nature
  • Significance of impact
  • Complexity
  • Interrelated market partcipants
  • Interplay with other markets
  • Nature of interaction with clients
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3
Q

Who benefits from regulation

A
  • Customers
  • The regulated company
  • Creditors
  • The general public
  • Governement
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4
Q

Name two broad aims of regulation

A
  • Limit the likelihood and failure of finacial institutions
  • Limit the likelihood of stepping in as a lender of last resort
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5
Q

Name 4 primary aims of regulation

A
  • Maintain consumer confidence
  • Reduce financial crime
  • Protect consumers
  • Promote market efficiency
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6
Q

What is the optimal level of regulation

A

marginal cost of regulation = marginal benefit of regulation

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7
Q

Name two direct costs of regulation

A

Administering the regulation
Compliance for regulated firms

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8
Q

Name 4 indirect costs of regulation

A
  • Undermining a sense of professionalism among advisors and intermediaries
  • Behaviour of customers
  • Reduction of consumer protection that might be inherent in the market itself
  • Reduced product innovation
  • Reduced competition
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9
Q

Regulation is normally separated into two parts, name them

A
  1. Prudential Management -
  2. Conduct
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10
Q

Regulation is normally separated into two parts, prudential management and conduct. Explain them

A
  1. Prudential Management - Deals with matters like fraud and mismanagement
  2. Conduct - Deals with the products offered
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11
Q

Seperate the functions of a regulator into 3 parts

A

Making the law
Enforcing the low
Addressing the two parts

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12
Q

Explain the functions of a regulator
Making the law
Enforcing the low
Addressing the two parts

A

Making the law
* Influencing and reviewing government policy

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13
Q

Explain the functions of a regulator
Making the law
Enforcing the low
Addressing the two parts

A

Enforcing the law
* Enforcing regulations, investigating breaches and imposing sanctions
* Vetting and registration of firms and individuals authorised to conduct certain types of business

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14
Q

Explain the functions of a regulator
Making the law
Enforcing the low
Addressing the two parts

A

The parts of regulation
* Supervising the prudential management of financial businesses
* Supervising the conduct of financial businesses, and taking enforcement actions where necessary

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15
Q

Discuss two examples where information asymmetry favours the individual

A

Anti-selection
Individuals who know that they will need to use insurance are the ones who take it out. Ie. When they believe that their risk is higher than the insurance company has allowed for in its premiums.

Moral hazard
The action of a party who behaves differently from the way they would behave if they were fully exposed to the consequences of that action.

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16
Q

State the ways one would deal with information asymmetry

A
  • Disclosure and education
  • Conflicts of interest
  • Negotiation, give individuals bargaining power
  • Unfair features of an insurance contract
  • Treating customers faily
  • Policyholders’ reasonable expectations
17
Q

Explain the following ways in which one can deal with information asymmetry
* Disclosure and education
* Conflicts of interest
* Negotiation, five individuals bargaining power
* Unfair features of an insurance contract

A
  • Disclosure and education
    o Full information in an understandable form.
    o Education of the public by the regulator.
  • Conflicts of interest
    o Chinese walls
    o Restrict a service provider’s knowledge about 3rd parties to public knowledge
  • Negotiation, give individuals bargaining power
    o Using price controls or selling practices.
    o Cooling off periods
    o Ability to terminate the process
  • Unfair features of an insurance contract – businesses have legal teams to put contract wording in their favour. Regulators could:
    o Requiring understandability
    o Contract terms – when and how to change
    o Discontinuance benefits
18
Q

What does TCF stand for? Explain its implications

A
  • Treating customers fairly – TCF
    o Fair treatment is central to the corporate culture.
    o Needs identified and targeted accordingly
    o Clear information at all times
    o Provided products that they were led to expect
    o No unreasonable post sale barrier.
19
Q

List what could influence policyholders’ reasonable expectations

A

o Statements made by provider.
o Past practice
o General practices of other product providers in the market.

20
Q

How is confidence maintained in the market using regulation

A

o Capital adequacy
o Competence and integrity
o Compensation schemes
o Other protection for investors - Security markets aim for transparency, order and protection of investors.
o Stock exchange requirements

21
Q

Differentiate between integrity and competence when maintaining confidence in the market

A

Competence means that they know the appropriate course of action to take on behalf of the investor and integrity means that they choose to take it

22
Q

Name the regulatory regimes

A
  • Prescriptive
  • Freedom of action
  • Outcome-based
  • Unregulated markets and unregulated lines of business
  • Voluntary codes of conduct
  • Self-regulation
  • Statutory regulation
  • Mixed regimes and intermediaries
23
Q

Explain the following regulatory regimes:
* Prescriptive
* Freedom of action
* Outcome-based
* Unregulated markets and unregulated lines of business
* Voluntary codes of conduct
* Self-regulation
* Statutory regulation
* Mixed regimes and intermediaries

A
  • Prescriptive – Detailed rules detailing what can and cannot be done.
  • Freedom of action – but with rules publicised so that 3rd parties are well informed
  • Outcome-based – allow freedom of action but the are rules on what the outcome should be.
  • Unregulated markets and unregulated lines of business – Cost of regulation outweigh benefits in some markerts, so they are not regulated.
    Sometimes, parties are well-informed so they are not regulated
  • Voluntary codes of conduct – Lack public confidence and some companies refuse to cooperate.
  • Self-regulation – set up by people in the industry
  • Statutory regulation – The government sets out rules and polices them.
  • Mixed regimes – Often made by market driven institutions as well as government
    o Professionalism and professional bodies
    Regulation aims at the professional responsibility of market practitioners and intermediaries
24
Q

What are the incentives for self-regulation

A

o Incentive is that regulation is an economic good that customers are wiiling to pay for.
o Another incentive is that the government may threaten to regulate the market if it is not done satisfactory.

25
Q

Advantage of self regulation

A

o Advantage is that the market is regulated by those who know it best
o Disadvantage is the regulator is close to the industry and accepts the industry’s view and is less in tune with the views of third parties. They may also inhibit new entrants to the market.

26
Q

Advantage of statutory regulation

A

o Advantage is that it is less prone to abuse.

27
Q

Disadvantage of statutory regulation

A

o Disadvantage is that it can be more costly and flexible.

28
Q

What is the role of the Central Bank in regulation

A
  • Lender of last resort
  • Control money supply
  • Interest rates
  • Inflation rates
  • Unemployment and growth
  • Exchange rates
  • Stability of financial system
29
Q

What is the role of the state in regulation

A
  • Some products may only be sold by state monopolies.
  • Some tariffs are placed on product
  • Slow down innovation and new development.
30
Q

What is the role of large market participants in regulation

A
  • Large companies can allow small companies to enter the market and stabilise premiums.
  • They could also distort the market, to the detriment of customers.
  • Systematically Important Financial institution – Instutions whose failure could lead to systematic failure, triggering a financial crisis.
31
Q

Why are the UN policies on climate change and sustainability necessary

A
  • If not controlled, climate change will cause irreparable damage to the environment and ecosystems.
  • This will mean more claims on natural disasters and high mortality rates.
  • The government will eventually place aggressive measure to tackle climate change, which would be detrimental to institutions with a high carbon footprint.
32
Q

What are the aims of climate related regulations ?

A

Impact of financal sector on climate change
* Consider climate risks
* Disclose and report climate risk
* Incoporate environmental, social and governance factors into investment management decisions.
* Incoporate financial risks from climate change and into existing risk management processes.

**Impact of climate change on financial sector **
* Consistent and reliable means of assessing, pricing, and managing climate related risks
* Use scenario analysis to inform risk identification and to estimate the impact of financial risks arising from climate change

Actuarial Risk Management (38 decks)

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