Chapter 4 Flashcards
How can benefits be categorised?
Benefits can be categorised as:
Benefits on events that are unpredictable – both whether and when
Benefits on events certain to occur but unpredictable in time
Benefits from immediate consumption
Benefits on events predictable in time
Benefits from the accumulation of disposable income and capital
What are the main types of provision that can be offered?
Types of provision
In some countries, state provides certain benefits to citizens
When these are at a low level or not offered at all, individuals and organisations often prepared to pay another party to protect themselves against risk of certain events
Main types of:
Social security Financial products Contracts Schemes Transactions, fall into the categories described in chapter 4
Discuss the main characteristics of social security benefits.
Social security benefits
- Benefits offered by the state vary significantly by country – type, amount and whether or not they are means-tested
- Means test is an assessment to determine eligibility for benefits – may only be eligible for a specific benefit if they earn less than certain level of income per year
- OR based on level of individual’s assets or combination of both income and assets
- Where means testing applies – may be financial disincentive to individuals to makes alternative private provision
- Citizens may or may not be required to contribute towards costs of social security benefits
- Benefits subject to political risk that state may change or withdraw benefits in future
- Main possible types of benefits offered are:
Retirement pensions
Medical care
Income support due to unemployment, illness or disability
Housing support due to low income
Child support
Long-term care support
What are the main characteristics and types of financial products and contracts?
Financial products and contracts
- Insurance contracts
In return for a single payment (or series of payments) the provider will pay an individual or any heirs an agreed amount (or series of amounts) that start or end on the occurrence of a pre-specified event
Event may happen to individual, individual’s property or a third party
- Reinsurance contracts
Providers of insurance may pass some of the risk to a reinsurer in return for paying appropriate reinsurance premium
What are the main characteristics of pension schemes?
Pension schemes
Involves accumulation of funds, which are paid out on a later event – usually retirement, but event can be death or early withdrawal
Pension schemes meet the need:
Accumulate assets to provide income in retirement
Increase this income in real terms in order to maintain a standard of living
To protect against financial impact of death of the member – both before and after retirement
Accumulate assets for other reasons – lump sum at retirement to contribute to paying off mortgage loan
What are the main characteristics of benefit schemes?
Benefit schemes
Similar legal and tax structure to pension schemes BUT may provide different type of benefit – cover medical expenses or unemployment
Funded by contributions made by members and/ or their employers and participation may be compulsory or voluntary
In return for series of monthly payments provider will pay individual’s or policy dependant’s medical costs in line with scheme rules
Medical costs could be paid in several ways:
Fee-for-service basis Capped amount according to fixed tariff schedule Fixed amount irrespective of cost or type of health event
What are the main characteristics of investment schemes?
Investment schemes
Involve individual paying single payment or series of payments to provider with expectation that higher amount will be paid back at later date.
Saving products offered by insurance companies and CISs (investment trusts and unit trusts)
What are the main characteristics of a derivative?
Derivative
Financial instrument whose value depends on value of other investments (shares, bonds) or variables (interest rates, exchange rates)
As with reinsurance, derivative can be used to pass risk to third party
What are the main insurance principles?
Insurance principles
Main principles of insurance and pensions that impact design of financial products and the benefits that can be provided from such products
These are:
Existence an insurable interest
Pre-funding of risk
Pooling of risk (continuing care retirement communities and microinsurance)
What are the main insurance principles: Insurable interest
Insurable interest
Insurance contract only valid if person taking out contract has a financial interest in the insured event
Primarily to prevent moral hazard, fraud and other crime
I.e. policyholder has interest in claim event not happening and will not encourage it to happen
Individuals generally assumed to have unlimited financial interest in own lives and lives of spouses and dependents – BUT other financial interest are limited in amount to prevent overinsurance
What are the main insurance principles: Pre-funding
Pre-funding
Key principle of insurance and pensions is that money is set aside in advance of occurrence of uncertain risk event.
Uncertainty might relate to:
Whether event will happen at all Timing of certain risk event – such as life expectancy The cost of an event that is certainly going to occur
Key issue is how much money is needed to provide a given level of benefit with desired probability.
This will depend on:
- Probability of risk event occurring - Amount that risk event will cost - Return that can be earned on pre-funded money before risk event occurs
Individual will also have risk tolerance – how comfortable they are with probability of desired outcome not being achieved
What are the main insurance principles: Pooling of risk
Pooling of risk
Alternative to financing benefits directly for themselves, individuals may group together and pool their finances
Will help to protect the individuals against some of uncertainties that may exist in cost of financing benefits
May also lead to more cost-effective provision that if each individual made own financial provision
Retirement communities
Trade union, employee association, or community or religious organisation may be way in which individual can group together to form pool
Retirement communities – originated as religious organisations into which members would contribute their available assets in return for lifetime care
Recently idea has developed to provide different levels of continuing care according to levels of initial and annual contributions
What is micro-insurance?
Microinsurance
Refers to insurance products that offer coverage to low-income households
Provides protection to individual who have little savings and tailored specifically lower values assets and compensation for illness, injury or death
Example: basic life and health insurance in deprived communities in developing countries
Differentiate between logical and emotional needs and how each can be analysed.
Analysing stakeholders’ needs
Logical or emotional needs
Two possible approaches to establish customer’s needs:
Logical approach of systematically and carefully working out what needs a customer has and fitting products to needs Emotional approach – plays more on what individual feels is needed
NB to differentiate between emotional needs and logical needs
If emotional needs met may get what they want rather than what they need
Logical needs approach involves establishing customer’s needs, analysing them, prioritising them and fitting the benefits or products provided to those needs
THUS, there is reconciliation between products and needs
Customer’s logical needs can be analyses as follows:
Maintaining current lifestyle Protection – against death, loss, illness and accident Accumulation for a known purpose – income in retirement, repayment of mortgage Accumulation for a purpose as yet unknown out of remaining disposable income or capital
May involve taking advantage of any tax-efficient arrangements available
Particular care needs to be taken when analysing needs of vulnerable stakeholders – low-income earners, elderly or those with limited access to services or info
Consideration given to impact of saving or new benefits on their current income, especially where state grants or rebates are involved
Access to info and lack of financial literacy could impact how needs are perceived and prioritised by customer
What other factors need to be considered when trying to establish the customer’s needs?
Current or future needs
Necessary to determine whether customer’s needs are current or will arise in future
Current need one that has immediate effect on customer’s circumstances
Future need one that relates to customer’s future aspirations
Some needs may be both – e.g. someone in retirement, the need to maximise returns earned on capital to provide income while at same time protecting value of capital from effects of inflation over time
Attitude to risk
In many cases stakeholders’ needs will be greater than money available to both fulfil those needs and to provide finance for desired current lifestyle
Difficult circumstances where individual needs to make hard decisions
Key features of individual’s decision will be their attitude to risk:
Risk-averse individual will prefer protection against future events at expense of worse immediate lifestyle High-risk individual will prefer to work on assumption that rare events will not happen to them and address such events when they occur – in meantime use money saved by not making provision to enhance their immediate lifestyle
Important that options and consequences of each possible course of action clearly set out
Vulnerability
Considering if every stakeholder has access to sufficient advice and means to mitigate risk of any harm is important
Vulnerability can arise from:
Low levels of education Limited knowledge of financial markets and products Low income levels Poor health status Limited access to advice Limited financial security due to low earning and low savings/asset levels
Vulnerable stakeholders should be identified and considered when determining optimal outcome
May involve adjusting benefit design, pricing basis, entry criteria, marketing material etc
Important to remember that treating these customers fairly makes good commercial sense for insurers
