Chapter 5: Intro to financial products and customer needs Flashcards
Benefits can be categorised as (5)
o Benefits for immediate consumption (mortgages for house purchase, loan for short-term needs)
o Benefits from the accumulation of disposable income and capital (CIVs, whole life ass., endowment ass., fixed term savings, immediate/deferred annuities, bank savings a/c)
PREDICTABILITY OF TIME & CERTAINTY
o Benefits on events unpredictable - both whether and when they might occur (critical illness, redundancy, fire, theft)
o Benefits on events predictable in time (retirement, loan repayment, school fees)
o Benefits on events certain to occur but unpredictable in time (death)
What are the 5 types of benefit provision types?
- Financial Products
- Social Security
- Contracts
- Schemes
- Transactions
5 Financial product categories
- Insurance contracts
- Reinsurance contracts
- Pension schemes
- Investment schemes
- Derivatives
Financial product - Pension scheme
Involves accumulation of funds paid out on later date, for example retirement, death or withdrawal from the scheme.
Financial product - Investment schemes
Involve an individual paying a single payment or series of payments to a provider with expectation that a higher amount will be paid back at a later date.
Financial product - Derivative
Financial instrument whose value depends on the value of other investments or variables.
Can be used by providers of financial products to pass on risks to 3rd parties or gain immediate economic exposure.
Financial product - Insurance contracts
- For a single payment (or series of payments) the provider will pay an individual or his/her heirs an agreed amount that start or end of a pre-specified event.
- This event may happen to the individual, the individual’s property or a 3rd party.
Financial product - Reinsurance contracts
- Providers of insurance products can cede some risks written to third parties through reinsurance contracts in return for paying a reinsurance premium.
Provision - Social security benefits
- VARY CONSIDERABLY under different states wrt:
o Form/level of benefits offered to citizens
o Whether they are means-tested - If social security benefits are means-tested SAVING & alternative private provision may be DISCOURAGED
- These benefits are subject to POLITICAL RISK that the State changes or withdraw benefits the following year
Outline the needs of customers that may be met by pension schemes.
- Accumulate assets to provide income in retirement
- To increase this income in real terms in order to maintain standard of living
- Protect against the financial impact of the death of the member, both before retirement (eg lump sum death benefits) and after retirement (eg spouse’s pension)
- Accumulate assets for other reasons (eg lump sum at retirement to contribute to paying off mortgage loans)
What are the main principles of insurance & pensions that impact the design of financial products and their benefits?
- Existence of insurable interest (prevent moral hazard)
- Risk pooling (Cost-effective pooling of finances to protect against uncertainty which may exist in cost of financing benefits)
o Could be done by retirement communities or microinsurance - Pre-funding of risk
o Need to put money aside in advance of contingent event uncertain in: timing, cost, incidence (will it even happen?)
o Also need in incorporate individuals risk appetite (acceptable probability of desired outcome not being achieved)
o Key issue: How much money is needed to provide benefits with desired probability?
How does attitude to risk play a key role in the individual’s decision?
- Risk-averse individual will prefer protection against future events even at the expense of a worse immediate lifestyle
- Risk seeking individual will prefer to work on the assumption that rare events will not happen to them and to address such events when they occur
o They use money to enhance their immediate lifestyle instead of making provisions
Why group provision may be more cost-effective:
It may be more effective as there can be benefits of economies of scale in:
- Provision (eg sharing of fixed costs)
- Administration costs
- Investment (as there is a larger pool of assets to invest)
Types of needs to differentiate for customers
- logical and emotional needs
- Current and future needs
Give three examples of emotional needs:
- Wanting more benefit than is needed
o Individual may believe there is need to generate additional income in retirement from investment capital.
o On analysis, it may be shown that additional income req. on retirement is much less than perceived - Need for spending money today on enjoying oneself
- Providing overly generous death benefits for dependents
