CHP 3 Flashcards
- Legislation and regulation
Some countries, certain forms of insurance are compulsory.
• Legislation requires certain individuals or organisations to hold them.
E.g. Employers Liability insurance, third party car insurance
• Regulation may influence the type of financial product most suited to customer needs
E.g. charge limitations on IV products may make it more suitable than ones without limitation
• Regulation may influence the type of product brought to market by providers
E.g. information requirements for a complex product (e.g. derivative IV strategy) may cause it to be unmarketable even though it is very suitable to client needs.
- State benefits
State benefits are usually at a low level – insufficient to keep out of poverty
Thus many want higher levels of benefits
Employers may provide this e.g. pension scheme, health scheme
Alternatively, individuals can provide themselves via purchasing saving or insurance products
State benefits can be taken into account when financial planning for an individual, there are 2 aspects to this:
- Less need for self-provision
2. Discouragement of saving
- Less need for self-provision
E.g. free health care services need not to be taken out again privately, only provide for events not covered by the government health care plan.
Employers may take this approach in providing health care to workers – only provide for events not covered by government.
- Discouragement of saving
It could be more beneficial for a low income person not to save and build up assets and take what is provided for free by government. This is because government benefits are means tested and will reduce if the individual has assets.
Thus the individual could be better off not saving at all.
If the State requires individuals to save for retirement or other benefits, this will reduce the amount that individuals feel they can or need to invest in individual arrangements.
- Tax Individual needs
tax treatment can have an impact on individual needs e.g. 1/3 cash withdrawal from RA, works out more tax efficient to withdraw the cash even if you purchase an annuity with the funds than to just purchase a compulsory annuity.
- Tax Product range
tax systems influence types and forms of products available.
- Tax Inheritance tax
consider this when estate planning e.g. take life cover to pay the tax.
- Tax Tax on savings
tax on savings will impact savings behaviour e.g. RA savings are pre-tax (within limits)
Also consider the individual’s marginal tax rate when choosing appropriate savings vehicles.
- Accounting standards influences
Way benefits are recorded in the accounting books will influence types of benefits employers are prepared to provide.
Presentation of financial instruments in providers’ books impacts range of products offered. E.g. requirements for setting provisions for insurance contracts can influence design.
A fund manager can bring an investment to market in:
• an insurance wrapper through a subsidiary,
• or through a unit trust, or
• mutual fund
depending on the presentation in the company accounts.
- Capital adequacy and solvency
Form part of banking and insurance regulation which sets a framework for measuring cap adequacy and solvency.
Basel II – framework for cap adequacy for banks. A bank’s cap ratio is the percentage of cap to its risk-weighted assets. The weights applied to the assets are defined by risk-sensitivity ratios, Basel II sets out the method for calculating these.
- Corporate governance
Is the high level framework within which managerial decisions are made.
- Corporate governance
aims
The company should be managed in order to best meet appropriate requirements of its stakeholders:
Shareholders, employees, pensioners, customers, suppliers and those affected by operations but has no contractual relationship with the company.
Corp gov – tries to prevent managers to make decisions for personal interests and not stakeholders.
- Corporate governance
Strategies
Align remuneration of managers to interest of stakeholders. E.g. share options (lack of downside could be a drawback – may not incentivise to control risk).
Non-executive directors:
• provide an impartial view and represent the shareholders’ interests
• setting the remuneration for executive directors’ pay
• audit committee, e.g. in relations with external auditors with no members of the executive present.
Governance arrangements influence ways in which stakeholder needs are addressed.
Guidance on corporate governance is often developed by private institutions and governments. E.g. in the UK, the Financial Reporting Council has issued a Code of Practice on corporate governance.
What role do Non-executive directors play
- provide an impartial view and represent the shareholders’ interests
- setting the remuneration for executive directors’ pay
- audit committee, e.g. in relations with external auditors with no members of the executive present.
- Risk management requirements
In corporate finance, risk management requirements are concerned with measuring, monitoring and controlling risk on the balance sheet. Applies to banking and insurance companies where regulators are responsible for safeguards to protect against systemic failure of the system and the economy.
- Corporate structure
Mutual societies:
Proprietaries:
Mutual societies:
Have no shareholders, profits belong to policy holders.
On face value, they should be able to provide better benefits for cheaper (no dividends)
Cannot raise capital as easy and is thus the product offering is restricted – cap intensive products will not be attractive and may be priced accordingly.
2 ways in which Mutuals approach pricing:
1. Surplus and distribution – may offer specific distributions of surplus to members.
With-profits insurance companies, friendly societies and co-ops tend to do this.
2. Pricing at cost – price at the lowest prudent margins and benefit members that way
Proprietaries:
Public proprietaries benefit from
• easy access to cap markets for finance,
• greater economies of scale,
• more dynamic management than mutuals
This may pay the dividends themselves and the co could have a competitive advantage over mutuals
Private companies are also restricted for raising cap but often has close involvement of owners – management advantage
For proprietary life companies, the division of surplus between shareholders and with-profit policy holders is important.
9.1. The underwriting cycle
This is a consequence of the competitive nature of the insurance business.
Profitability in insurance classes will move in cycles that are driven by demand and supply.
In the long term, profits and losses should even out.
In the short term, profitable classes will cross-subsidise losses in other classes.
More extremely, the inability to make profits at the bottom of the underwriting cycle could lead to:
• Loss of business – pressure on ability to recoup fixed expenses and future growth prospects
• Reduced solvency position, requiring additional capital support or other remedial action.
10.1. Changing cultural and social trends
e.g. if homeownership becomes more prominent, there will be greater demand for mortgages. State cuts back on free benefits. Increased amount of disposable income.
10.2. Demographic changes
Two main sources of changes in population ageing:
• Rising life expectancy
• Declining fertility – main contributor (decline over last 50 years in developed countries)
Many developing countries will experience faster fertility transitions and population ageing.
Effects of population ageing:
- Older people are more likely to save more and spend less – leads to lower interest rates and deflationary pressures.
- Social welfare systems – pay people for longer with less people to support this (pay as you go – young support the old)
- Cost of healthcare will increase as the average age is older. Government can increase taxes or reduce level of care.
- Education cost (second largest) will decrease as the population ages.
10.3. Environmental issues
- Providers that want to be attractive to the widest market will need to make environmental and ethical issues part of the decision making process.
- Operators of savings products have promoted products that have the aim to enhance the effect of the investment process on environmental and ethical issues. E.g. a social responsibility overlay.
- Communication to members – e.g. paper based?
10.4. Lifestyle considerations
- Younger people – higher demand for loans and mortgages and less for savings
- Middle aged people – more saving and increased demand for insurance (have dependents)
- Older people – less saving due to retiring and spending savings. Need annuities and long term care products. Need for insurance decline as dependents grow older.
- As people grow older, they need to save more/longer to ensure income for life.
10.5. International practice
Look at what is offered in other markets (overseas) and replicate. Different tax regimes sometimes prevent this. e.g. critical illness from SA, mortgage one account from Australia.
10.6. Technological changes
Way in which products are provided changes with available technology. E.g. internet quotes
