Ch 2: The external environment

Question 1

List the (16) factors to consider in relation to the external environment

(ACRONYM - CREATE GRAND LISTS - see last slide)

Ch2

Answer 1

Regulation and legislation
State benefits
Tax
Accounting standards
Risk management requirements
Adequacy of capital and solvency
Governance
Corporate structure
New business environment

Social and cultural trends
Demographic trends
Environmental issues and climate change
Lifestyle considerations
International practice
Technology
Economic outlook

Question 2

External Environment:
Legislation and regulations, definitions and explanation

Ch2

Answer 2

Legislation: Law formally declared by the governing body

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

• Require compulsory insurance in certain circumstances
• Influence the types of product available
• Regulate the sale process

Question 3

What two forms of GI cover are compulsory in many countries?

Ch2

Answer 3

1. Employer’s liability
2. Motor third party liability

Question 4

External Environment:
Tax

Ch2

Answer 4

• Tax treatments have an impact on individuals’ needs
• Affects types and forms of (benefits within) products that are brought to market
• Product innovations focus on tax systems (especially to avoid tax, like inheritance tax)
• Directs savings towards most tax efficient forms or tax shelters

Question 5

List examples of how benefits from financial products and schemes can be taxed

Ch2

Answer 5

• Tax free (e.g. life ins payout (except if paid to estate first - normal estate duty))
• Taxed entirely as income (e.g. in retirement pension annuities)
• Tax relief (hybrid) e.g. excess benefit over contributions taxed (inc/cap gains) (e.g. primary residence property sale?)
• Tax relief (hybrid) e.g. first x Rands or first x % tax-free, balance taxed (retirement lumpsum withdrawal in RSA R550k)

Question 6

Explain how items other than benefits can be taxed

Ch2

Answer 6

Contributions may be taxed i.e. paid from taxed income (normally coupled with tax relief on the resulting benefits). Usually, double taxation avoided - only contributions or benefits taxed

Income and gains may be taxed during the accumulation phase (paid by the product provider, on the underlying assets), normally coupled with no tax on the policyholder’s gains.

Tax may be payable on inheritance. Insurance can be available to cover this tax liability.

Question 7

Likely aims of Capital Adequacy and Solvency regulations

Ch2

Answer 7

• Reduce risk of insurers unable to meet claims
• Reduce losses by policyholders if ins unable to meet claims
• Early warning system for regulator to intervene if cap not adequate
• Confidence in ins sector

Question 8

Basel: 3 biggest components of capital requirements is to cover which main risks?

Ch2

Answer 8

• market risk
• credit risk
• operational risk

Question 9

Define corporate governance and outline the features/strategies of a good corporate governance framework

Ch2

Answer 9

Corporate governance is the high level framework within which a company’s managerial decisions are made.

A good corporate governance framework:
1. Encourages managers to act in the best interests of stakeholders, rather than in their own personal interests
2. Incentivises managers in a way to achieve the first aim
3. Utilises non-executive directors
4. influences the way in which stakeholders’ needs are met

Question 10

What are the key features of mutual and proprietary financial providers?

Ch2

Answer 10

Mutual societies
- No shareholders
- Better benefits as profits belong entirely to with-profit policyholders
- Restricted access to new capital, which may restrict product offerings
- Specific distributions of profit are made, or contracts
priced at cost

Proprietary companies
- Shareholders
- Profits may be shared between shareholders and with profit policyholders
Public proprietary companies
* * easier access to capital markets for finance
* * possible benefits of economies of scale
* * more dynamic management
Private proprietary companies
* * restricted access to capital
* * possible benefits from close involvement of owners (owners may have access to significant additional capital, edge over mutauls and public proprietaries)

Question 11

Describe the underwriting cycle

Ch2

Answer 11

Profitability in the various insurance classes tend to go in cycles, driven by market forces of supply and demand combined with actual claims experience and economic climate.

• When business is profitable, more insurers enter the market. Premium rates reduce as insurers compete for market share.
• This leads to reduced profits or to losses, loss of business and reduced solvency, and the cycle goes into depression. The position may be accentuated by catastrophes or by the economic climate.
• At the bottom of the cycle, insurers leave the market or reduce their involvement in the classes concerned, as premiums are too low to be profitable. Eventually premium rates increase to cover the losses being incurred (in light of reduced competition) .
• Speed of cycle depends on position adopted by leading insurers in that business, and demand for market share

Question 12

Why stay in market that is loss-making?

Ch2

Answer 12

• Think things will turn up (losses less than future profits)
• Too expensive to quit (and expensive to later return)
• Cross-subsidy (2 or more markets might be out of sync, losses in one offset by profits in other)
• “loss leader” (need to offer this product to attract sales of other more profitable products)

Question 13

Give four examples of changing social and cultural trends

Ch2

Answer 13

1. Increased home ownership increases the demand for mortgages
2. Cuts in state healthcare increases the demand for private health insurance
3. Increasing prosperity increases the demand for savings products
4. Increased use of telematics for motor insurance, in many countries, allows the risk factors of the individual, the policyholder’s driving behavior and other factors to be monitored through a device installed in the insured vehicle or a smart phone app

Question 14

Demographic changes

Ch2

Answer 14

two main sources of demographic changes leading to population ageing:
* rising life expectancy and
* declining fertility.

Question 15

Give 4 examples of the effects of an ageing population

Ch2

Answer 15

1. Economically: Older people tend to spend less and save more. This leads to lower interest rates and deflationary pressures on the economy.
2. Some pay as you go State pension schemes are becoming unsustainable as the income received from the working population falls short of that needed to pay the retired population
3. Increasing costs of healthcare systems lead to either higher levels of tax to be paid or reduced healthcare provision by the state
4. The cost per capita of educating the population will tend to fall

Question 16

List potential impacts of climate change on population trends:

Ch2

Answer 16

• mass migration from areas at higher risk of flooding due to heavy rainfall and rising sea levels
• increased morbidity and mortality
• increased incidence of diseases in some areas
• conflict and wars.

Question 17

Explain the concept of emissions trading

Ch2

Answer 17

This is a market based approach to address pollution, with the aim of minimizing the cost of meeting an emissions target set by the government.

The government issues permits to emit up to the overall limit. Permits are sold or are equal to historical trading emissions for each polluter. A participant can use permits exactly, or emit less and sell the excess permits, or emit more and buy permits from other polluters.

The usual aim is for the government to lower the overall limit over time.

Question 18

Lifestyle considerations

Ch2

Answer 18

• younger people have preferences for loans rather than savings
• people with children may have a need for life insurance protection products
• older people may have a need for annuities and long-term care products

Question 19

External Environment: International practice

Ch2

Answer 19

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

Question 20

External Environment: Technological changes

Ch2

Answer 20

• Impacts distribution of financial products
• Impacts administration of financial products
• May impact costs, pricing and profitability

Question 21

Give examples of technological advances that can have an impact on financial products, schemes, contracts and transactions

Ch2

Answer 21

1. Internet quotation and sales
2. Price comparison websites
3. Social media for advertising and links to sales/enquiry websites
4. Banking over the internet and phone
5. Easier to reach specific target markets (e.g. microinsurance)
6. Insurance companies increasingly using websites to capture customer enquiries and register claims and transactions
7. Email as a fully accepted and widely used means of communication
8. Increased use of AI in e.g. making underwriting decisions; recording/summarising advice given by intermediaries
9. Medical advances (equipment, substances, etc) may impact mortality/morbidity and impact pricing

Question 22

List the (16) factors to consider in relation to the external environment

(ACRONYM order)

Ch2

Answer 22

CREATE GRAND LISTS

Corporate structure
Regulation and legislation
Environmental issues and climate change
Accounting standards
Tax
Economic outlook

Governance
Risk management requirements
Adequacy of capital and solvency
New business environment
Demographic trends

Lifestyle considerations
International practice
State benefits
Technology
Social and cultural trends