Chapter 2: External environment Flashcards
(22 cards)
List the factors to consider in relation to the external environment
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
Legislation and regulations
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
- Influences the types of product available
- Regulate the sale process
What are 2 forms of General Insurance cover that are compulsory in many countries?
- Employer’s liability
- Motor third party liability
State benefits
Where the state provides benefits to its citizens, these are often at a low level which may only be sufficient to keep individuals just out of poverty. Many individuals will require a higher level of benefits.
An employer may provide this, or the individual may wish to provide personal benefits either through savings or through the purchase of insurance.
The level and form of the state benefits will influence the level and form of additional non-state benefits provided.
Tax
- Tax treatment will have an impact on the needs of individuals
- Affects the type and form of products offered by the financial service industry
- Means that product innovations may be designed to avoid paying tax
- Inheritance tax will change the amount of money passed down
- Directs savings towards the most tax-effective forms of tax shelters.
List 4 examples of how benefits from financial products and schemes can be taxed
- Benefits can be received free of tax
- The excess of the benefits over contributions can be taxed as income or as capital gains
- Benefits can be taxed entirely as income
- A portion of the benefits can be tax-free with the balance being taxed.
Explain how items other than benefits can be taxed.
Some arrangements may offer tax relief on contributions, normally coupled with tax on the resulting benefits. Alternatively, contributions may be paid from taxed income, normally coupled with tax relief on the resulting benefits.
Income and gains may be taxed during the accumulation phase, 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.
Accounting standards
The way that benefit schemes need to be reported in company accounts may influence the types of benefits that employers are prepared to provide for their employees.
The presentation of financial instruments in the accounts of product providers also impacts the range of products that is brought to the market.
Risk management requirements, capital adequacy and solvency
Some regulatory regimes impose minimum standards of risk governance, and there may also be specific regulatory requirements relating to risk management roles within a firm.
Capital adequacy and solvency form part of banking and insurance regulation which sets a framework on how financial institutions measure their capital adequacy and solvency.
Define corporate governance and outline the features of a good corporate governance framework
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.
What are the key features of mutual and proprietary financial providers?
Mutuals - no shareholders:
- Better benefits as profits belong entirely to with-profit policyholders
- Restricted access to new capital, which may restrict product offerings
- Specific distribution of profit are made, or contacts priced at cost.
Proprietaries - shareholders:
- Public proprietary companies have easier access to capital markets for finance, can possibly benefit from economies of scale and have more dynamic management
- Private proprietary companies have restricted access to capital, can possibly benefit from close involvement of owners (owners may have access to significant additional capital, edge over mutuals and public proprietaries) and profits may be shared between shareholders and with-profit policyholders.
Describe the underwriting cycle
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. Eventually premium rates increase to cover the losses being incurred and in the light of emerging experience.
Give 4 examples of changing social and cultural trends.
- Increased home ownership increases the demand for mortgages
- Cuts in state healthcare increases the demand for private health insurance
- Increasing prosperity increases the demand for savings products
- Increased use of telematics for motor insurance, in many countries, allows the risk factors of the individual, the policyholder’s driving behaviour and other factors to be monitored through a device installed in the insured vehicle or a smart phone app
Demographic changes
Two main sources of demographic changes leading to population ageing:
* rising life expectancy and
* declining fertility
Give 4 examples of the effects of an ageing population on the economy or State
- Older people tend to spend less and save more. This leads to lower interest rates and deflationary pressures on the economy
- 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
- Increasing costs of healthcare systems lead to either higher levels of tax to be paid or reduced heealthcare provision by the state
- The cost per capita of educating the population will tend to fall
List potential impacts of climate change on population trends
- Mass migration from areas at higher risk of flooding due to heavy rainfall and rising sea levels.
- Increased morbidity and mortality
- Increased incidence of diseasees in some areas.
- Increases conflict and wars
Explain the concept of emissions trading
This is a market based approach to address pollution, with the aim of minimising 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.
Lifestyle considerations
- 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
International practice
- Providers may look at the suitability of replicating overseas products in the domestic market
- Differences in tax and legislature must be considered
Technological changes
- Impacts the distribution of financial products
- Easier to reach specific target markets
- Better pricing and may reduce costs
Give 6 examples of technological advances that can have an impact on the availability of financial products, schemes, contracts and transactions.
- Internet quotation and sales
- Price comparison websites
- Banking over the internet and phone
- Social media for advertising and links to sales / enquiry websites
- Insurance companies increasingly using websites to capture customer enquiries and register claims and transactions
- Email as a fully accepted and widely used means of communication
Capital is required to cover which 3 risks?
- Market risk
- Credit risk
- Operational risk
