Chapter 3

Question 1

Aims of regulations (8):

Answer 1

• Limit the likelihood and potential cost of failures of financial services companies
• To limit the need for central banks to step in as lenders of last resort.
• Correct market inefficiencies: (due to lack of information) and to promote efficient and orderly markets
• Market Stability: Ensuring stability within financial markets to prevent systemic risks (relevant to actuarial risk models).
• Consumer Protection: Safeguarding clients from fraudulent activities and market abuse.
• Public Confidence: Enhancing trust in financial products and services, which is essential for actuaries working in insurance, pensions, and investments.
• Financial Crime Prevention: Mitigating risks such as money laundering and fraud that can impact financial products and actuarial assumptions. (FICA – if there is a transaction above a certain amount then it is flagged to investigate money laundering)
• Competition: Promoting fair competition to avoid monopolies and promote innovation (key for pricing strategies). (keeps innovation)

Question 2

What are the 2 main types of costs associated with regulation?

Answer 2

Direct costs
* Compliance Costs: Firms may face significant compliance burdens, impacting profitability (especially in pricing models). – (compliance officer, there is a compliance team which is an expense - overhead)
* Administering the regulation - Increased Operational Complexity: Higher regulatory requirements can lead to more complex systems (relevant to actuaries designing models).

Indirect costs
* Alteration in customer behaviour – due to false sense of security
* Undermining of the sense of professional responsibility among intermediaries and advisors
* Reduction in self-regulation by the market
* Reduced product innovation
* Reduced competition

Question 3

What is the optimal level of regulation

Answer 3

marginal benefits = marginal costs

Question 4

Benefits of regulation (3):

Answer 4

• Consumer Protection: Preventing exploitation by ensuring fair pricing and safeguarding policyholder interests.
• Market Integrity: Ensuring financial firms remain solvent, directly impacting the reliability of actuarial assumptions. – protects consumers and the whole industry
• Long-Term Stability: Promoting long-term stability that supports accurate projections, essential for actuaries in reserving and pricing

Question 5

Why do we need regulation (2)?

Answer 5

• Maintain confidence in the sector – avoid problems in one area spreading to other parts of the system (systemic risk)
• Deal with information asymmetries – avoid better-informed parties from using its information advantage to detriment the other party

Question 6

Who do we need to regulate (5)?

Answer 6

-banks
-financial institutions
-security market
-advisers
-non-financial companies offering securities

Question 7

What are the functions of a regulator (8)?

Answer 7

1. Influencing and reviewing government policy
2. Supervising the prudential management of financial organisations
3. Providing information to customers and the public
4. Licensing and Supervision: Ensuring financial firms meet required standards, impacting how actuaries assess financial stability and risk - Vetting and registering firms and individuals authorized to conduct certain types of business
5. Monitoring Compliance: Ensuring that actuarial standards (such as reserving and pricing practices) align with regulations. - Supervising the conduct of financial businesses and taking enforcement action where appropriate
6. Setting Standards: Defining regulatory frameworks that actuaries must follow in their work (e.g., Solvency II in Europe or the Twin Peaks model in South Africa).
7. Enforcement: Taking actions against firms that fail to comply, which can influence actuarial assumptions regarding business risk. - Enforcing regulations, investigating suspected breaches and imposing sanctions
8. Advising Policymakers: Providing insights into financial market trends that can shape the future of actuarial practice