Ch 2: The external environment

Question 1

List the factors to consider in relation to the external environment

Answer 1

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

Question 2

Describe the underwriting cycle

Answer 2

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.

Question 3

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

Answer 3

1. Employer’s liability

2. Motor third party liability

Question 4

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

Answer 4

1. Benefits can be received free of tax
2. The excess of benefits over contributions can be taxed as income or as capital gains
3. Benefits can be taxed entirely as income
4. A portion of the benefits can be tax-free, with the balance being taxed

Question 5

Explain how items other than benefits can be taxed

Answer 5

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.

Question 6

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

Answer 6

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

Question 7

Give 4 examples of the effects of an ageing population on the economy or State

Answer 7

1. 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 8

Explain the concept of emissions trading

Answer 8

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 9

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

Answer 9

Mutuals - 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 contacts
priced at cost

Proprietaries: shareholders:
- Public proprietary companies
 > easier access to capital
 > possible benefits of economies of scale
 > more dynamic management

• Private proprietary companies
  > restricted access to capital
  > possible benefits from close involvement of owners
• Profits may be shared between shareholders and with profit policyholders

Question 10

Give four examples of changing social and cultural trends

Answer 10

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 11

Give 6 examples of technological advances that can have an impact on the availability of financial products, schemes, contracts and transactions

Answer 11

1. Internet quotation and sales
2. Price comparison websites
3. Banking over the internet and phone
4. Social media for advertising and links to sales/enquiry websites
5. Insurance companies increasingly using websites to capture customer enquiries and register claims and transactions
6. Email as a fully accepted and widely used means of communication

Question 12

External Environment:

Legislation and regulations, definitions and explanation

Answer 12

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 13

External Environment:

Tax

Answer 13

• Tax treatments 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

Question 14

Capital is required to cover which 3 risks?

Answer 14

• market risk
• credit risk
• operational risk

Question 15

External Environment:

International practice

Answer 15

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

Question 16

External Environment:

Technological changes

Answer 16

• impacts the distribution of financial products
• easier to reach specific target markets
• better pricing and may reduce costs