The External Environment

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Chapter 3
Asset-Liability Management for Actuaries

• The External Environment

Shane Whelan, L527
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External Environment

• The external environment is the milieu in which
  the stakeholders interests must be reconciled
  (conceived wider that the business context of the
  problem). Important components are
• legislation
• regulations
• contract Law
• the State
• benefits
• tax
• corporate governance
• accounting standards
• competitive advantage commercial requirements
• insurance cycles
• ethical environmental issues
• lifestyle considerations
• changing social trends

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External Environment (cont.)

• technological changes
• international practice
• Well make some brief remarks on each.

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Legislation

• Actuaries often advise of providing benefits in
  the long term.
• Such advice only required if confidence that
  long-term contracts can be enforced.
• So stable State developed legal system
  confidence in its continuation
• Within that basic requirement, actuaries tend to
  find themselves in quite a regulated environment
• Some products compulsory to buy
• Regulation on charging structure, method of sale,
  etc
• Regulation on reserves to be held
• This environment significantly influences the
  types of products that can be offered.

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The State

• State often provide benefits to citizens
• But perhaps low level and, perhaps, means tested.
• Hospital care, pension, sickness benefits
• Does means testing create anomalies in the long
  term?
• Need complementary products
• So, when integrated with State benefits, provided
  targeted benefit.
• Often encouraged by State
• Through tax reliefs or subsidies.
• In Ireland UK, pension has tax relief on
  contribution, investment return and lump sum on
  retirement.
• Contrast with discretionary savings.
• How does this affect allocation of savings by
  product type?

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Thought Experiment

• It is suggested that the only tax to be levied on
  providers of life contingent products in Ireland
  in the future is a premium tax that is, a
  percentage of each premium received by the office
  is paid as tax.
• Outline some advantages and disadvantages of this
  method of taxation from the perspective of the
  government.
• State other practical ways of taxing the
  business.
• What long-term affects will such a new tax system
  have on the life assurance industry?

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Corporate Governance

• Corporate governance refers to the framework
  within which managerial decisions are made in a
  company.
• Good corporate governance means that a company is
  managed to best meet appropriate requirements of
  its stakeholders the shareholders, employees,
  pensioners, customers, suppliers, and others.
• Key is overcoming the principal-agent conflict
• Remuneration incentives to bring interest of
  management in line with key stakeholders.
• Options in stock? Bonus system related to
  profits?
• Mutual versus proprietary public versus private
  company
• Raising finance quality of managers owners
  exercise of control
• Accounting standards can be seen as helping to
  achieve good corporate governance by the simple
  technique of disclosure.
• Reporting reality has a big affect on reality!

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Corporate Governance

• A notable feature of general insurance business
  is what is known as the insurance cycle, where
  profitability in the various insurance classes
  tends to go in cycles.
• Why?
• Elasticity of supply?
• Is it rational?
• The position of a class of business in the
  insurance cycle is, therefore, an important
  consideration when making strategic decisions.
• Also should influence the mix of business - in
  the short term, profitable classes may be able to
  cross-subsidise losses in other classes so
  leading to a stable profit stream.

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Ethical Environmental Issues

• One channel that informs future laws and
  regulations the sentiment of the public.
• Can be considerd as a niche market social
  responsible management
• Or
• A means to meet all stakeholders (albeit less
  significant but) common interests.

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Lifestyle or lifecycle Considerations

• The requirements of people depend on their stage
  in the life-cycle
• Young workers borrow as outgo exceeds income
  e.g., mortgage, car loans, college fees.
• Life assurance/widows pension when children come
  along.
• Middle age to 65 is saving period.
• Older members draw-down savings replace salary
  after retirement, long-term care expenses,
  medical expenses. Insure against longevity.
• Insure to meet inheritance/death taxes.
• Applies to economy as a whole on aggregation.
• Changing social trends can be added to reflect
  evolution of lifestyles with time
• E.g., home ownership decreasing meaning pension
  provision must increase State cuts back on
  healthcare gives opening for private provision
  increasing wealth increases demand for savings
  products.

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Technology

• A constant source of change in product, method of
  sale of product, etc
• Mobile phones and internet
• Commodity-type market in standard products
• Protection life cover, 3rd party insurance,
  annuity
• Reduce costs of bringing product to market
• New products? Or just new packaging?

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Finally, International Practice

• Good ideas often invented elsewhere
• Australia and flexible mortgages
• South Africa and critical illness cover
• Actuarial profession
• So copy!

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Completes Chapter 3
Asset-Liability Management for Actuaries

• The External Environment

Shane Whelan, L527