Conditions and Processes in the Sale of Insurance and Financial Services Products - Essay Example

The financial system is one of the most important inventions of the modern society. The phenomenon of imbalance in the distribution of capital or funds exists in every economic system. There are areas or people with surplus funds and there are those with a deficit. A financial system functions as an intermediary and facilitates the low of funds from the areas of surplus to the areas of deficit. A financial system is a composition of carious institutions, markets, regulations and laws, practices, money managers, analysts, transactions and claims and liabilities. Insurance is one among the financial system. Insurance is a part of financial system. It takes care of the financial consequences of certain specific contingencies both in case of individuals and corporate bodies. The effect of the losses o financial system is not only negative but may be disastrous and catastrophic also. It may be at micro - level or macro - level. Insurance provides financial security wherever there is an insurance policy. In fact, insurance is legally compulsory. The insurance sector has weathered terrorist attacks of previously unknown magnitude; it has suffered from a severe drop in equity markets; it is going through a prolonged period of historically low interest rates and has even suffered from major credit defaults (Rossum, 2005). But it remains in good shape. The attack on the World Trade Centre is a good example in this context. Though past performance can be relied upon to decide whether regulation is necessary or not with respect to sale of insurance and financial service products, there are certain trends which support the need for regulation. They are - The trend towards 'fair value' accounting. An increasing complexity, especially in the life insurance sector. The emergence of integrated financial conglomerates (Rossum, 2005). The regulation of the financial system can be viewed as a particularly important case of public control over the economy (Giorgio, 2004). A plethora of theoretical motivations support the opportunity of a particularly stringent regulation for banks and other financial intermediaries. Such motivations are based on the existence of particular forms of market failure in the credit and financial sectors. Regulatory Framework A regulatory framework is most essential in order to manage any financial system as a matter of fact ((ICMR), Financial Management for Managers, 2003). The governmental regulatory framework seeks to Define avenues of investment available to business enterprises in different categories, ownership-wise and size-wise; Induce investment along certain lines by providing incentives, concessions, and reliefs; and Specify the procedure for raising funds from the financial markets. Despite the existence and sale of numerous insurance policies that cover various contingencies, the economic reason for the regulation of the insurance is yet to be defined in the financial literature. There are many rigorous arguments in favour of the regulation of insurance companies, some of which are discussed as follows (Booth, Oct,2007). First and foremost, regulation can prevent the adverse affects of information asymmetries in markets for illiquid contracts. Secondly, regulation can be used to ensure that insurers commit to contracts. In the case of life insurers these contracts may be incomplete, and it may be difficult to determine the terms of the contracts objectively; this is particularly so with U.K. with-profit contracts, for example. As discussed in the initial paragraphs of this paper, the term 'financial system' traditionally includes banking, financial and insurance segments ((ICMR), Commercial Banking, 2003). A primary objective of financial market regulation is the pursuit of macroeconomic and microeconomic stability. Safeguarding the stability of the financial system translates into macro controls over the financial exchanges, clearing houses and securities settlement systems. Earlier, many academics and practitioners have argued that, there is a definite need to regulate banking and non - banking institutions (Booth, Oct,2007). Also, it was felt that the principles of regulation should be the same. But, if we look at the economic reasons for regulating banking institutions, they may differ from insurance institutions. This clearly states that regulatory framework may not be the same for all the different institutions of the financial system. There also exists a secondary objective behind the regulation of the financial market. The secondary objective is transparency in the market and in intermediaries and investor protection. At the macro level, transparency rules impose equal treatment and the correct dissemination of information. Equal treatment in this context means imparting rules regarding takeovers and public offers. Correct dissemination of information is with respect to insider trading, manipulation and, more generally, the rules dealing with exchanges microstructure and price-discovery mechanisms. At the micro level, such rules aim at non - discrimination in relationships among intermediaries and different customers. This can be simply described as the conduct of business rules (Giorgio, 2004). There is yet one more objective behind the regulation of the financial market and the financial system. It is linked with the general objective of efficiency, is the safeguarding and promotion of competition in the financial intermediation sector. This requires rules for control over the structure of competition in the markets and, at the micro level, regulations in the matter of concentrations, cartels and abuse of dominant positions. In the recent past banking, securities and insurance segments are becoming increasingly integrated in terms of markets, intermediaries and financial instruments. The boundaries separating banking, securities and insurance activities are in fact on their way out in most developed financial systems because of the strong process of technological, geographical and functional integration among these three sectors; and as a consequence of the de-specialization of the intermediaries. Also, the role of insurance companies as financial intermediaries is also constantly increasingly, thanks to contracts involving life insurance and capitalization, whose services are directly tied to investment funds or to stock exchange or other financial indices. There has recently been financial market regulation in Italy which has been affected by the structure and the evolution of the financial system. Italy's regulatory system's basic approach was to carve a three-way division of the financial market into banking, securities and insurance sectors. This division was reflected in a three-way division of the intermediaries and a corresponding division of the regulatory authorities (Giorgio, 2004). Market imperfection and failures are also important reasons behind financial regulation. If there are market imperfections and failures but no regulation, the consumer pays a cost because the un-regulated market outcome is sub-optimum (Llewellyn, 1999). The basic intention behind governments regulating the financial service industry is to protect consumer interests and to correct for market imperfections or market failure. There are many market imperfections and failures in retail financial services which create a rationale for regulation: Problems of inadequate information on the part of the consumer; Problems of asymmetric information (consumers are less well informed than are suppliers of financial services); Problems of ascertaining quality at the point of purchase; Imprecise definitions of products and contracts (Llewellyn, 1999); In a regulation-free environment these considerations impose costs on the consumer. The main purpose of government regulations with respect to sale of insurance and financial service products is to enhance it and make it effective in the marketplace by offsetting market imperfections which potentially compromise consumer welfare. But the perception with regard to the government imposing regulations on the sale of insurance and financial service products is that the government is trying to replace competition which is actually false. Let us say, there exists no stipulated regulating authority for the financial institutions which clearly means that there is nobody to monitor the activities of the institution with respect the sales of financial service products. In such a case many problems may arise like principal-agent problems, difficulty in ascertaining the quality of a financial product at the point of purchase, and there is often a fiduciary role for the financial institution, etc. All these issues therefore substantiate the need for regulation of the financial markets and the financial system. With the presence of a regulating agency i.e. government, consumers in effect delegate to the regulator and supervisor at least some of the monitoring responsibilities and, in the process, reap the benefits of expertise and economies of scale. For any product or service to be successful in the market, the most important thing that is necessary is the confidence and the trust in the minds of the customers about the product or the service. There exists both good and bad products in the market and this is a known fact to the customers (FSA Library, 2002). Also, any product or service would definitely have both good and bad aspects with respect itself and most of the customers know both these aspects of the product or the service. Due to lack of credible information about the products, customers find it difficult to distinguish good products from bad ones. This may result in the decline in the demand for the products and services. Under some circumstances, and with known asymmetric information features, risk-averse consumers may exit the market altogether. If this trend continues for a continued period, then it would result in a complete breakdown of the market. The reason behind this breakdown is the perceived costs of purchasing a low-quality product are valued highly, and consumers may forego the possibility of purchasing what might be a high quality product because of the high risk and high cost of unwittingly purchasing a poor product (Llewellyn, 1999). In such a situation, consumers do not purchase products they believe might be beneficial because they are unable to distinguish high and low quality products. In this context, it is all the more viable to recollect the words of Davies that say "'Without regulation to give consumers some independent assurance about the terms on which contracts are offered, the safety of assets which underpin them, and the quality of advice received, saving and investment may be discouraged, again with damaging economic consequences'. A relevant example to support this stance is the UK market, where part of the explanation for the substantial fall in the sales of life assurance and personal pension products in 1994 and 1995 was the lack of consumer confidence in the industry following a series of scandals and hazardous selling practices (Business Insights, 2003). According to the Financial Times editorial of April 1998, the customers of the United Kingdom are increasingly reluctant to take on long - term commitments. Also, the customers are becoming highly concerned about the selling standards of the products and services in the market. A more similar opinion was even expressed in a report of the House of Commons Treasury and Civil Service Committee which states that the government and the regulatory authorities need to recognise the deep unease felt by many people towards involvement in the financial services industry (Llewellyn, 1999). Given that regulation sometimes fails, and has its own costs and problems, some argue the case for private self-regulation, reinforced by common, commercial and contract law. As a result of all the latest developments and mishaps happening in the market, now-a-days consumers have also started demanding regulations, supervisions and various forms of compensation mechanisms despite the huge costs that may have to be met by the government in implementing these customer demands. Consumers may demand a degree of comfort that can only be provided by regulation. There are several reasons why it can be rational for the consumer to demand regulation: Lower transactions costs for the consumer (e.g. saving costs in investigating the position of financial firms, costly analysis etc.), Lack of information and ability of consumers to utilise information, A demand for a reasonable degree of assurance in transacting with financial firms, Past experience of bad behaviour by financial firms, As a result of government regulations, a risk-averse consumer may willingly pay a high insurance premium through regulation. Bibliography 1. (ICMR), I. C. (2003). Commercial Banking. Hyderabad: ICFAI Center for Management Research. 2. (ICMR), I. C. (2003). Financial Management for Managers. Hyderabad: ICFAI Center for Management Research . 3. ARckatty, D. S. (2008, 01 09). Associate Dean - ICFAI National College. (Rajyalakshmi, Interviewer) 4. Bank, B. (2007, 05 25). Fxstreet.com. 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