Buku Asli CII - Insurance Business and Finance - v.1 PDF

INSURANCE BUSINESS AND FINANCE
Bisnis Asuransi dan Keuangan

Dibuat untuk UJIAN LSPP AAMAI 103 dengan Kurikulum Baru
The Chartered Insurance Insurance 2010
Pengantar Penerjemah
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kurikulum baru LSPP AAMAI untuk materi K.651210.103.01 atau 103: Bisnis dan keuangan asuransi.
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Jakarta, 1 Januari 2014

Salam hormat,
Afrianto Budi P, SS MM
akademiasuransi.org
Daftar Isi
ii | A f r i a n t o B u d i , S S M M
1. Struktur bisnis asuransi
A. Perbedaan tipe perusahaan asuransi
B. Perbedaan penjual asuransi
C. Pentingnya pelanggan
D. Pentingnya stakeholder asuransi
E. Perspektif global
F. Pertumbuhan perusahaan dan merger dan akuisisi
G. Outsourcing (alih daya)
H. Pendelegasian otoritas dalam underwriting
2. Manajemen bisnis asuransi: peran, tanggungjawab, dan gaya

A. The board of director (Dewan direktur)
B. Senior executives (Eksekutif senior)
C. Manager and Supervisor
D. Non-managerial Staff
E. Gaya manajemen
3. Manajemen bisnis asuransi: perencanaan dan kontrol

A. Proses perencanaan
B. Perencanaan dan kontrol anggaran
C. Pengambilan keputusan
D. Informasi manajemen
E. Manajemen pengetahuan
4. Aspek utama dalam tata kelola perusahaan

A. Struktur peraturan
B. Penggabungan usaha
C. Persyaratan pelaporan yang berlaku
D. Fungsi audit internal dan eksternal
E. Rapat dan fungsinya
F. Agenda, menit, dan dokumentasi terkait
G. Kunci laporan tata kelola dan persyaratan
H. Kerahasiaan
5. Pemasaran
A. Fungsi pemasaran dan bisnis
B. Konsep kunci pemasaran
C. Riset pasar dan proses pengembangan produk
D. Komunikasi dan promosi
6. Sumber daya manusia

A. Fungsi manajemen sumber daya manusia
B. Rekrutmen dan seleksi
C. Penilaian dan penghargaan
D. Pelatihan dan pengembangan
E. Motivasi dan moral
F. Peraturan ketenagakerjaan dan tempat kerja
7. Prinsip dan praktek utama akuntansi

A. Tujuan dan fungsi akuntansi keuangan
B. Akuntansi manajemen dan keuangan
C. Pengguna informasi keuangan dan kebutuhan informasi mereka
D. Konsep keuangan dasar dan persamaan akuntansi
E. Tanda terima dan pembayaran
F. Neraca keuangan
G. Laporan laba-rugi
H. Laporan arus kas
iii | A f r i a n t o B u d i , S S M M
I. Catatan wajib untuk akun
8. Standar akuntansi dan akun perusahaan asuransi

A. Peran Dewan Standar Akuntansi Internasional (International Accounting Standards Board
IASB)
B. Standar Pelaporan Keuangan Internasional (International Financial Reporting Standards
IFRS)
C. Prinsip Akuntansi yang diterima secara umum di UK (UK Generally Accepted Accounting
Principles)
D. Dafar autran FSA Inggris (FSA UK Listing Rules)
9. Pencadangan klaim
A. Pentingnya cadangan yang akurat
B. Incurred but not reported (IBNR - Dikeluarkan namun belum dilaporkan) dan perannya
dalam akun perusahaan
C. Metode pencadangan
10. Rasio finansial

A. Rasio yang sering digunakan
B. Rasio dalam industri asuransi
C. Menilai hasil kinerja perusahaan asuransi
11. Kekuatan finansial perusahaan asuransi

A. Lembaga penilai
B. Margin solvabilitas dan ketentuan yang berlaku
iv | A f r i a n t o B u d i , S S M M
Bab 1: Structure of the insurance
business
Introduction
Insurance companies have a valuable function to perform within society by insuring the wealth
of the country. It will come as no surprise that no two insurance companies are identical in their
structure and outlook. However within the UK, all insurance companies can be grouped into
three broad types: 1
A composite Company: an insurance company that transacts both long-term business (life)
and general business.
A life company: a life assurance company that is only able to transact long-term business.
A general insurance company: an insurance company that is only able to transact general
business.
These three styles of companies do not make one single large market, since the insurance
marketplace refers more to the mechanism by which buyers and sellers come together, rather
than a physical location. However, every rule has an exception and the one exception is that the
transaction of insurance business within the London Market, including Lloyd's of London, can
be classified as a physical location. We shall look at the London Market in more detail in section
E1.
Structure and size of the UK insurance industry

The UK insurance industry:
is the largest in Europe and third largest in the world (behind USA and Japan};
accounts for 7% of total worldwide premium Income;
in 2010 employed around 290,000 people- or 1% of the working population (Source
ONS);
had total net investments of 1.7 trillion at the end of2010; accounts for 26% of the net
worth of the UK economy;
is a major exporter- 28% of its net premium income comes from overseas business.
As at 31 March 2010 there were 477 authorized UK insurance companies, of which Ill were life
companies, 17 composites and 349 general insurance companies. (Source FSA.)
Worldwide net premium income of UK insurers in 2010 was 200bn of which 61bn was
general business and 139bn was long-term business.
Activity
Find out more about the insurance industry's role in the UK economy and society.
See if you can find the answers to questions such as:
How does the industry help to promote investment in future economic growth?
How does it help public services and company expansion?
What role does it play in the following issues?
fighting crime; improving safety at work;
dealing with the effects of climate change;
and supporting the nation's health?
Chapter 1: Structure of the insurance business
The market for insurance

Like any other market, the insurance market comprises:
sellers: insurance companies and Lloyd's;
buyers: general public, industry and commerce, and public authorities;
middlemen: insurance brokers and intermediaries.
In other markets the buyers, sellers and the middlemen come together to examine the
merchandise that is for sale. With insurance it is not possible to bring a house, factory or ship to
a marketplace, and in any event what is being insured is the financial interest in that asset which
is at risk.
The buyer is any person, company or organization wanting to purchase insurance. This may be
a homeowner spending a few hundred pounds purchasing home insurance or one single
company spending many millions of pounds per year on insurance premiums. They may he
faced with many different insurance companies to choose from the buyer will often use an
insurance broker or intermediary.
An 'intermediary' is an agent who is authorized by a party, often a commercial company to

recommend an insurance company and/or insurance policy. They may even be authorized to
purchase it.
An insurance broker is an individual or firm whose full-time occupation is the placing of

insurance with insurance companies. A high standard of expertise is expected of insurance
brokers. The broker shall place the interests of their client before all other considerations. The
insured can obtain independent advice on a wide range of insurance matters from a broker,
without direct cost to themselves. From the insurers' point of view, negotiations with brokers are
easier and speedier because only the intricate points or special requirements require detailed
discussion, thus saving time and money on routine matters.
Lloyd's
Lloyd's occupies a unique position in the world of insurance. A society incorporated by statute it
provides premises, services and regulation to a marketplace ('the Lloyd's market') which has
been trading in insurance for over 300 years.
Lloyd's does not itself transact insurance, as this is the business of the underwriting members of
Lloyd's (both individual and corporate) who make up the Lloyd's market. They underwrite for
their own profit and loss and in administrative groups called syndicates. The underwriting
members appoint independent companies known as managing agents to carry out the
underwriting business (write the risk, pay the claims etc.) on their behalf. Since Lloyd's was first
established in the late seventeenth century the Lloyd's market has develop a strong worldwide
reputation for its ability to provide the finest risk solutions for its customers. These customers
generally instruct to act for them one of the firms of Lloyd's brokers, all of whom have a good
understanding of the Lloyd's market and many of whom specialize in particular risk categories.
Lloyd's has a unique 'chain of security' to protect insurance policyholders, should any member
be unable to pay a claim.
A development in the modernization and reform of Lloyd's was the creation of a franchise
structure, whereby Lloyd's acts as the franchisor and the managing agents and the members for
whom they acted are the franchisees. The aim of this structure is to improve market profitability
and to allow monitoring and guidance of franchisees, with the franchisor having ultimate power
to eject businesses that are unable to respond. As franchisor, Lloyd's now pursues a much more
proactive role than had been undertaken previously. A Franchise Board with members drawn
from both inside and outside the Lloyds market carry out the franchisor's role.
Activity
Visit the Lloyds website at www.lloyds.com for more information on how the Lloyds market
works.
Chartered Insurance Institute www.AkademiAsuransi.org repro by: Afrianto Budi SS MM

A Different types of insurance company
A.1 Proprietary companies

The majority of insurance sellers come under this heading. Proprietary companies have an
authorized and issued share capital to which the original shareholders subscribed, and it is to
the shareholders that any profits belong after provision for expenses, reserves and, in the case
of life business, with profit policyholders bonuses. The shareholders' liability is limited to the
nominal value of their shares (hence the term limited liability}, but the company is liable for its
debts and if the solvency margin (see chapter II) cannot be met the company will go into
liquidation. The public can deal direct with these companies but often a broker or an
intermediary is involved.
In most classes of business there is keen competition among proprietary companies and also
between proprietary companies and other sectors of the market.
Most are composite or general companies writing issuance and reinsurance business. Insurance
companies operate by charging relatively small premiums in comparison to the exposed risk to
large numbers of the same type of customers- in other words the losses of the few are paid for
by the premiums of the many (risk transfer).
Good examples of insurance and reinsurance classes are:

accident and health;
motor;
aviation;
fire and other damage to property;
liability.
Reinsurance companies operate in a similar way to insurance companies, as they transfer risk.
They allow insurance companies to pass risk onto them in return for a premium. There are many
types of reinsurance contract but this course does not expect you to have a working knowledge
of the reinsurance market, other than having an appreciation of the diversity of the term
insurance market.
However, you do need to understand why the reinsurance market exists. Insurers purchase
reinsurance for two basic needs:
To limit ( as much as possible) annual fluctuations in the losses that affect their
underwriting account, often referred to as 'smoothing the underwriting result.
To be protected in case of a catastrophe (both man-made and natural).
Reinforce
Before you move on, make sure you know how reinsurance companies help general insurance
companies. Make some notes below:
A.2 Mutual companies

Mutual companies have been formed by Deed of Settlement or registration under the
Companies Acts. They are owned by the policyholders, who share any profits made. Most
mutual companies operate in the long-term sector (life) offering their customers the full benefits
of saving over a long period - often between 10 25 years. The shareholder in the proprietary

company receives their share of the profit by way of dividends, but in the mutual company the
policyholder owner may enjoy lower premiums or higher life assurance bonuses than would
otherwise be the case.
Many companies, which were originally formed as mutual organisations, have now registered
under the Companies Acts as proprietary companies, although they have retained the word
mutual in their title. Others, registered as companies limited by guarantee and without the word
mutual in their title, are actually owned by the policyholders.
Mutual companies may transact life or general insurance business. A feature of mutual status is
a difficulty in raising additional capital since they cannot issue additional shares in the way that
proprietary companies can. 'The 1990s saw growing pressure on mutuals to convert to the
status of proprietary companies (a process known as 'demutualisation').
Good examples of long-term business are as follows:
life and annuity

permanent health;
pension fund management;
linked long-term.
As with reinsurance, this course does not expect you to have a working knowledge of the life
insurance business, other than having an appreciation of the diversity of the insurance market.
Be aware
A mutual firm will concentrate on getting the best returns for its members as there are no
shareholders to take a share of the profits through payments or dividends.
A.3 Captive insurance companies

Captive insurance is a tax-efficient method of transacting risk transfer, which has become more
common in recent years among the large national and multinational companies. The parent
company forms a subsidiary company to underwrite certain of its insurable risks.
The main incentives are to obtain the full benefits of the group's risk control techniques by
paying premiums based on its own experience, avoidance of the direct insurers' overheads and
obtaining a lower overall risk premium level by purchasing reinsurance at lower cost than that
required by the conventional or direct insurer.
Many captives are operated from offshore locations such as Bermuda, Guernsey and the Isle of
Man. This does give the captive certain fiscal advantages, but it also reduces the volume of
paperwork associated with registering as an insurer and, because so many captives are off-
shore, allows the captive to tap into all the necessary ancillary services such as investment
management, banking and accounting.
Reinforce
Make some notes on the key benefits of having a captive insurance company below.
A.4 Takaful insurance companies

Takaful is a basis of insurance that has its roots in the Islamic financial services industry. The
model has been developed over a period of time and it is based on the rulings of Sharia law on

financial and commercial transactions. It works on the principle that in any transaction, risk and
profit (and loss bearing) should be shared between the participants.
The reason for this business development is to meet a newly identified customer group for both
insurers and intermediaries with a need for products to meet their particular religious principles.
Under Islamic (Shariah) law, traditional insurance policies are seen by Muslims to be contrary to
some of the fundamental principles of Islam, as they involve:
Gharar uncertainty. Islamic law forbids sales where there is risk to the buyer, unless the risk
is of a normal or reasonable proportion. Some believe that traditional insurance policies do not
remove uncertainty because how much and when, if at all, a policy will pay out remains
uncertain;
Maisir - gambling. Traditional insurance policies are seen to be a sort of gambling because
some policyholders receive payouts whilst others do not. Gambling is forbidden under Islamic
law;
Riba - interest. Islamic rules also forbid making money from money, such as through interest.
Wealth can only be made through the trade of assets and investments.
To respond to the specific needs of these customers a new type of product - takaful insurance -
has been developed.
Takaful is an Arabic word meaning 'guaranteeing each other'. Takaful insurances embrace the
Islamic principles of:
mutuality and co-operation;

shared responsibility;
joint indemnity;
common interest; and
solidarity.
They are similar to those which underpin mainstream mutual insurance and involve a number of
participants sharing risk on a co-operative basis. This avoids policyholders gambling on the
fortunes or misfortunes of others, as customers pay money into a communal fund and take out
what they need in the event of a claim. Insurance companies charge a fee for managing the
fund. Any money left over at the end of the year, after payment of claims and business expenses
incurred by the insurer, is distributed to policyholders, who are treated as shareholders.
Policies also need to be carefully worded so that no cover is provided for areas prohibited by
Islam. For example, there is no cover for items connected to alcohol or pork.
Products need to be approved by Islamic scholars to ensure they are compliant, and many
providers consult special Shariah advisory committees during the development process.
There is a significant potential market for products developed to meet the needs of those with
specific religious preferences. For example, the total value of takaful premiums is predicted to be
anywhere between US$ 7.5bn and US$ 20bn by 2015. While takaful insurance has been in
existence for at least 20 years, it was only in 2005 that a major high street bank became the first
to offer Islamic insurance policies for buildings and contents. This is a trend, which has
continued since, with an ever-increasing number of providers entering the marketplace.
Therefore, with the instrument funds that the Middle East has available, these funds are now
being used to buy and take over companies that are established in the Western World.
Consequently takaful as a means of underwriting risk is growing at a very rapid pace in many
Middle Eastern insurance sectors and also it is being taken into other parts of the world.
The current key centres of takaful activity are Dubai, Bahrain and Kuala Lumpur, but London is
now also recognised as an emerging centre for Islamic finance and there is at least one takaful
insurer that has gained FSA approval. There will no doubt be others shortly. In addition, banks
are also developing takaful products.

The following articles on takaful have appeared in the en Journal (available to en members
at www.knowledge.cii.co.uk): ,.
'Divine intervention' by Timothy Evershed in the Oct/Nov 2009 edition.

'The nearly A-Z of takaful insurance' by Liz Booth in the Feb/Mar 2011 edition.
Activity
Identify how takaful premiums have grown on a worldwide basis over the last five years and the
expected growth over the next five years. Make some notes below.
Question
Takaful companies have a similarity to another type of company. Which is it?
B Different sellers of insurance

Think
Before moving on, how many different sellers of insurance can you think of?
Insurance is now sold through an extensive list of distribution channels which includes:
the types of insurance companies (proprietary, mutuals, takaful) mentioned above;

Lloyd's of London, mentioned above;
direct insurers;
the internet;
independent intermediaries;
agents;
building societies;
banks;
retailers and affinity groups;
travel agents and tour operators;
aggregators;
the State;
self-insurance.
B1 Direct insurers
Use of the latest technology in telecommunications and telesales techniques means that the
new 'direct' writers do not require extensive branch networks to service their business. Their
administrative and underwriting centres may be located anywhere in the country and contact by
customers only charged for on the basis of the cost of a local telephone call.

Cost of office accommodation and proximity of a suitable workforce may be the most important
considerations in the choice of location. Direct insurers still, of course, have to settle claims and
arrange vehicle repairs at a local level and their arrangements in this respect are similar to
traditional insurers.
The traditional composite insurers ha\'e established their own direct writing subsidiaries. The
direct market continues to grow and, as the public become more and more used to dealing by
telephone for all sorts of products and services it is difficult to predict when the direct share of
the market will level off. Some feel that this is already beginning to happen.
B2 The internet
The development of the internet in the insurance industry has been somewhat cautious
compared to online banking. The first generation of internet users mainly consisted of young
people with high incomes who were inspired by the new technology. Now a second wave of
users has emerged: people less interested in the technology, who use the internet mainly
because it is convenient and saves time. In the financial sector, the marketing of products via the
internet has presented a number of difficulties, one being the significant differences in some
national regulations. Customers also appear to have reservations about data security,
particularly since financial transactions (particularly for life rather than general insurance) contain
extremely sensitive data.
Major UK insurers are now selling motor and home insurance on the internet. However, they
face growing competitive pressure from new entrants, in particular, banks, online insurance
brokers and internet service providers. These companies take advantage of their internet
presence and brand name to add insurance products to their existing range.
Over the past few decades there has been a rapid and significant increase in the number of
distribution channels available for personal insurance. A number of new indirect distribution
channels have been developed. Some of the most important are examined below.
B3 Independent intermediaries
These include both insurance brokers and consultants. Both operate as full-time experts in
insurance, and can offer various personal insurance products with a range of companies. They
provide a personal service to their customers enabling case of access to products and giving
advice and choice.
Independent intermediaries work on behalf of the client and recommend an appropriate insurer
on the basis of price, product features, service and security, negotiating with the insurer on the
client's behalf. The intermediary normally collects the premium on behalf of the insurer and will
often issue the policy documents. They are able to give advice and guidance to the customer
when making a claim. Some may have delegated authority to handle and pay claims on the
insurer's behalf (see section H for more delegated authority in underwriting). The intermediary is
usually paid commission on the premium by the insurer. This is known as brokerage.
These intermediaries may also have their own schemes underwritten by insurance companies or
Lloyd's underwrite, often offering broader cover as standard at competitive rates. They are often
targeted at a specific sector of the market, such as members of a particular profession, club or
society and are known as affinity schemes. In these cases, they will be responsible for both
policy issue and claims handling, and so will receive a higher rate of commission.
B4 Agents
These are intermediaries whose main business is not the transaction of insurance, and include
estate agents, and other professions whose clients may have a demand for insurance of a
particular type. For example, veterinary surgeons may act as agents for pet insurance.

Agents will usually be appointed representatives and may be tied to one particular company.
B5 Building societies
Traditionally, building societies provided mortgages, and their involvement with insurance came
through mortgage-related life assurance products, household buildings insurance and mortgage
guarantee business.
However, legislation including the Financial Services Act 1986, the Building Societies Act
1986 and more recently the Financial Services and Markets Act 2000 has changed their
position. They now have the freedom to engage in activities other than loans on property,
including estate agency services and insurance intermediary activities.
The Building Societies Act provided the opportunity for building societies to demutualise and
become proprietary companies whose shares are publicly traded. This change of status gives a
building society access to greater funds to expand its operations into new areas. Many building
societies have extended their activities by entering into competition with direct marketing
operations. They are able to offer most product lines, underwritten by authorised insurers over
the telephone or the internet, targeting sectors of the general public with a view to increasing
their customer base. Where new customers are obtained this provides a further opportunity to
cross-sell their other associated investment and lending products.
B6 Banks
Banks (some of which are former building societies) are now a very powerful force in the
personal insurance marketplace. They have the advantage of large customer base and an
extensive distribution network to develop new customers.
Banks have moved on considerably from the situation in the 1970s, where individual managers
were local agents of insurance companies. Some have set up their own insurance companies
while others have become intermediaries forming partnerships with selected insurers or Lloyd's
syndicates for the provision of household, motor and travel insurance. Cover is, however, usually
branded in their own name, in the same way as discussed for retailers and affinity groups in
section B7. The types of personal insurance offered by banks include the following:
When agreeing a loan for a customer, a bank may provide creditor insurance.
When a bank grants a mortgage, it may also offer creditor insurance to protect mortgage
payments in the event of sickness, accident or redundancy.
Banks have their own schemes for cover, such as household, motor, hospital plans and
travel. Special covers are also available such as for articles in safe custody, and for
students and nurses living away from home.
B7 Retailers and affinity groups

This distribution channel is known as 'brand-assurance', where organisations offer products
branded with their own name, but underwritten by insurers or at Lloyd's. These policies are
sometimes referred to as 'white label' products. They have recognised the broader commercial
opportunities that can be developed through well regarded brand names with an extensive
distribution network. They have used these to enable them to maximise on their large
established customer base by cross selling insurance products. Retailers, utilities, mail order
companies, membership and consumer groups have all entered the marketplace.
Some offer a broad spectrum of the more commonly purchased personal insurance products,
such as household and travel. Others offer products particularly associated with their own
product lines, such as credit insurance in relation to store card and extended warranty insurance
in relation to white goods.

All providers of consumer goods and services are potential channels for the sale of insurance
products. Recent insurance tie-ins are as diverse, ranging from power utility companies to
organisations targeting particular groups of society such as Age Concern and SAGA.
B8 Travel agents and tour operators

Other than the channels noted above there are three other distribution channels for travel
insurance:
Travel operators a provide as of package holidays usually offer travel insurance facilities
to their customers. Generally the cover is offered on a package basis and is usually
underwritten by an insurance company. Many tour operators make it a condition that
holidaymakers arrange adequate insurance cover, but customers are not legally obliged
to buy the operator's own policy. Tour operators' control on travel insurance has been
affected by the activities of travel agents.
Travel agents have embraced the opportunity to sell to their customers at the point of
sale as they have more opportunity to influence the choice of scheme and receive
further income by way of the commission made on the sale.
A further opportunity for distribution of travel insurance is at the point of departure,
particularly in airports. Travellers are able to purchase policies in coupon form, obtained
through machines situated at airports. This method has the advantage of attracting the
client's attention at a time when they are psychologically receptive to the need for travel
insurance.
B9 Aggregators
Most money supermarkets are essentially price comparison websites. They are a relatively new
concept on the internet and are referred to as 'aggregators. Aggregators can and do cut across
traditional boundaries. As we have seen direct insurers by definition deal directly with the public.
However, the prices of many direct companies as well as intermediaries may be accessed
through aggregators.
An aggregator is an internet-based distribution channel, which relies upon the co-operation of

insurers and intermediaries to access their pricing for different risks. Aggregators aim to deliver a
service whereby the customer completes one set of questions and is provided with quotations
from a number of insurance providers. The proposer can then approach that company direct-
often through a link from the aggregators website, to complete the purchase of their insurance.
Activity
Can you identify at least two major insurers who do not use aggregator sites?
These arrangements have attracted some criticism in the marketplace. Many insurers and
intermediaries are happy to participate in such sites, but others have chosen not to (Aviva, Direct
Line). One concern is that only a limited number of questions are asked at the initial quotation
stage, which may affect the accuracy of the quotation given or the willingness of the insurer to
offer cover, once the complete facts are known. Often the aggregator will rank quotations solely
in terms of price and not necessarily in terms of the covered offered. The results can be
confusing as they are not always an accurate reflection of what the insurance product will
actually cost once fuller details have been submitted to the chosen insurer. Aggregators have
also been criticised for the use of default positions on questions such as voluntary excesses.
The Financial Services Authority (FSA) has recently carried out a review of comparison
websites. It found that there was mixed evidence in terms of the clarity, fairness and accuracy of
information given to customers. The FSA has called on aggregators to give more information to
consumers so that they understand how their premiums are being calculated, the scope of their
cover and the level of excess on their policy.

There is a useful article on aggregator sites entitled 'Getting the price right' by Harvey Jones in
the Oct/Nov 2009 edition of the CII Journal.
Activity
Access one or more aggregator websites on the internet Try entering your own details to learn
more about how they operate.
B10 The State

Following numerous terrorist incidents in the UK, Pool Re was established by statute in
1993 as a mutual reinsurance company to provide cover above a threshold for property
damage and business interruption from fire or explosion caused by terrorist actions. It is owned
by all of the most significant participants in the UK commercial property insurance market. The
Treasury stands behind Pool Re as the reinsurer of last resort, though no call has been made on
the Government during the lifetime of Pool Re.
In July 2002, the UK Government announced an extension of the remit of Pool Re to help
address the widespread post-11 September withdrawal of UK terrorism cover.
As from January 2003 the UK insurance industry has their total responsibility for terrorism cover
capped at 30 million per event and 60 million per year. Pool Re picks up the bill for losses
above a particular insurer's 'retention' limit. Pool Re sets its own premium rates for its share of
cover. The limit for any single UK insurer is based upon market share. With this approach, UK
insurers know in advance their terrorism exposure in any one year. Pool Re does not tell them
what to charge. Insurers are free to set the premiums for their policies according to normal
commercial considerations.
B11 Self-insurance
As an alternative to purchasing insurance in the market, or as an adjunct to it where the-
first layer or proportion of a claim is not insured in the commercial market, some public bodies
and large industrial concerns set aside funds to meet insurable losses. As the risk is retained
within the organisation there is no market transaction of buying or selling, but such
arrangements have an overall effect on the funds of the market in general and on premium
levels where the organisation is carrying the first layer.
These organisations have made decisions to self-insure because they feel they are large
enough financially to carry such losses and because the cost to them, by way of transfer to the
fund, is lower than commercial premium levels. This could happen where an organisation
decides that it has an exposure to loss involving a large number of incidents, all of which are of
fairly low severity. This high frequency and low severity profile implies that the losses are
predictable.
Were the organisation to insure such losses, there would be a kind of pound swapping exercise
with the organisation paying a pound to an insurer only to get it back when the losses, which
both parties knew would occur, actually take place. The problem for the insuring company is that
it would also have to recover its costs, and so the amount paid in premiums would probably
exceed the cost of the predictable claims.
In such cases a fund could be created, out of which the losses will eventually be met. You
should note the difference between 'self-insurance' where a conscious decision is made to
create a fund and 'non-insurance' where either no conscious decision is made at all, or where no
fund is created.

C Importance of the customer
Think
Why do you think that being customer focused has become so important for Insurance
businesses today?
Owing to advances in technology and the use of the internet, many products and services are
delivered without the customer and supplier ever meeting. Examples of means of doing this
include transactions via telephone banking, fax and electronic data interchange (EDI).
Information about customers has become more plentiful as a result of these technologies, which
not only facilitate trade, but also store it very efficiently. As information about customers
increases and becomes more detailed, the customer's needs and preferences become more
clearly visible to the seller of goods or services.
In this section, we look at the practices that financial services organisations use to interact with
their customers.
C1 Customer expectations
While the key objective of any business is to make a profit, in most cases today this can only be
achieved by winning and keeping customers. Customers are the lifeblood of an organisation and
the reason for its existence. Every organisation needs to provide good service to its customers,
because it depends on them for prosperity, salaries and jobs.
It is crucial today for organisations to know, understand and meet their customers' expectations.
Competition is fierce, and customers will very quickly move on to a competitor if their
expectations are not met. Contrary to popular belief, price is not always the deciding factor for
customers. Research has shown that while 10% of customers discover that they prefer a
competitor's product or service, 70% leave because of indifference, rudeness or lack of service
from staff.
It is essential; therefore, that if a company is going to meet its customers' expectations that it
knows those expectations in the first place. These expectations will usually be identified through
market research. Having identified the expectations to be met it is necessary for the company to
measure itself against those expectations. This will mean returning to customers to assess the
level of satisfaction achieved through customer surveys, and/or an analysis of the complaints
received. The customer is the only judge as to whether a company has met their expectations.
Customer satisfaction and delivering a quality service also makes very good business sense as
it costs, on average, five times as much to win a new customer as it does to retain an existing
customer.
Customers usually have plenty of choice when buying goods and services in the commercial
sector. Their spending power creates competition between suppliers of similar goods and gives
customers choice. There are only a few areas in which customers cannot change a supplier if
their standards do not meet their expectations.
Businesses have no choice but to compete for their customers and to listen carefully to what
they are saying. Every time a customer buys something from a supplier, they are sending a
message to competitors that their sales message is wrong. Competitor businesses will have to
try harder next time to win the customer's business.
It has never been more important to know your customers' expectations and to deliver to those.

C2 Customer focus
We has already seen that customer demands are ever increasing and if companies do not
deliver that customers want, in the way they want it, and with quality, they will take their business
elsewhere.
As mentioned earlier, customers are the lifeblood of an organisation and the reason for its
existence. They have a right to expect friendly attentive service and to expect efficient company
procedures and systems that will support, not hinder, good service. Customers are also
motivated to use organisations, which treat them with respect and provide a high quality product
or service at a reasonable price. It is, therefore, vital today those companies recognise this and
become truly customer focused.
To ensure a true customer focus, this approach and attitude must exist through the whole
organisation and start from the very top. It must apply not only to front offices who talk directly to
customers, but also support or back office operations as it is often they who fulfil the promises
made to customers by the front office. It must apply to all managers within the organisation at
whatever level they work. All managers, supervisors and team leaders should be customer
champions and role models. If management is not customer focused one cannot expect staff to
be.
There are, therefore, two types of customer, the external customer and the internal customer.
External customers are those who are not on the company's payroll. Internal customers are
those people who work for the organisation, and they are as much customers as those outside
the organisation who pay for the company's services. If suppliers of internal services do not
serve their internal customers well, the chances are the external customers will not be served
well either. External customers generate income for the business .md therefore must be given
top priority. Everyone within an organisation should either be serving an external customer, or
someone who is.
Giving customers what they want and expect is the key to excellent customer service and being
customer focused.
Another important part of being customer focused is to find out regularly what customers feel
about the company's product or services. This can be done through customer satisfaction
surveys, analysing the results and putting in place improvements that are found to be necessary.
Seeking customer feedback and taking action on that feedback is a key ingredient in customer
focus.
Reinforce
Remind yourself of the difference between external and internal customers.
Activity
In your own role, Identify who your customers are and whether they are internal or external
customers. Then assess how you can ensure you deliver what your customers expect of you.
However, in any business things will go wrong from time to time. When this happens it will often
generate a complaint from a customer. Analysing these complaints in a positive way to identify
the root cause of what went wrong and why, is a good way to help improve quality. Often it
highlights a fault in the process, or a training need, and if these are addressed it will help to
avoid the same problem happening again. Positively analysing complaints to put the root cause
right is a part of continuous improvement and an important part of being customer focused. It is
looking at what went wrong for the customer to avoid it happening again.
The issue of the correct handling of complaints is now becoming even more important following
the decision by the Financial Services Ombudsman to publish complaint data so as to make the
financial services industry more transparent around customer complaints. There is useful article
entitled 'Here's looking at you' by Edward Murray in the Dec/Jan 09/10 edition of the Cll Journal.
It sets out the impact and feelings within the insurance industry to the Ombudsman's proposal.
The article also includes comments made by Ian Cowie, the personal finance editor of the Daily

Telegraph.
With more businesses now providing more services than ever before, it means increasing
competition for everyone. Quality customer service and being really customer focused gives a
competitive advantage to the organisation.
C3 Customer relationship management

Customer relationship management (CRM) is largely about getting closer to the customer and
moving into a proactive environment. It is about trying to build relationships with customers by
understanding their needs and offering products and services that meet those needs.
Why is this seen as important today? Put simply, if a customer obtains only one product from a
company it is very easy for that customer to move away to a competitor. If, however, the
customer obtains several products from that company it is not so easy to move to a
competitor.By selling further products to a customer the company will increase its revenue and
profit.
This approach to business takes a lot of energy in companies today. It means adopting a clear
locus in the war business is done with customers as it entails:
offering a relationship focus rather than an enquiry focus;

a better understanding of buying patterns of customers to expand business relationships;
moving to a proactive rather than reactive environment, for instance starting the process
with welcome telephone calls;
adopting a total relationship management approach, including:
direct mail,
telemarketing, direct selling,
cross selling,
customer service,
email,
internet,
face "to face or personal attention;
enhancing/complimenting additional revenue generation efforts.
Activity
Identify how your company tries to generate more business from its own customer base.
Expectation levels of customers are ever increasing. They now expect not only to be able to
reach suppliers easily by whatever means that suits them, but to be proactively informed of new
products and services that could be of benefit or help them to be more productive and profitable.
Therefore, for those companies who can deliver increased levels of service, the rewards are
considerable.
These expectations can be addressed through the Customer Life Cycle (CLC). This is an
approach built around the whole lifetime relationship of a customer, and understanding the value
of that customer to the organisation. Let us take a simple example. A customer aged 25 spends
on average 50 per week at the local supermarket. Over a year they will be spending around
2,600. If that supermarket keeps their custom until the age of 65, which is for 40 years, the
customer will have spent 104,000 with that supermarket. The lifetime value of that customer is,
therefore, at a minimum of 100,000.
So the approach means managing a customer on an end-to-end basis, from listening to

customers and identifying new revenue opportunities, to selling new or enhanced products/
services, and to fulfilling and servicing the contract to achieve further revenue opportunities.
It depends on building a successful relationship with customers ensuring their needs are
identified and fulfilled. It is a value proposition that is driven by capturing knowledge about the

customer and using the information in a proactive way, which benefits both the customer and the
organisation.
The following diagram illustrates these points:
Figure 1.1
Customer Quality of Customer Long Term

Service Relationship Retention Profitability
Supplier service is By using

the key: driven by Why go information
Recognises the
listening to the elsewhere? Need proactively to
lifetime value of
customer and to ensure needs inform/sell new
the customer to
capturing are identified and products and
the organization
knowledge about fulfilled services that
the customer benefit customer
Customer expectation addressed by building a lifetime relationship with them every time an
organization inter relates with a customer, there is an opportunity to build the relationship
and preduct where the customer is in their life cycle.
One of the most cost effective ways of handling this process is through the telephone, so call/
contact centres are ideally placed to help develop and deliver a CRM capability.
However, probably the most challenging issue for companies in developing a CRM capability is
how the disparate computer database systems companies have can be brought together to
present a single view of the customer. Having done that, what is the information they currently
have, how up to date is it, what further information needs to be captured, and where and how is
the additional information to be stored? So developing effective computer systems to be able to
support this is an important challenge.
C4 Internet and e-commerce

At its most basic level, the internet is the way that computers are connected by telephone lines.
The internet allows computer users to communicate quickly, cheaply and internationally with one
another through their computer terminals by using the world's existing telephone communication
structure.
On the internet, communication takes the form of written electronic mail or paperless faxes, but
there are also opportunities to 'chat' in writing with other users or to make use of video linking
equipment. Many of these services are also now being extended to mobile phones through text
messaging and the internet capability that many mobile phones have.
E-commerce is the name given to electronic business. Business transactions can be carried out
swiftly and efficiently over the internet, with instant payment for goods by credit cards or debit
cards. For the insurance industry, this means that policies can be bought over the internet. The
ability to reach customers and potential customers in this way makes transacting insurance
businesses relatively cheap, and allows small insurance organisations with low overheads to

compete effectively with larger and more well-established insurers. The changes to all industries
brought by the internet are strategic and fundamental.
However, the internet poses a challenge for established businesses. It offers opportunities such
as direct links to anyone anywhere. It lets companies build interactive relationships with
customers and suppliers. It also lets them deliver new products and services competitively.
Managers need to focus in a systematic way on what the internet can allow their particular
organisation to do in order to determine what opportunities and threats it poses.
Through the growing use of the internet for business a security issue has arisen. There are now
many instances where fraud is being committed through the internet, therefore, both companies
and customers need secure systems to stop fraudulent access to customer and company
information. This is an issue that is constantly taxing organisations as the fraudsters develop
new wars of hacking systems.
C5 Direct link to customers

Financial services organisations can establish a direct link over the internet to customers,
affiliates and associates to complete transactions or trade information more easily. They can do
so by thinking in terms of the devices outlined in the following three subsections.
'The combination of these three levels of service make the internet channel very compelling for
customers, and because these services are basically just electronic exchanges, they are
delivered at very low cost.
Investments in the electronic channel displace traditional sales, marketing and service costs;
moreover, the technology allows companjes.to offer increasingly higher levels of service without
incurring incremental costs for each transaction.
C5A Sales
Insurance companies can offer the same level of service through the internet as they offer
through telephone agents or field salespersons. For example, they can offer a choice of products
provide an electronic quotation and allow customers to pay for policies electronically.
C5B Personal records

Financial services companies can use internet technologies to personalise interactions with their
customers and build customer loyalty. This can be done by tailoring the information and options
customers see at a website to just what they want, often basing this on past visits by the
customer.
For example, when visitors carry out on-line banking, they may be able to personalise the
display of information in the way they want to see it. Over time, insurers and insurance brokers
can collect information about their customers' preferences and use that information to offer other
customised services for instance by 'cross-selling' other financial products.
C5C Internet portals
Think
What is an internet portal and how can customers use it?
Internet portals are website which people visit because they provide a range of information and
links about a particular topic or area. For example, to attract visitors and potential customers to
its site, a financial services organisation might draw on data from its entire customer base to
make available wide-ranging knowledge of some topic.
For instance, claims statistics may produce information on loss prevention that is of universal
interest. Equally, a motor insurer might include reviews about new cars, or a marine insurer
might include weather information for its shipping clients. Some insurers may encourage
customers to post comments for other visitors to see; making it possible for a potential customer

to sec an existing customer's review of insurance cover prior to buying that product.
Some organisations mar aim to specialise in a specific type of product or service, a particular
segment of customers, an entire industry or a unique business model to become the main portal
for that group.
C5D 'Treating Customers Fairly'

A central theme of the FSA regulation is the principle of Treating Customers Fairly' (TCF).The
FSA sees this theme as so important that it considers it needs to be a central part of insurance
business philosophy. As a result, the FSA aims to achieve a number of outcomes with regard to
the general insurance regime philosophy so that:
1. Consumers can be confident that they are dealing with firms where the fair treatment of
customers is central to the corporate culture.
2. Products and services marketed and sold in the retail market are designed to meet the
needs of identified consumer groups and are targeted accordingly.
3. Consumers are provided with dear information and are kept appropriately informed
before, during and after the point of sale.
4. Where consumers receive advice, the advice is suitable and takes account of their
circumstances.
5. Consumers are provided with products that perform as firms have led them to expect,
and the associated service is of an acceptable standard and as they have been led to
expect.
6. Consumers do not face unreasonable post-sale barriers imposed by firms to change
product, switch provider, submit a claim or make a complaint.
To achieve these outcomes the FSA is applying a thematic approach in choosing the important
issues and investigating these across a sample of firms. It is also using a risk-based tool for
small firm supervision and then communicating the findings back to the industry. Details of the
approach can be found on the FSA website.
Activity
Bearing in mind the very active attention the FSA is giving to the Treating Customers Fairly
initiative you should access the FSA website www.rsa.gov.uk and search for the latest
information supplied. You can find this by entering 'treating customers fairly' in the search box of
the FSA site.
The TCF theme is now seen as so important to the insurance industry that the Chartered
Insurance Institute has also issued guidance to companies, brokers and employees working in
general insurance.
This guidance can be found on the Cll website under Treating Customers Fairly. In addition,
there is a set of fact sheets available that cover the following aspects:
1. Relevance for senior management.

2. Management information.
3. Product design.
4. Relevance for human resources- including remuneration.
5. Advertising.
6. Sales process.
7. Customer service.
8. Complaint handling.
CII members can access the detail of these fact sheets through the CII website- www.cii.co.uk
A useful article entitled 'Treating customers fairly- an update' by Lesley Titcomb can be found in
the April/May 2010 edition of the CII Journal.

D Importance of other stakeholders

Within the context of business management it is important to understand the impact that
stakeholders have in a business. Stakeholders are people or groups of people who have an
interest in the way a company acts. Principal examples of stakeholders are:
customers;
shareholders;
Government;
the public;
employees.
However, there are others such as creditors/suppliers, consumerists, the law and unions.
Question 2
What do you think are the stakeholder types of interest and expectations that Government has In
a business?
Stakeholders may or may not have any formal authority in a company but each does have some
vested interest in the organisation such as finance, work, or other resources. As a result they will
want something from the company and will often want to apply some influence in one way or
another.
Table 1.1 indicates the types of interest and expectations the various stakeholders can have in a
business.
Table 1.1: Stakeholder interest and expectation

Customer Quality products
Value for money prices
Warranties and guarantees
Rapid delivery / service
After sales service
Shareholders: High rate of investment return
Sustained and increased growth
Increased share value
Profitable products and services
Cost effective operating
Government Tax revenue
Openness
New job creation
Introduction and adoption of new technologies
The Public Environmental responsibility
Safety
Time at working
Good neighbour policies
Employees Good salary / wages
Staff benefits
Job security and promotion opportunities
Good working conditions
Suppliers/ Creditors Prompt payment
Reasonable delivery expectation
Long term company solvency
Consumerists Product safety
Fair treatment of customers
Value for money
Good service

Product information
Redress
The law Proper application of health and safety and other regulatory
legislation
No corruption
Fair competition
Sanctity of contract and contract law
Unions Negotiating rights
Fair treatment of its member
Input to company policies and strategies
D1 Stakeholder theory
Stakeholder theory relates to the fact that as stakeholders exist and can apply considerable
influences on a company, management will have a key task of having to balance the
requirements of the various stakeholder groups. They will need to develop good relations with
the groups, create alliances, and use persuasive and influencing skills to ensure stakeholder
needs are as near as possible met.
This means that management will need to gain a very clear appreciation of the stakeholders who
have an interest in the business and what their needs are. To achieve this the following actions
will be needed:
identify the business's stakeholders, and who they are;

find out their expectations, and the minimum return each stakeholder will accept;
identify the strength of each stakeholder's influence on the way the company acts;
establish who the key people are in each stakeholder group and develop good relations
with them;
identify the views and attitudes of the various stakeholders to the company's mission,
strategies, activities, and where necessary invoke any change;
establish the stakeholders who support the management's business policies and
approach, and find out those who do not agree;
find out how antagonistic stakeholders can be won over, use supporters to exert their
influence on antagonists.
Within all this, the power of the shareholders must be clearly understood. If there are only a few
major shareholders their power will be considerable. However, if there are a high number of
small investors, they will not exert a high level of power which means they are unlikely to have
much influence on a business's strategy, unless something happens that makes the investors
act together.
Question 3
What do you think are the specific stakeholder interests an investment analyst would have in an
organisation?
Let us now look at some of the more specific interests that stakeholder groups will have in an
insurance company:
Shareholders will be interested in the:

- return on their investment - profits, dividends, capital growth;
- stability of the company, its solvency and whether there may be a need for it to raise
extra capital;
- future profitability of the company, including the type and spread of its business.
Policyholders will be interested in:
- the stability of the company including its solvency margin as a guarantee of its ability to
meet its obligations to them;

-
whether they are gelling value for money or if premiums include an undue profit
margin;
- policy holders have certain rights which arise out of the purchase of an insurance
policy, the most important of which is the right to receive the benefits of the insurance
contract.
Investment analysts and commentators arc interested in:
- the performance of the company's shares, which depends on market perception of the
future, influenced by, among other factors, type and spread of business, profitability,
distributable reserves, dividend policy, management policy and ability as well as
general economic trends.
Reinsurance security advisers are interested in the:
- soundness of the company's underwriting;
- security of the company as shown in its solvency;
- durability of the company;
- strength of any group to which the company belongs. Other insurers are interested in:
- underwriting and profit comparisons;
- marketing policy and developments.
Employees (including management) are interested in:
- the efficiency and profitability of the company as a whole;
- future plans;
- the security of the company, including possibilities of takeover.
The Government and regulators are interested in:
- the profitability of the company - will it be able to:
o meet its taxes?
o continue to employ people?
o be a strong competitor in the global market?
- compliance with legal and regulatory requirements;
- compliance with ethical and social responsibilities.
The information requirements of those stakeholders who have a specific interest in an

organisations financial affairs are examined in more depth in chapter 7, section C.
D2 Stakeholder management
The objectives of an insurance organisation will, therefore, need to be derived by balancing the
conflicting claims of the various stakeholders in the organisation. The firm has responsibility to
all these groups and needs to provide satisfaction to them all. The difficulty is balancing the
conflicting interest s and differing degrees of power. For example, there may be conflicts of
interests between an insurance company's shareholders and its employees. If the strategy of the
organisation is to truly reflect the interests of its stakeholders. the strategic planners will need to
consider: and be influenced by, factors relating to them, for example:
composition and significance of each group;

power that each group can exert;
legitimate claims that each group may have on the organisation;
degree to which these claims conflict and significant areas of concern;
extent to which the organisation is satisfying claims;
overall mission of the organisation
Example
The concerns of shareholders have long been a low priority in many companies and few
shareholders were prepared to go public with their negative views about the firm and t en watch
their share price slide; so many directors have been happy to listen politely at the annual general
meeting (AGM) and t hen do nothing.
However, in recent times there have been several shareholder rebellions. Legislation now
enables shareholders to hold an advisory vote on companies' remuneration policies and some
large companies, including financial institutions, have found their shareholders casting
disapproving votes.

Groups of the more powerful shareholders (including fund managers and pension funds) are
also expressing their concerns in a more public way and have, in some cases, been able to
challenge high profile board appointments. Such an outbreak of public disputes between
investors and companies is unprecedented and both directors and non-executive directors are
learning to pay more attention to the voice of the shareholders.
D3 Ethics and organisational beliefs

Think
What do you understand by the term business ethics?
By business ethics we mean that standards and conduct that a company or business sets
itself in its dealings within the organisation and outside with in the business and social
environment. It concerns the application of moral principles and how individuals conduct
themselves in social affairs.
As a result ethical issues now frequently play an important part in management for the following
reasons:
Large organizations can have revenue income which is often more than small nations,
therefore, how these companies use their wealth can have implications for the wellbeing of
the countries in which they operate.
Responsibility and power are closely interlinked. For example, senior managers in large
companies occupy positions, which can impact on promoting or affecting the interests of
large numbers of employees, and may take decisions that can affect whole communities.
Consumers and consumer groups now increasingly judge organisations by the way they
handle ethical and environmental issues.
As strategic business decisions are partly determined by the cultural influences of societies,
cultural factors can affect the moral thinking of managers.
Today, therefore, it can be argued that no organisation can divorce itself from the society with in
which it operates. The stakeholder points mentioned above now often affect ethical issues and
thinking.
However, it should be noted that not all commercial organisation believe that they have a role
beyond their own business. They take the view that society is quite capable of looking after itself
and that the key responsibility of a business is to look affairs its shareholders. Such a view can
mean that the company's purpose is unlikely to include any actual comment on business ethics.
However, this does not mean that this sort of company behaves unethically; it just means that it
works with a clear shareholder perspective.
Other companies take the view that it is in their long-term interests, including those of its
shareholders, to play a role in society beyond what is required by the law. Sponsorship and
community projects are a good example of this. This approach is known as a stakeholder
perspective and this is the perspective that many financial organisations follow.
D4 Ethical standards in insurance

The Cll considers that ethical standards within the insurance industry as being very important.
Therefore, it is crucial that all those who work in insurance follow a set of ethical standards and
in support of this the Cll has developed a Code of Ethics for all its members to follow.
The code has recently been revised and took effect in July 2009.
The code represents a set of ethical principles for insurance and financial services professionals
worldwide. Because the code is 'principles based' it is sufficiently flexible to take account of the

wide range of different roles undertaken within the sector. It is described in the following way by
the Cll:
This Code should not be seen as yet another regulatory burden but rather as a virtuous
platform for improving the reputation or Cll members as a whole and In distinguishing our
membership in comparison with less qualified and regulated competitors. Beyond this,
adoption of and adherence to the Code can help promote standards and public trust.
D4A Scope and operation of the Cll Code

The Code has as its purpose the meeting of standards and maintaining the reputation of the Cll
through following its terms. It is concerned with attitude and behaviour, and therefore tends to
have a wider application than the regulatory rules that will overlap many aspects of business life.
Rather than setting a series of minimum requirements, the Code represent s a positive
statement of the core principles that must inform decision-making, business relationships and a
member's more general behaviour.
To assist members in the way that the principles should be applied in different situations, there is
a section entitled 'key questions to ask yourself. This section tries to help people think about
how the Code and the principles that underpin it affect them as an individual. The Cll's aim is to
make the Code more of a living' document that individuals will read and consult regularly.
Members are obliged to comply with the Code. If they do not the CII may take disciplinary action
against them. The Code appears as an appendix to this chapter. The central principles that
underpin it are summarised in the next section.
D4B Central principles

There are five central principles in the new Code of Ethics. TI1e Code states that members
must:
comply with the Code and all relevant laws and regulations;
act with the highest ethical standards and integrity;
act in the best interests of each client; provide a high standard of service; and
treat people fairly regardless of race or racial group; sex or sexual orientation; religion
or belief; age and disability.
We will very briefly consider the scope of each in the following sections. You will find the detail at
the end of this chapter in appendix I.
D4C Compliance with the code, relevant laws and regulations

This section of the Code embraces the member's dealings with the Cll and regulatory
authorities, requiring an open and courteous manner. Emphasising the ethical nature of the
Code, members must abide by both the spirit and letter of the law. The need for proper
authorisation and regulation is also covered.
Key questions include the currency and comprehensiveness of knowledge in legal and
regulatory areas and the effectiveness of the compliance regime within the firm.
D4D Highest ethical standards and integrity

Honesty, trustworthiness and reliability underpin this section of the Code. It deal s with avoiding
taking unfair advantage of a client and offering or accepting wrongly motivated inducements. On
the positive side, members must promote professional standards and encourage the use of
ethical codes within their firms.
This section also covers membership of the Cll and the use of Cll designations. It includes a
requirement to advise the Cll of material changes in circumstance that affect either of these.

Key questions include assessing the likely perception of others of ethical standards, and matters
of trustworthiness. The difference between 'getting away with things' and positive ethical
behaviour is highlighted.
D4E The best interests of each client

The fair treatment of clients is a key theme of the FSA. In its Code the ClI states that members
should encourage their firms to place them treatment of clients at the centre of the firm's culture.
The Code deals with client needs, product performance and the need to avoid conflicts of
interest.
Key questions in this section focus upon honesty truthfulness and objectivity. They also cover
the rewards culture within the firm the and they need to take account of client requirements.
D4F High standard of service

Accuracy, transparency (including earnings) and suitability are the main elements of this section
which also emphasizes the need for a member to recognize their personal limitations and to
keep up to date. Key questions include reliability in the fulfilment of promises, approachability
learning from complaints and customer satisfaction feedback.
D4G Treating people fairly (non-discrimination)

The focus of the section is the voidance of unfair discrimination on grounds of race, gender,
sexual orientation, religion, age or disability. It relates to the equality and diversity laws in the
member's country. Rules relate to openness, fairness, respect and opportunity.
The key questions emphasise the need to consider actions or treatment from the perspective of
the other individual and to consider whether any requests present unnecessary barriers or
difficulties.
The enforcement of the Code of Ethics is the responsibility of the Cll Disciplinary Committee.
E The global perspective

As the world becomes more international, expansion and gobalization issues will become
important factor within the business environment. This will have an impact on how the
organisation is controlled and managed along with its corporate strategy. As this is very complex
issue, all we will do in this section is gain an understanding of the different types of international
company; international, multinational, and global.
Richard Lynch, in this book 'Corporate Strategy' identified that during the late 1980s the
management academics Christopher A. Bartlett and Sumantra Ghoshal conducted research
and analysed international company activity. By doing this, they distinguished international
company expansion into three different types:
International
This is where most of the organisation's activities are outside the home country but each one is
managed as a separate area. It is where the key focus is on the business's domestic operation
with its international activity being an extension of this core practice. The strategic driver will be
the home market and international revenue will be a subsidiary. Some strategic areas are
centralized, but some mil be decentralised. A good example of this is IBM.
Multinational
A company that operates in a number of different countries but may still have a home base. The
aim of this approach is to have the ability to respond to local demands, as the business is a
cries of semi-independent operations all working under a global brand. National subsidiaries are
likely to solve their operational tasks and activities. With this business approach, each of the
various national and regional markets will be separately identified from a strategic point of view.

Unilever is one such multinational.
Global
This is where a company sees the whole world as one market and a single source of supply.
There will only be a limited response to local demand, with the business focus being the one
world market and each operation delivering contributions to th at activ1ry. They are tightly
centralised businesses. As the whole world is viewed as one market, the competitive advantage
comes from the common global brand. Production activity is concentrated in areas that can
produce economics of scale there may be some adjustments for local markets but mainly the
product will be the same around the world. An example of this is the Disney theme park
business.
From a strategic point of view, it is important that a company properly identifies that type of
business it is. When considering Bartlett and Ghoshal's definition, it can be seen that just
because a company is international or multinational we should not necessarily see it as global
but one that is merely selling in many parts of the world.
Think
Why is this?
The main factor is that countries such its Indonesia and India have huge population s but the
average wage is very low, plus there is a limited awareness of the economic importance of
insurance. Few businesses understand the need for insurance and society is not litigious, by not
looking to the courts for a legal redress to an accident. (However premiums almost quadrupled
in China between 2004 and 2010 so the industry is expanding rapidly there.)
This means that in many less advanced countries with growing economies, insurance markets
arc developing but they are far less advanced than, say, the London Market.
E1 The London Market

Think
Why do you think that the London insurance market has become so important?
The London insurance market is a distinct, separate part of the UK insurance and reinsurance
industry centred on the City of London. It comprises insurance and reinsurance companies,
Lloyd's syndicates, and brokers who handle most of the business. In global market terms it is
unique as it accepts risks from all around the world. The UK leads the world in internationally
traded insurance and reinsurance and is safely the number one global market for aviation and
marine business.
While there is no watertight definition of the market, there is general agreement that the core of
its business internationally traded insurance and reinsurance business which would include the
very large risks of UK companies and multinationals .The business traded is almost exclusively
non-life (general) insurance and reinsurance, \\ith an increasing emphasis on high exposure
risks.
The main participants in the London Market are:
insurance companies operating from London establishments that are members of the
International Underwriters Association (IUA), including branches or subsidiaries of
foreign companies;
other insurance companies with London underwriting offices;
European companies providing insurance or reinsurance to the London Market from a
European office the completion of the single European market, culminating with the
third Non Life Insurance Directive that extended 'freedom of services' to all general
insurances in July 1994 mean that European Economic Area insurers can now take
advantage of their 'home country licence to sell their services to the resident s of other
Member States);

the contract offices of foreign companies not authorised to transact business in the
UK; and
the P&l club - these marine associations (clubs) insure liabilities for cargo, liabilities
to crew, to passanger and to third parties, including one-quarter of the shipowner's
liability for for damage to another ship in collision, as the shipowner's hull policy only
covers three-quarters of such liability;
Pools there are two in London Market, International Oil Insurers and the British
Insurance (Atomic Energy) Committee. Both operate on a net lines basis; that is, insurer
participating in the pool must retain for their own accounts the business that they write
and not seek to transfer any to reinsurers;
Lloyd's of London ;
Insurance brokers- until very recently (November 2008) only Lloyd's broker s could place
business with Lloyd's syndicates. However, following the introduction of the Legislative
Reform (Lloyd's) Order 2008 which introduced a package of measures aimed at
modernising and strengthening the operation and governance of Lloyd's to enhance its
position in the global insurance market, this restriction was removed.
London Market business accounts for over one-third of the total non-life insurance and
reinsurance business written in Great Britain the UK insurance industry.
E2 Requirements for an international market

Think
What do you think are the factors that have helped the London Market to be a key part of the
global insurance market?
The London Market has always been considered part of a global insurance market. There are a
number of factors that have allowed London to develop into a successful international center for
insurance and reinsurance:
Political and economic stability

Both buyers and sellers of the product want to be sure that the market will not change
out of all recognition in the future. The UK has a long history of stable government and a
bias towards free trade promoting economic growth, plus London has been a major
trading point for world markets.
Geographical location
For an international market to be successful it must have access to not only its own
internal insurance markets but also to any neighboring foreign insurance markets. The
UK is part of the EU (single market), plus has strong ties with the Commonwealth.
Quality transport system

The market must be easily accessible by foreign insurers by air. London has some of
the best connected and busiest airports in the world.
Highly qualified personnel

There must be a pool of specialised staff available to service the industry. This means
the underwriters as well as the support staff such as claim s and accounting personnel.
London has an excellent pool of talent to support the London market.
Office space at competitive prices

There is no shortage of high quality office space in or around the 'square mile' in the City
of London. Lloyd's of London has proved to be a magnet for other insurance and
reinsurers, e.g the Swiss Re Tower.
English is the business language

The most common business language in insurance is English, so London is again well
placed as an international market.
Stable legal and regulatory environment

English law has built up a large background of developed insurance and reinsurance law
and is recognised as n choice of law for disputes. The UK regulatory authorities have
built upon a good track record for sound decisions and being supportive to the UK
insurance market.
Time zone
London is well placed between Asia and North America, allowing some overlap in the
time zones between the relevant markets, so that direct communication is available
sometimes at least.
Foreign presence
Domestic insurers do not solely dominate London. A strong foreign presence allows the
development of international insurance and reinsurance business.
Developed Financial centre

London has a premiere financial market (banking and currency trading). With the
advent of alternative risk techniques the location of a strong market is of advantage-to
insurers looking for different way of handling their risks away from the traditional
reinsurance placements.
Centralisation
If there is limited competition from other cities in the country or other cities in nearby
countries, this is distinct advantage. In the UK, although there are other regional centre
such as Leeds, Birmingham and Edinburgh, foreign insurance and reinsurance has
always predominantly been conducted in London.
F Company growth a nd mergers and acquisitions

F1 Organic growth
Organic growth is where a company develops and expands by increasing its sales, revenue and
output through its own current businesses, activites, and effort, rather than through mergers or
acquisitions. However, organic growth can only be achieved when a business has the financial
resources to pay for the expansion.
The following is a definition from Peter Drucker:
Organic growth is the rate of business expansion through increasing output and sales.
This means that any boost in profit s or growth acquired through mergers and acquisitions are
excluded, as they were not brought about through profits generated within the company, and so
aare not considered organic. The closures of any whole business are also excluded. The
mergers and acquisitions route is known as nonorganic growth
It needs to be remembered that organic growth can also be negative as this show a business is
contracting. Organic growth docs not, however, include the impact of foreign exchange.
F1A Why should a company want to grow?

There are many reasons why a company would want to grow and examples are increasing
consumer incomes, ready availability of finance, low interest rates, buoyant markets,
opportunities for product development, export opportunities, economies of scale through lower
operating costs, but normally it will come down to the opportunity of increased revenue, profits

and shareholder value. At the present time due to recession issues, it could be argued that
increasing consumer incomes, ready availability of finance and buoyant markets are not
particularly applicable, however, it can be expected that these will return as countries come out
of recession.
F1B Current growth trends

In the 1990s there was a considerable amount of merger and acquisition activity, however, in
recent years this has slowed down particularly within the financial services industry.
Consequently, a key and viable trend now is to strategically grow a business organically and
more leading-edge companies are using this approach. This m means that from a growth
standpoint, companies have to closely examine their own resources, assets and finances and to
find ways to really effectively use them so as the businesses' growth demand s and goals can be
achieved. In other words these companies are growing their businesses through internal means.
Howefer to be successful at this it is essential the executive management team leads the effort.
As the organic expansion route requires companies to maximise their internal resources, there
are indications that more companies are moving away from using bottom-line targets as
performance measures and adopting ideas generation, quantified customer service
improvements, improved cash flow and sales increases as a means for measuring improvement
and consequently executive and management rewards.
The use of these approaches to grow businesses has been found to be less expensive than a
non-organic route as it can not only offer improved returns but it also forces a company to build a
strong base for further growth. However, it makes heavy demands on management, as creativity
and innovation will be essential to achieve a high level of growth.
F1C Organic growth drivers

The following are the key examples of organic growth drivers:
lt is now a favoured approach of many executives and investors as it provides a sound

means to measure progress and success in that the growth figures are not distorted by
a merger or acquisition.
Organic growth is seen as more profitable route with a better investment return.
It enables executive management to demonstrate long-term commitment to a business
by building it through the effective use of internal resources.
With the organic growth approach, management can fully focus on growing the business
and the achievement of goals, and not be deflected from these as a result of merger or
acquisition structural changes and integration.
The route also enables the executive to be in complete control and to steer the business
in the direction it considers is necessary.
F1D Benefits of organic growth
Many key companies that have followed the organic growth approach have found
that it can deliver long-term benefits and profitable relationships with customers. When
compared with a non-organic approach, organic growth can deliver lower costs and a
better return on investment as it makes a company stretch its boundaries and take on
innovation.
The approach enables the executive to concentrate on achievement of strategic goals
and not be deflected by having to lead the integration of a merger or acquired business.
Culture clashes and morale issue, which ofter arise through a merger or acquisition, are
avoided. People are able to continue to focus and concentrate on achieving the
business
goals without clear differences in opinion on the norms and how they should work
together.
When there is a company merger or acquisition, employees will expect staff reductions
and cost savings. This will introduce uncertainty among staff the consequence of which

is often likely to be lower productivity. An organic approach helps staff to feel more
secure so enabling them to focus better on internal demands. Also with this approach,
staff are often involved in ideas generation to improve performance and reduce
operating costs.
Organic growth can be more economic compared with acquisitions. When there is a
company acquisition, often a premium is paid for the business and this could reduce the
real value of the acquisition and not increase the shareholder's value as was hoped.
From an analyst's standpoint, this approach has real benefits in that they can measure
the business's effectiveness that has been achieved through its internal efforts without
the figures being distorted through any merger or acquisition. It mean s a check can be
made as to whether the business's growth is real, sustainable or actually contracting.
The organic growth approach can also be a less risky one. A good example of where
things went wrong in the non-organic route was the Royal Bank of Scotland's (RBS)
acquisition of the Dutch Bank ABN AMRO, which resulted in RBS having to be bailed
out by the UK Government largely due to the toxic portfolio of the Dutch Bank.
F1E Disadvantages of organic growth
With the organic growth route businesses usually need more time to grow as it requires
employees who can handle the growth process along with the other actions that are
needed to move the business forward. This can mean an enormous commitment of time
and resources as personnel may need to be found, recruited and trained, premises and
equipment acquired, sales conduits established with extensive marketing to get products
known in their new field.
More risk can be involved in the organic route, as a business will need to bear the cost
of the whole risk itself. Combined with having to set up new business avenues can mean
the generation of revenue and profits may be slow. In addition, if unreasonable market
share aspirations and targets are set, risky and potentially unprofitable business may be
taken on thereby not only on angering sound growth prospects but also the financial
stability of the company.
F2 Mergers and acquisitions

Non-organic growth is where a company merges with or acquires a not her with the aim of
rapidly growing its business and we will new look at mergers and acquisitions, what they mean
and how they are used.
Mergers and acquisitions are known as M & As. A merger only happens if two companies agree
to join forces on a basis, while an acquisition is where a company gains control of another
company by purchasing a majority shareholding.
M&As can be divided into what is known as horizontal or vertical integration.
Horizontal integration is where the two companies are in the same market and the non-organic
growth integration is aimed at:
improving a mediocre performance to a better market position;

achieving economics of scale;
improving competitiveness;
possible opportunities for diversification.
Vertical integration is where a company, through the M & As is attempting to control a stage
either closer to the source of the manufacture or closer to the source of the customer. Here the
aims can be to:
reduce costs,
gain more control over the market, including sources of supply;
deprive competitors of low cost inputs or convenient distribution systems.

F2A Reasons for insurance M&As

As mentioned earlier, non-organic growth means achieving growth through the merger or
acquisition of another business. It is often a rapid way for a business to achieve growth. An
example of this is gaining access to new distribution channels. In the past this was achieved by
controlling a large sales force through a branch network. Now it involves buying a broker
network or a direct dealing arm of an existing insurer. A recent significant example was the
attempt by Prudential to purchase the Asian arm of the US insurer AIG. The objective was to
quickly gain a strong foothold in the Asian market. To achieve this organically would have been
slow, by taking a non-organic route its growth aspirations in this market could have been
achieved quicker. In the end, however, the price being asked by AIG for the Asian arm was too
high and the Prudential did not proceed with the purchase.
Today, a key way to operate within a global market is to be sufficiently large and this often
means growing though M&As. Many of the largest insurers are now considered to be financial
service provider - more than just risk takers. This is also a non-organic growth means.
Another non-organic growth means is to beat the competition within a market and an effective
way of achieving this is to buy or merge with it.
However, growth is not the only reason that companies merge with or achquire other companies.
The following are examples of other reasons for M&As:
As duplication is removed, efficiency and improved performance can be gained through

synergy of processes or economies of scale by lowering unit costs.
Overcoming the cost of IT by being large enough, through the sharing of resources,
which are becoming ever more expensive if the latest IT platforms are to be used.
Provides investment opportunities if an insurance company has spare capital.
Two companies joining together to spread risk for example if one is based in the USA
and one is based in Europe, the two books of business will then balance the risk of a
catastrophe.
An excellent why for a company to purchase new skill s or enter a new market without
having to develop the knowledge organically (in-house).
F2B Disadvantages of M&As

It does, however, need to be remembered that there can be a number of disadvantages to
mergers and acquisitions, for example:
Reduced customer choice through the reduction in the number of organisations offering
products to customers. This means there can be a reduction in competition. To guard
against this the Government set up the Competition Commission (formerly the Mergers &
Monopolies Commission). In addition to this, as a result of the banking crisis and the need
for the Government to step in and bale out some banks, the EU competition commissioner
has become involved and registered concern at the lack of competition in the banking
industry in the UK This is likely to mean that banks that have received public funds will have
to be broken up to create greater competition.
Impact on staff affected and cost of redundancies-staff morale can be impacted
considerably, especially if the whole change process is not managed effectively. Often the
cost of redundancies and/or staff redeployment is high with a significant loss of valuable
staff experience, skills and knowledge.
Clash of corporate cultures-corporate culture can be described as the personality of the
organisation. If these are very different one another it may be difficult to agree on a cultural
approach that will enable the organization to work together effectively and move forward.
There have been a number of instances where cultural clashes prevented mergers going
ahead.
'Eye off the ball' while change taking place-often a merger or acquisition will cause a large
amount of changes. As a result, most of the organizations energies may be directed toward

the change process instead of growing the business and delivering service to customers.
Reduced customer service while changes being implemented any number of factors may
impact on customer service such as reduced staff morale, lack of communications, staff not
knowing what is going on or what products they are to sell or what they are to say to
customers with a consequent increase in complaints and loss of business.
Expected M&As saving not actually being realised whatever a merger or acquisition is
announced, big promises are made by the directors as to the costs that can be saved and
how shareholder value will be improved. Often these promises do not come to full fruition or
are not properly measured so the real value of the change is not clearly evident.
G Outsourcing
Many companies within the financial services sector are out sourcing a number of their key
functions, some of which are going offshore to countries like India and South Africa. Outsourcing
is the use of a skilled resource outside the company to handle work that was previously
performed by in-house staff. These external organisations are independent specialist companies
who can offer a range of services. The earliest examples of outsourcing were cleaning and
catering services and for the insurance industry, loss adjusting. However, the range of
outsourcing services now available is extensive and includes IT and data processing, employee
benefits administration and parroll processing, accounting, claims management, telesales and
customer service.
The key benefit of outsourcing is that it frees the company so it can focus on its core activities,
usually those that are revenue earning. However, regulated businesses are required to source
and manage outsourcing in accordance with FSA guidelines (sec section G5 for more on this
topic).
Good examples are:
IT function;
claims function;
telesales;
loss assessing;
risk surveys;
underwriting function;
customer inquiry function;
customer helplines, e.g. legal advice;
human resources administration..
G1 Main features of outsourcing

The working relationship is governed by a legal contract, whereby for an agreed for the
outsourced company promises to deliver an agreed service over an agreed period. Naturally if
the outsourced company fails to deliver the required service, then the contract may be
terminated and damages may be sought against it.
It is imperative that the business has effective controls of the outsourcing relationship to manage
the regulatory, operational and reputational risks inherent in these arrangements.
The agreed service can either be run from an external site, or as often happens, the outsourced
staff work alongside the in-house permanent employees.

G2 Advantages of outsourcing
As business needs change, the company has the advantage of only paying for what
they need rather than maintaining their own in-house service. This is apparent when
there is no demand for the service and a company is left with an unused resource.
Without sourcing it can finish with the contract for less cost than closing an in-house
area down.
The business is guaranteed a certain level of service as set out within the contract.
The business can budget for a pre-agreed fixed cost for the agreed service:
Outsourced companies are normally specialists within their area and will bring new skills
and working methods to a company.
Many outsourcing contracts lead to new partnership opportunities between the business
and the outsourced company, as they learn new ways of doing business processes.
The businesses that do outsource claim to be far more flexible in attitude as they are not
tied to in-house practices and politics.
The business may increase its capability to develop new product s and their speed to
the market.
The businesses that do outsource have more time to focus on their core business areas.
G3 Disadvantages of outsourcing
Any form of contract that allows the business to outsource processes will mean that a
certain control and direction will be lost.
Even if damages can be awarded for a poor service, the business will lose out, as
customers will not understand the intricacies of the need for out sourcing, therefore
damage to the reputation is difficult to reverse.
In certain area, there is a real risk that confidential information or sectors will be lost or
lacked out to outsiders as external staff are not aware of their importance.
If the business is too dependent on outsourcing process, then it will be open to higher
cost, as it must maintain the external contract, even if cheaper alternatives exist
internally. If the Outsourced Company get s into financial problems the business will he
faced with problems of finding an alternative provider.
Full understanding of customer behaviour and satisfaction can be lost if communication between
the business and outsourced company is in inadequate.
H Delegated authority in underwriting

Here we will consider the issues and implications of granting underwriting authority to third
parties such as intermediaries. Many insurers have delegated some authority to intermediaries
to act on their behalf. This could be, for example, simply the issuing of a motor cover note book
to an intermediary. The intermediary is authorised to issue cover provided that new business or
changes to existing policies fall within defined criteria. Some delegated authority schemes (often
called 'binders') give a great deal or flexibility to the intermediary within defined limits. Often the
policy wording will have been specially negotiated to fit a particular category of client, e.g.
haulage contractors, warehouse keepers, hoteliers. These will often be referred to as schemes.
There is a general market trend for more and more business to be placed on such schemes and
some brokers have specialist divisions set up to manage such facilities. Others have formed
separate subsidiaries for this purpose (see also reference to managing general agents below).
The attraction of these schemes from the insurer's point of view is a flow of business arising
from the tailored wording. There may also be an agreement on rating, but many schemes rely
upon individual rates being provided by the insurer upon receipt of proposal information. From

the intermediary's point of view there is an case of operation, and quite often some kind of profit-
sharing provision if the results of the scheme are good.
H1 Delegated authorities and line slips

We will now look at the type of delegated authority which typically involves an arrangement
whereby an insurer or underwriter (the risk carrier) authorises another party, usually a broker or
intermediary to accept risks and/or sign and issue documentation on its behalf. In these
circumstances the party to whom authority has been delegated is known as the 'coverholder.
An agreement called a 'binding authority' is set up between the parties, which set s out the
scope and extent of the authority delegated to the coverholder. The level of authority will be
negotiated between the parties and will vary from signing and issuing policy documentation only
through to quoting and binding risks. In addition, a coverholder may even be authorised to
handle and settle claims. Binding authorities are an important way of transacting business in the
UK Lloyd 's and London markets.
Outside of these specific markets there is a general market trend for more and more business to
be placed on schemes where insurers delegate authority to brokers and other intermediaries to
underwrite risks on their behalf. Some brokers have specialist divisions set up to manage such
facilities. Others have formed separate subsidiaries for this purpose.
There are benefits to both parties in the operation of such schemes.
They enable the insurer or under writer to:
gain access to business it might not usually have the opportunity to see;
be able to obtain business in parts of the world where it has no office;
have the benefit of local expertise and knowledge, which it m ay not possess;
acquire income at low costs and without the costs and risk of establishing braches or
employing underwriters to obtain the business.
The are also benefits for intermediaries in that:
they incur less cost in placing business;

in many cases, they can give cover immediately;
they receive enhanced levels of commission to reflect the additional work taken on;
they may participate in any profit from the risks written under the scheme.
A line slip - although a form of delegated authority - has a number of different features and
specific uses. We shall consider what these are and how they are used later in the section.
We shall start by looking at the basis of a typical delegated or binding authority.
H2 Operation of a delegated authority

No insurer or underwriter is going to delegate their underwriting authority without ensuring that
the authority is strictly delineated and properly enforced. There will be strict limits on the
intermediarys authority which specifically deal with the following:
What risks can be covered and what cannot, e.g. classes of business that may be
bound, the trades (or a list of excluded trades) etc.
Rates of premium to be charged, including any minimum levels.
Limits, e.g. limits of indemnity, any minimum excesses to apply etc.
Cover that may be granted and the wording to be used.
It would also be usual for the authority to set out geographical limits for business to be bound.

An important aspect of the authority is the overall premium limit that the intermediary can accept
during any one any one year/month/quarter. This is to ensure that the ultimate capacity of the
risk carrier is not breached.
Where claim s settlement authority is included in the delegated authority, there will also be clear
parameters setting out the extent of the authority to agree and settle claims.
H2A Importance of records

These types of authorities require accurate and precise records to be kept for a variety of
reasons. Typically these records will be in the form of bordereaux containing detailed information
regarding the risks accepted and - if claims handling authority is included - details of all claims
paid and outstanding. The detail of each bordereaux will naturally depend upon the term s of the
authority but will typically include information on:
the identity of the client;

the risk location;
the sums insured and, in relation to a major portfolio, the potential maximum amount
of any one loss;
a breakdown of income section by section as well as details of individual premiums
written;
retention rates of the business transacted.
In addition, the risk carrier may specifically request other management information to allow them
to evaluate the contract and establish its viability.
H2B Auditing and monitoring

The risk carrier will regularly carry out audits during the year to ensure the terms and procedures
of the scheme are being adhered to. At the end of the year (or more frequently if the scheme is
large) the two parties to the agreement review the results and the risk carrier will deceide
whether or not it will continue with the arrangement.
H2C Problems with delegated authorities

One of the potential problems with delegated authorities is the legal relationships that exists
where underwriting and acceptance authority has been granted to an intermediary.
The scope of the authority provided must be clearly expressed and to avoid any conflicts of
interest it is vital for the insurer or underwriter to make sure that the intermediary has a clear
separation of duties between business acquisitions (where the intermediary is deemed to be
acting as agent for the client/insured) and the underwriting facility (where the intermediary is
deemed to be the agent of the insurer).
Liability for risks written under delegated authorities remains with the insurer or underwriter in
the same way as if they had written such risks individually themselves. However, problems can
arise if the terms of the authority are unclear with the possibility of the intermediary accepting
risks that are in breach of the terms of the authority in which case they can incur liabilities as a
result of their activities.
H4 Lines lips
You will recall from previous studies that a slip is a document used in certain parts of the market
as part of a system of placing business.
An intermediary-usually a broker- prepares a 'slip' containing details of the insurance and

approaches insurers or under writers to obtain agreement from them to accept either the whole
risk or a percentage of the total risk. In circumstances where a number of insurers share the risk,

the intermediary will select an insurer or underwriter to 'lead' the risk. This insurer or underwriter
is referred to as the 'lead underwriter and it agrees the premium, terms and conditions for the
risk with the broker. The 'lead underwriter signs and stamps the slip and confirms the portion
(percentage) of the risk it wishes to write. The broker will then approach and obtain agreement
from other underwriters (known as the 'follow underwriters') to write a portion of the risk on the
terms and conditions agreed by the 'lead underwriter until 100% of the risk has been placed.
A line slip is an agreement between an individual broker and a group of two or more insurers or
underwriters whereby each insurer or underwriter agrees to accept a pre-agreed proportion of a
specified type of risk. General criteria for risk acceptance and terms and conditions are agreed
at the outset between the insurers and underwriters and there is usually some form of pre-
agreed rating (pricing) scheme used for premium calculation. The underwriting of individual risks
to be included in the line slip is delegated to one or more designated members of the group who
act as 'lead underwriters' and accept risks on behalf of all the insurers.

Bab 2: Management of the insurance
business: roles, responsibilities and
styles
Introduction
In this chapter we will look at further aspects that relate to business today. These aspects are
generic and apply to other industry sectors too. Even though effective managers frequently
have a deep knowledge and understanding of the industries in which they operate, it has
become increasingly common for senior managers with broad management experience and a
track record of managerial responsibility to move freely from one industry sector to another.
This is because, at high levels, managerial skills and experience are transferable from one
business to another.
Insurance and other services in the financial services sector can be differentiated from their
counterparts in the hard product sectors like manufacturing by the fact that the former are
offering their customers intangible services while the latter are offering tangible products.
So, although the role of management in manufacturing companies includes facilitating their
production and delivery of 'hard' products like cars and clothing, the emphasis in the financial
services sector is on the delivery of 'soft' services like insurance, accounting and banking. This
is most commonly achieved by relying on the interaction between the organisation's staff and its
customers.
Because of this emphasis on people delivering services to other people, the main function of
management in the financial services sector is to facilitate and sustain the positive interplay
between:
the organisation as a corporate entity;

its employees; and
the external environment, mainly composed of its customers, the general public, the
Government, individual or corporate shareholders and any other stakeholders or
interested parties
Reinforce
Before you move on, make sure you understand the difference between hard and soft
products and what the key impact is on the management function.
We will now look at the way companies, including insurance companies, are run starting with the
role of the board of directors.
A The board of directors

A1 Composition of the board
Shareholders of public companies appoint directors who form a board and who then elect a
Bab 2: Management of the insurance business: roles, responsibilities and styles
chairman from their members. An important duty of the chairman is to ensure that meetings are
run in an orderly and efficient manner. In additional the chairman is often the organisation's
representative to the outside world.
Types of director
There are two different types of directors:
executive directors who work full time in the company and are given management
responsibility for running parts of the business. The board usually appoints one of the
executive directors to be accountable for the running of the company on a day-to-day
basis and is known as either the chief executive officer (CEO) or managing director who
in turn appoints the company management (see section B).
non-executive directors who work part time and are chosen for their particular area of
expertise and do not perform an executive management role in the company. They
attend board meetings and may be members of sub-committees in order to provide
independent views on matters such as audit, management remuneration and risk
management.
A2 Responsibilities of the board

The actual responsibilities of boards may vary depending upon the type of company, but for the
purpose of this course, we shall focus on public companies listed on the London Stock
Exchange.
The board of directors of a company is concerned with representing the broad interests of the
shareholders and staff in the company, but does not take an active part in the daily running of
the company. Under the chairman, the board concerns itself with the broad plans and policies of
the company. It is concerned with the reviewing of past performance, the making of plans for the
future and the formulation of policy to carry out those plans. It will determine market strategy and
resource utilisation, which will then be communicated to the management team whose job it is to
determine how the policies are to be put into effect. In practice, of course, the board will be
influenced strongly by the recommendations and reports it receives from the managers.
To summarise, most boards are responsible for:
overseeing the executive directors and other senior management to ensure they uphold
the shareholder interests and the laws governing the conduct of the business;
approving the company report and accounts, annual budgets, strategy and other
important plans;
selecting, appraising and rewarding the CEO and ensuring succession planning is
actively addressed;
overseeing the process of risk assessment and ensuring the necessary actions are
adopted to mitigate against those risks (see chapters 4 and 11 for more on this aspect of
insurance company management);
ensuring that the company integrity and principles are upheld on critical matters such as
financial reporting accuracy, legal and regulatory compliance, as well as adherence to
the company's stated ethical standards.
Reinforce
Before you move on, make sure you understand the responsibilities of the board. This will be
important for when you come to chapter 4. Make some notes below.
A3 Compliance with corporate governance requirements

Following a number of high profile corporate failures in the 1990s and early 2000s there has

been significant development of an increasingly stringent body of laws and processes _that
determine the way by which companies (especially public companies) are controlled internally
through the board and executive management. This is called corporate governance and is
described and discussed in chapter 4.
The UK Corporate Governance Code (formerly the Combined Code) is a key document setting
the corporate governance standards for the UK. It sets out standards of good practice in relation
to issues such as:
board composition and development;

remuneration;
accountability and audit; and
relations with shareholders.
It is appended to the Financial Services Authority (FSA) Listing Rules (see chapter 4, section G7
and chapter 8, section D) which requires listed companies to report on how they have applied
the main principles of the Code.
Appendix 1 of chapter 4 sets out the main principles of the Code.
A4 Other operating structures

There are in financial services a number of trade associations, educational bodies and other
organisations such as the Association of British Insurers (ABI), British Insurance and Investment
Brokers Association (BIIBA) and the Chartered Insurance Institute (CII), which, although they
have no shareholders or boards of directors as such, operate in much the same way as do
financial services companies. In place of shareholders or boards of directors there are Councils,
with their presidents, and committees and sub-committees, each with a chairman, which perform
the function of non-executive directors. The carrying out of a policy is in the hands of the full-time
secretariat of the bodies concerned.
B Senior executives
All the members of the senior executive team would normally have a 'cabinet responsibility' to
propose developments to the company's strategy for discussion at the board. As we have
established in section A2, it is for the board to discuss and determine the company's strategy.
The board would normally prepare a document setting out which matters it reserves for itself and
which matters are delegated to the CEO and possibly to other members of the senior executive
team. There would then be separate statements on how authorities are delegated from the CEO.
B1 CEO/managing director
As mentioned in section A 1, the relationship between the board and the management company
is the CEO or managing director (or general manager with a seat on the board if there is no
managing director). Managing director, and is also a director, responsible for business functions
and daily activities of the company. The position of managing director clearly shows the division
of functions between the directors and managers. As a director, they helped to formulate the
goals and policies of the company; as managers, they manage resources so that they will work
efficiently to translate policy into practical terms the board. They also will lead the organization's
culture and management style (see section E).

B2 Finance Director
The finance director (FD), sometimes referred to as the chief financial officer, would normally be
a member of the senior executive team and is usually but not necessarily a director of the
company. The FD would normally have responsibility for, or at least significant influence over,
the following:
The economic capital model to assist in the determination of the appropriate level of capital
for the company to hold (see chapter 11).
Stress and scenario testing to assist in the determination of the amount of extreme risk the
company may be subject to (see chapter 11).
Proposals to the board on the form of capital to hold in addition to equity capital, such as
subordinated debt (see chapter 7, section D 1).
Preparation of papers for the board to assist in the determination of the appropriate level of
dividend to pay to shareholders.
Making recommendations to the board on the appropriate level of claims provisions to hold
(see chapter 9).
Preparation of the statutory accounts of the company for approval by the board and
shareholders (see chapter 7).
Making presentations to, and managing the relationships with the investment analysts who
prepare reports on the companys performance and holders of the company's debt.
Preparation of the financial information required by the FSA and be one of the main
contacts the FSA has with the company (see chapter 11).
Preparation of the management information, such as leading indicators of financial
performance, for the executive team and the board.
Management of debt, cash flow, liquidity and treasury matters, management of the
investment portfolio.
Management of the financial aspects of the planning process, the budgetary process and
the forecast process.
Preparation for the reviews by rating agencies (see chapter 11, section A).
Preparation and planning for the statutory external audit conducted by the independent
auditors (see chapter 4, section D).
Management of the reinsurance accounting process.
B3 Company secretary
The Companies Act 2006 requires all public companies to have a company secretary, although
a private company need not have one. See chapter 4, section C3 for more detail on the role of
the company secretary.
B4 Chief Actuary
In the UK, the chief actuary is a statutory appointment for life insurers (the appointed actuary).
However, actuaries are increasingly employed in non-life business. The chief actuary may be
responsible for:
technical pricing of new and existing products;

calculation of claims reserves;
calculation of risk based capital requirements;
assessment of investment risk for funds supporting technical reserves.
See chapter 11, section B8 for more on the role of the actuary.
In addition to these key senior executive positions, a typical insurance company will also have
the following senior positions:
chief risk officer;

head of internal audit;

underwriting director;
claims director;
marketing director;
human resources director;
information technology director;
strategy director;
investment director.
Reinforce
Before moving on, remind yourself of the key issues covered by the UK Corporate
Governance
Code and which companies are required to report on how they have applied the main
principles of the Code
We shall now go on to look at the key roles and responsibilities of managers and supervisors.
C Managers and supervisors
C1 Broad role of management

Management can be said to be the process of planning, organising, leading and controlling the
material, financial and human resources of an organisation.
To be effective, the management process requires a combination of formal planning, clear

communication and efficient execution. Above all, it requires vision.
C2 Roles and responsibilities of managers

In order to nurture the interaction between the organisation, its employees and its customers,
financial services managers must carry out a series of actions (planning. organising, leading and
controlling) that affect a range of business components (the material, financial and human
resources of the organisation). These actions will take the business forward in its trading
activities. We examine each of them, and each of the business components, in more detail in
this section.
C2A Management actions

Planning
Planning is a continuous and repetitive process made up of many different phases. In
management terms, the usual result of this process is an agreed general plan covering the use
of physical resources, the allocation of responsibilities, timetables and budgets, with the aim of
achieving clearly identified results.
Planning is covered in greater detail in chapter 3.
Organising
Related to the planning process is organising material and human resources so that they are
utilised to the full and help to achieve the aim of the business within the agreed time frame. Time
frames will vary from short-term projects lasting a few weeks to strategic planning and
organisation in the medium term, say over three to five years. Organisational ability is an
important characteristic of successful managers, particularly since the execution of any

management plan is likely to involve the co-ordinated efforts of a number of different people.
Leading
Much has been written about the relationship between leadership and management; effective
leadership skills and effective management skills are often linked.
What differentiates managers from other employees within an organisation is the fact that they
are expected to lead their subordinates. Even though some organisations ha\'e 'flat'
management structures- i.e. structures that are not hierarchical- many others may use vertical,
militaristic structures to ensure that corporate objectives are achieved.
In hierarchical management structures, management authority grows in tandem with seniority

and junior staff is expected to follow the decisions and vision of their superiors. In flatter
structures. decisions are more often taken by consensus.
One of the most important aspects of leadership is accountability. This is the leader's
acceptance of responsibility for the actual performance of the organisation or department, its
material and human resources, and the result of their own decisions. It is the manager's role as
leader to give an account to the organisations various stakeholders of how the organisation has
performed.
Controlling
Every plan needs to be controlled, and it is one of the manager's roles to monitor and evaluate
its progress. There are several common methods of controlling management activities.
C2B Business components

Material resources
Material resources include all of the physical resources - such as plant, equipment, office space
and vehicles and any capital equipment such as information systems or communication
management systems - that are at the disposal of the business and can be used to help it to
achieve its objectives.
Financial resources
Financial resources constitute the funds that are available to the managers of the business to
allow it to carry out its day-to-day operations. These include cash, bank loans, share capital and
other financial instruments against which it can raise money.
Human resources
Human resources are made up of the people who work for the organisation on a permanent,
temporary, full-time or part-time basis and those who work directly or indirectly for the company
in an outsourced capacity. As we shall see, the ability to manage people has become an
increasingly important management skill - especially in more democratic societies, where people
are used to having certain freedoms and rights that protect them from being exploited at work.
Whereas, during the industrial and colonial eras of the late nineteenth century, the management
of people relied on one-way relationships between dominant managers and subservient workers,
the gradual emancipation of workers through trade union movements has made management
more of a partnership between the two.
C3 Individual manager's role

In practice the job of management is complex and demanding as managers are required not just
'to do the right things' but also to look as though they are doing the right thing.
Other managers, particularly those in more senior positions, will have expectations of what
subordinate managers must do, or be. Such expectations do not necessarily tie in with the
managers' own perception of their role; they may not for example see the exercise of authority
as giving orders, but their superior might. Managers must be conscious of the constraints that
might arise from such 'shadow' roles.

Managers need to:
Structure and organise their team to meet the needs of the job. 1l1ey need to have regard
for the size of an effective working unit, for defining jobs, for clarifying reporting
relationships and for defining and clarifying objectives.
Clarify the accountabilities and authorities of subordinates. Staff need to know what they
are required to do and what they are allowed to do.
Ensure staff are trained and developed and that individual subordinate strengths and skills
are used for both their benefit and that of the business.
Establish a system of personal targets and a performance and reward review which
emphasises the contribution that staff are making and the level of their achievement and
seek to reward them accordingly.
Ensure that correct decisions are taken at the right time. The commitment to action
authority to make decisions must be delegated as far down an organisation as possible
and whenever possible, staff should be consulted before a decision which affects them is
taken.
Communicate regularly with their staff. They will organise meetings so that they can brief
staff regularly on what must be achieved and why they need to establish a system
whereby they can receive feedback from their team so that they understand their
problems and their reactions to the requirements.
Being a role model for subordinates and people within the business. A manager cannot
say one thing to their people and then behave in a manner that does not support what has
been said.
Establish a system which enables them to consult with representatives of their group on
plans and objectives which affect the way they work and their security.
Take a positive attitude towards employee representation and participation. If their
company recognises a particular group for negotiation purposes they should encourage
people to join that group, to attend meetings and play a part as a representative.
Consider how jobs can be designed to meet the needs of staff in order to maximise their
contribution and allow for job satisfaction.
Establish a system for monitoring results and performance.
Maintain discipline and control through the effective use of authority and by seeking to
encourage co-operation and commitment.
Consider their responsibilities to society and the relationship between the work they
control and the community at large.
The manager's role is both complex and, as has been said, dynamic; the mere exercising of
skills in the areas mentioned will not of itself produce a successful manager. A manager is
surrounded and constrained by more and more legislation, by ever-increasing demands for
greater efficiency, by changing social and moral standards and by changes in their own horizons
and motivations; without integrity they will not cope.
Because business has become increasingly sophisticated as world economics have developed,
so too has the practice of management. As a result managers now need to use new skills that fit
changing working patterns, new technologies and the gradual deregulation of domestic and
international commerce. Examples of these key skills are:
Earning the respect of subordinates and colleagues - In line with a gradual move
towards democratisation a manager is more likely to be answerable to their subordinates
now than in the past. This means that there is a much greater emphasis today on earning
the respect of colleagues by developing interpersonal skills and empathy with other staff.
Focusing on customers - The way in which organisations now have to regard the
customer means that managers must be aware of the impact that their decisions have on
existing and potential client-bases. Successful business managers acknowledge that their
management policies must now be customer facing, and that acting on feedback from
their clients and customers is essential.
Multi-tasking - Today's managers have the benefit of advances in technology, such as
data storage systems, sophisticated communications methods and easy access to

information. As a result the costs of clerical and administrative staff are harder to justify.
Therefore, managers today need to be able to carry out administrative functions quickly
and easily themselves. Added to this, managers today need to know the fundamental
concepts behind information technology (IT), finance, accounting, human resources and
sales and marketing, in addition to having a deeper knowledge of their own specialised
areas.
Mobility and a global outlook - Many organisations trade internationally or with regional
trading partners, and managers are expected to be able to travel and conduct business in
different economic, cultural and financial environments. Also in an increasingly
deregulated commercial world, it is important for managers to be able to identify the
advantages of operating in other countries, and ways of entering new markets.
New management concepts
There is now a fast stream of new ideas often accelerated by technology advances and
globalisation. Management theory has become a developed academic discipline in its own right,
so keeping abreast of new concepts is an increasingly important skill for today's managers.
C4 Manager's role in internal communication

An essential element of managing organisations effectively is the ability of managers to
communicate clearly with their staff. Generally speaking, organisations that communicate well
with their employees are rewarded with a motivated workforce, greater commitment to the
organisation and employee support for management decisions.
Poor communication is no longer a management fact that organisations can overlook. Increasing
competition and the consequent need to convey business realities to employees; changes in the
culture and structure of businesses; the need for increased staff.co-operation, innovation and
ideas; and for greater commercial flexibility and efficiency all require internal communication
systems that work.
Practically speaking, the aims of communication within an organisation are likely to include
informing, instructing, persuading, negotiating, advising, challenging, motivating and involving
staff. There is evidence to show that most employees want to know about their organisation's
plans for the future and how well they are performing in their job. Many financial services
organisations have also recognised the need to encourage start to provide ideas and
suggestions for improving business performance. Managers at all levels are seen to consult
people on issues that directly affect them.
Characteristics of effective internal communication
To ensure internal communications are effective, they should have the following characteristics:
accuracy;
clarity;
relevance;
reliability;
credibility;
timeliness.
It is also necessary to ensure that any barriers associated with communication do not get in the
way and reduce the effectiveness of messages that have to be delivered.
Barriers to effective communication Common examples of these arc:
The problem of size; where there are three or more levels in an organisation, a
deliberately designed communication system becomes vital. The casual approach can

only work in very small units and even then a systematic method is usually found to be
more helpful.
Natural reserve/fear/lack of confidence; British people, perhaps above all, are well-
known for 'keeping themselves to themselves: In addition, many people tend to feel that
'if in doubt, keep your mouth shut'. Many managers experience fear, which, often
through inadequate briefing, results in the feeling that it is better to say too little than too
much.
Knowledge is power; for many people, the possession of confidential information
confers a sense of power. Withholding information may be viewed as a means of
preserving status or of having an extra ace or two up one's sleeve in case of the need
for resistance to management proposals, and far too many people are frightened of
saying they do not know the answer.
The language problem; it is well known that many people interpret words in different
ways, therefore this barrier must be carefully removed by explanation, especially where
jargon is used.
The problem of time; people are always immensely busy with something else, probably
sorting out the problems caused by a previous failure in communication. In addition to
this, the management team is busier still at times of upset or change, just when the
exchange of understanding is more important than ever.
Training; many managers are inadequately equipped with, and unaccustomed to, using
organised methods of information flow. Moreover, many do not even know that it is an
essential part of their duties to be skilled, however simply, in the exchange of
understanding, including feedback.
The grapevine; one of the most subtle methods of passing information is through the
grapevine, the characteristic of which is to generally impute uncharitable motives to the
often accurate information which it conveys.
Failure to recognise the need to tell; this is a common cause of breakdown in
communications. 'I didn't think to tell him' or 'I didn't realise they needed to know' are the
kind of expressions which so often demonstrate this failure.
Inability to listen; often managers incorrectly deduce that to communicate means
giving or sharing information. It is worth emphasising that to be effective,
communication needs to be a two-way process. Active listening is just as important.
Benefits of efficient internal communication

Efficient internal communication will help the organisation to:
bring about change in the culture and structure of the business more quickly;
encourage staff to be co-operative and innovative;
ensure that all relevant staff are helping to meet corporate objectives.
C5 Supervisor/team leaders
Supervisors and team leaders are the front-line managers. As a result they need to have similar
skills to a team, team leadership and motivation, handling team conflict, team development and
coaching. They will also need to be highly customer focused and a good role model for the team.
The management writer Dr John Adair provides a useful explanation of a team leader's role
through his action centred leadership (ACL) approach, which is today widely used as a model for
leadership effectiveness.
In this approach he identified three key areas of team leaders' effectiveness:
the task- the primary need to get the job done;

the team - the need to build a cohesive unified team, a bunch of star players does not
always equate to a team;
the individual - we all have a variety of needs which motivate us into action to satisfy
them; to be wanted, to be useful, to have our way. If these needs are not met, we become

frustrated, and this affects our performance.
The concept comes down to understanding the needs of these three areas, therefore, for:
task needs the leader should:

- define the team's goals and objectives;
- ensure the appropriate resources are available;
- develop work plans and define team tasks;
- allocate the work and resources;
- control the work rate and quality;
- check performance against plans;
- adjust the plans as necessary.
team needs the leader should:

- set and agree standards and maintain discipline;
- build and maintain team spirit and morale;
- encourage, motivate and give a sense of purpose;
- ensure communication within the team;
- appoint sub leaders;
- train and develop the team.
individual needs a leader should:

- agree individual objectives;
- attend to and personal problems;
- give praise and reward to individuals;
- train and develop individuals;
- recognise and use individual abilities.
Three overlapping circles illustrate the concept and relationships; each key area can affect the
other two positively and negatively.
For example:
task achieved - individuals happy - team morale high;

high team spirit - affects individuals and can help achieve tasks;
disgruntled individual- can reduce team cohesion and influence achievement of task.
The converse of each example follows too; for example task failed or incomplete - affects
individual satisfaction and team spirit.
(Reproduced by the kind permission of MacDonald Futura, from Training for Leadershtip by J.
Adair.)

D Non-managerial staff
On the basis that no manager can advisory relationship to line management. They do not
necessarily have authority to convert recommendations into actions and often work through line
management.
An example of a staff relationship in insurance is the role of the company secretary whose work
does not impinge on line management except that in certain circumstances they are able to give
specialist advice.
The size of the organisation will have a heavy bearing on whether a speciality role has line
management responsibilities. In the larger organisation there are likely to be line responsibilities,
as they will have staff working for them, whereas in the smaller company these people often
work on their own.
Examples of other roles that are often viewed as staff positions are:
personal and executive assistants - provide support for senior managers and managers;
training officers/managers- identify training needs, design and deliver training courses/
workshops, plan and co-ordinate training needs;
recruitment officers- identify recruitment needs, conduct job analysis, handle job
advertising, interview candidates, obtain references;
technical underwriters- provide technical advice on product underwriting, rate technical
risks;
claims specialists - handle complex claims;
accountants -handle accounting needs including budgets/expenditure reporting and end
of year accounts;
procurement managers - develop company purchasing policy, identify preferred
suppliers, negotiate purchasing contracts;
in-house solicitors- provide legal advice.
The actual roles these support staff provide can vary considerably depending on the
organisation's business needs and structure, and the above are just examples.
Be aware
The key difference is that these specialists, while having the management responsibilities of
planning, organising and controlling the material, financial and human resources of an
organisation, do not normally have the leading responsibility. However, in all other respects
they do have similar management responsibilities to line managers.
D1 Other staff
There is a whole range of different roles within the insurance industry but regardless of a staff
member's role and where they work, there are a number of generic skills all members of staff
should have.
As most staff working in the insurance industry have customer facing roles it is very important
that they have the core skills and attributes that relate to dealing with customers. These core
skills are an understanding of the importance of customer focus and communication skills and
the ready and willing application of those skills.
You will remember that in chapter 1 we talked about the external and internal customer. So
regardless of whether a staff member is working in a front or back office, it is essential that they
understand and act in a manner that is customer focused.
In considering communication skills, all staff members need to be effective in their verbal and
written communications and active listening. Where written communications are concerned it is

especially important to apply these to the proper and effective use of emails.
In addition to these core skills, staff also need to be:
positively responsive to change (this is particularly important s change is constant today

so they need to be able to accept and work with it);
flexible and adaptable;
able to use their initiative;
able to organise and effectively manage their own time.
Being able to apply and work with all these skills will help their organisation to achieve effectively
its goals, objectives and mission.
E Management styles
Our definition of management describes it as a process. In the same way that there are different
ways of carrying through a process, there are different styles of managing businesses and a
business's culture will have a key impact in this. The issue of corporate culture is important
because, although management involves the effective use of an organisation's machinery and
property, it is mostly concerned with the effective deployment and supervision of its people.
E1 Impact of culture on management style

Corporate culture is still regarded by many as rather a shapeless notion, but there is no doubt
that organisations display (sometimes subtly) signs that they believe in conducting their day-to-
day business in a certain way. An organisation's management style shapes its atmosphere,
giving it its own corporate culture, which can be defined as 'the way we do things around here
It is made up of a range of factors, including the organisations:
norms: the behaviour which is most acceptable to the organisation - for example
approaches to problem solving, time-keeping, the way meetings are run, the use of first
names, dress standards and standards of performance;
beliefs and values: for example: 'We stand for quality, the input of every employee is
valued', 'We won't make a drama out of a 'crisis', 'We do not test our products on
animals'; management style: the behaviour of the managers. e.g. 'open door', autocratic,
paternalistic, hierarchical, democratic, mechanistic, organic (we look at this shortly).
An organisation's corporate culture and management style are heavily dependent on the
personal values of its chief executive senior partner or founder.
The way in which new staff are integrated into the organisation through the process of
socialisation is an important part of forming and maintaining the corporate culture.
E2 Appropriate management styles

A number of different management styles have been mentioned in the previous section. Each of
these has different characteristics, as shown in table 2.1.
Table 2.1: management styles and their characteristic

Style Characteristic
Open door Manager are approachable by staff at all times
Autocratic Control and power rest with a single individual usually the chief

executive
Paternalistic The company looks after its employees in a fatherly way and the
employees respect the organizations managers in the way that
children respect their parents this style is sometimes perceived
as too interving
Militaristic/ hierarchical The management is structured in a formal way with clear job
demarcation
Democratic/ consultative Decision are taken with prior reference to as many staff as
possible
Some styles of management are more appropriate than others in given situations, and the most
effective style in each case will depend on the type of business and current stage of the
business's life; that is whether it is expanding, contracting or stagnating.
For example, when the management's priority is the completion of a task at a time of crisis or the
business, management style is likely to be focused on taking fast decisions. In these
circumstances, management style will be more effective if it is militaristic, impersonal and
concentrated on getting the job done, if necessary at the expense of people and their feelings.
On the other hand, in times when the organisation is performing well, and the management
wants to encourage staff to contribute new ideas in a relaxed environment, management style is
likely to be more democratic, participative and tolerant. This will promote an atmosphere in
which staff are not afraid to take risks and be creative. Management styles are often reflected in
management structures.

Bab 3: Management of the insurance
business: planning and control
Introduction
Managers need to ensure that they use the company resources they have effectively. It is
therefore necessary to develop plans and budgets. In this chapter we will look at the planning
and budgetary processes along with the control methods that help managers to check progress
against their plans.
Planning is concerned with the future and, in a typical business environment, usually divides
into long-range planning (strategic or corporate planning) and short-term planning (operational
planning and budgeting).
A The planning process

A1 Setting strategic business plans
Strategic planning is a process whereby the future direction of the business entity is decided
upon and a statement (the plan) is developed detailing long-term goals together with a definition
of the strategies and policies, which will ensure achievement of those goals.
Such goals normally cover periods of between three and ten years depending upon the nature
of the industry (oil companies, for instance, would normally plan at least ten years ahead given
uncertain future supply, lead times involved in exploration and final recovery etc.).
Therefore, strategic management and planning is about deciding a strategy for an
organisation's long-term future. To put this into action, managers need to devise
operational/business plans to realize the short- and medium-term objectives.
At corporate level planning needs to cover the key areas that will allow the organisation's
objectives to be achieved, Including:
setting objectives;
identifying what needs to be done for those objectives to be achieved; creating the most
appropriate organizational structure;
allocating management duties and responsibilities to senior managers; agreeing and
establishing a consistent management style;
agreeing and setting budgets;
agreeing staff incentive ;
setting sales target;
planning the most efficient use of material resources; setting timetables and deadlines;
identifying contingency plans.
So the strategy sets the broad direction and methods for the business to reach its goals and
objectives. However, none of this would be achieved without more detailed implementation. The
strategy implementation stage involves the development of detailed tactical plans, policies and
procedures and operational plans and decisions that will include consideration as to the
resources required to achieve the strategic plan.
Bab 3: Management of the insurance business: planning and control
The tactical plan will include medium-term policies (often one to three years) designed to
implement some of the key elements of the strategy, for example, developing new insurance
products, recruitment or downsizing of staff or investing in services. Project appraisal and
project management techniques are invaluable at this level.
The third level of plan is the operational plan which covers routine day-to-day matters (usually
focusing on the current year) and is concerned with ensuring that the strategic goals and
objectives are met, for example, in meeting service levels, cost and revenue targets. Here
detailed action/business plans are drawn up that show the specific measures which need to be
taken if the corporate objectives are to be achieved. An action plan shows the measures and
projects which have been adopted, a timetable, allocation of responsibility and how resources
are to be allocated. Budgetary control is also an important element here.
2
A2 Implementing business plans

Action/business plans should be worked out for each separate division, project or operational
area, and should include the following points:
The objectives of the plan (which must be SMART- specific, measurable, achievable,
relevant and time defined).
The strategy for achieving those objectives.
The specific activities which will be undertaken.
Allocation of specific responsibility for carrying out each activity. The dates for starting
and finishing each activity.
The specific estimated resource requirement (based on time estimates) for the period of
implementation.
The expected cost of the activities.
The expected results (sometimes called milestones) on completion of the activity.
Once an action plan has been drawn up, it can be implemented according to the timetable and
responsibilities contained within it.
Activity
Are you aware of the planning process used in your organisation and what the operational
plan for your department or unit covers? If not, find out.
Note: Departmental/unit operational plans should not be confidential, as they need to be
communicated to the people who are contributing to the achievement of these plans.
The most effective way of monitoring the plan is to check whether the original objectives and
the expected results have actually been achieved, there are also several criteria for evaluating
the outcome of both strategic and operational plans. These should be identified as critical
success or failure factors at the planning stage and may include:
sales revenue;
overheads or production costs;
the learning effect (e.g. to what extent staff have gathered and are using new skills);
overtime and under time;
dismissals, redundancies and attrition (in human resources terms);
turnover of labour and its cost implications; productivity and efficiency;

market performance against the competition; profitability; and

customer satisfaction surveys.
Later in this chapter you will see how the process of management by objectives helps to provide
a link between corporate goals and management/staff targets.
A3 Control systems and models

It is essential that all business plans be effectively monitored. As a result it has become good
business practice to use control models that follow a similar generic structure. They tend to start
with a selection of relatively few business objectives. From these objectives, suitable targets 3
can be derived so that pressure can be created for effective strategic performance, but without
setting up a bureaucracy to achieve it.
Control is the process by which management assures itself that actions taken by staff conform
to the management's plans and policies. A series of milestones can be identified which are
tracked over time. These serve as benchmarks for evaluating strategic performance, and
provide early warning of deviations from expected outcomes.
Think
Can you think of the names of some control models that are available to management and
what they do?
There are a number of control models available to management to enable them to monitor the
achievement of their business plans such as:
management accounting;
budgeting (this will be looked at in detail later); critical success factors;
key performance indicators; balanced scorecards; benchmarking; management by
objectives; network diagrams;
closed-loop feedback system;
's' graph;
gantt charts.
A3A Management accounting

Management accounting is undoubtedly the most commonly used management control tool.
The practice of management accounting is based on the concept that resources should be
obtained and then used efficiently and effectively in the accomplishment of the organisation's
objectives.
The main systems and techniques that are currently available to the management accountant
include the items listed immediately below:
historical costing;
standard costing: budgetary control;
marginal costing:
cost/profit/volume relationships and ratios:
uniform costing:
interfirm comparisons: and

capital investment appraisal.
A3B Critical success factors

In defining its objectives, an organisation may have identified certain factors that are critical to
realising its mission either by exploiting opportunities or by fending off the dangers posed by
external threats and internal weaknesses. These factors are known as critical success factors
(CSFs) and are usually derived from a 'SWOT' analysis (strengths, weaknesses, opportunities
and threats).
CSFs are most commonly associated with strategic plans based on surviving competition from
rival organisations. The alleviation of an organisation's weaknesses and threats in the face of
competition can be identified as a CSF. For example, an organisation may decide that it will 4
only survive If its weak distribution systems are improved. The improvement of these systems
becomes a CSF, and can then be linked to business processes or action points aimed at
carrying it through.
Example:
An insurance organisation may have identified the following three factors that will affect its
ability to survive:
We need to have an internet presence.
We need to have a marketing expert.
We need to have a stable lease on our office premises.
Each of these factors can then be linked to key action points, thereby ensuring that the
critical success factors are achieved. For example:
Critical success factor Business process/action point

We need to have an internet presence Devise a technical specification
Appoint an internet manager
Prepare an internet finance plan etc.
A3C Key performance indicators

Key performance indicators (KPIs) are expressions that mirror the measurable objectives
mentioned earlier.
Key performance indicators are those quantifiable points in the development of a company's
strategy that show whether or not the company is reaching its targets and objectives. The
managers can determine these indicators at the planning stage.
Be aware:
When developing a set of measures it will be necessary to ensure they are:
meaningful;
well understood;
fairly simple to prepare and collate; relevant to the business;
balanced;
supportive of the overall strategy.

KPls can be results oriented or effort oriented. Examples of results-oriented performance

measures:
sales volumes and/or revenues;
rates of return in investment;
market share;
asset growth.
Examples of effort-oriented performance measures: number of potential customers contacted;

number of complaints handled;
extent of relationships with customers; 5
effort applied to improve staff relations;
staff turnover and absence rates;
active pursuing of debtors.
Results-oriented measures usually represent the 'bottom line, whereas effort-oriented

measures indicate Ihe level of effectiveness being achieved.
The important factor to remember when working with KPls is that they are not just for
information. They are measures that show the performance being achieved so if any
unfavorable position is indicated, action must be taken.
A3D Balanced scorecards

Organisations need to be managed with a range of management tools and performance
indicators, and new approaches are emerging which support the measurement of business
objectives and goals on a wider basis. Kaplan and Norton, two Harvard Business School
academics, devised the balanced scorecard. This is an approach that measures an
organisation's performance by looking at its activities from four perspectives:
financial perspective;
internal perspective;
customer perspective;
learning and growth
Figure 3.1
financial perspective
To succeed financially, how
should we appear to our
shareholders
customer perspective internal perspective

To achieve our vision, Vision and strategy To satisfy our shareholders and
how should we appear to customers, what business
our customer process must we excel at?
learning and growth

To achieve our vision, how
will we sustain our ability to
change and improve

Briefly summarised, balanced scorecards identify the knowledge, skills and systems (learning
and growth) that employees will need to innovate and build the right strategic capabilities and
efficiencies (the internal processes) that deliver specific value to the marketplace (the
customers), which will eventually lead to higher shareholder value (the financials).
When balanced scorecards are mapped, they can show a company's subsidiary objectives,
building up from the bottom le\'el (learning and growth objectives) to the top (improving
shareholder value). Balanced scorecard strategy maps can be used as blueprints for the
achievement of the company's aims.
A3E Benchmarking 6
Benchmarking is a process that allows a company to compare its own progress with that of a
comprehensive standard. For example, a company's growth Gill be measured against the
growth of the UK economy as a whole, or a company's staff turnover can be compared with the
UK national average or with a company in the same industry and of a similar size.
It usually means the establishment of performance measures that enable a company to analyze
its efficiency against competitors or leading companies in the industry. Three types of
benchmark are usually used:
Internal - these compare the performances of divisions and departments within the
same organisation.
External - these contrast the company's overall performance with competing firms. e.g.
profitability, rate of return on capital employed, growth, market share.
Functional - this covers an assessment of the company's main functions and processes
and compares them against the same functions and processes in other organisations
but not necessarily competitors.
To ensure that benchmarking is successful it is essential that:

comprehensive and accurate information is available on competing or comparison
industries;
benchmarks are based on industry best practice;
benchmarks used are flexible and can be altered if the external environment changes;
benchmarks relate to the company's corporate strategies and plans;
there are sound internal audit processes in place.
Activity
Find out If your organisation uses benchmarking, and If so, what benchmarking approach Is
used and how.
A3F Management by objectives

An important element in the achievement of a company's goals and objectives is the
contribution that managers and staff make. A key tool in this is what is known as management
by objectives.
Peter Drucker sees the management objective setting as a key process of planning and control
that provides co-ordination, i.e.:

co-ordination of short-term plans with longer-term plans and goals;

co-ordination of the plans (and commitment} of junior and senior management;
co-ordination of the efforts of different departments.
Therefore, the successful achievement of organisational goals requires a number of key
management factors, namely that:
each job is directed towards the same organisational goals. Each managerial job must
be focused on the success of the business as a whole, not just one part of it;
each manager's targeted performance must be derived from targets of achievement for
the organisation as a whole;
a manager's results must be measured in terms of their contribution to the business as
a whole; 7
each manager must know what their targets of performance are;
a manager's superior must know what to demand from the manager, and how to judge
their performance.
Another writer who became a leading advocate of this approach in the 1960s was John Humble
(in Improving Business Results and Man11gement by Objectives). Humble states that against a
background of long-term corporate plans, the operating and functional units of a company
(branches, regions, marketing department etc.) should clarify their own objectives:
Both team objectives and individual manager's objectives must be identified; therefore,
key tasks must be analyzed and performance standards agreed.
These key tasks should be fused together into individual plans, prepared by divisional
managers, and expressed in strategic terms rather than in short-term budgets.
The divisional plans should be reviewed centrally and amended by company or group
headquarters, in consultation with divisional managers. Any imbalance between
divisional objectives can be adjusted at this stage - i.e. is one division attempting to do
too much and another attempting too little? Are the divisional plans consistent with each
other? If resources are scarce and the demand by divisions for resources exceeds the
supply, how should a fair allocation be made between them?
Having agreed annual plans for each division, with key tasks identified and
performance indicators established for each team and individual manager within the
division, managers can identify:
- policies: by setting down guidelines for making decisions which are in keeping with
corporate objectives;
- financial budgets: monetary statements of plans to achieve certain objectives.
Financial budgets are not the objectives themselves;
- procedures: for reviewing and monitoring the implementation of policies and
performance against budgets.
Humble also said that each of the three devices (policies. procedures and financial
budgets) is necessary for sound management control.
Each division should prepare monthly operating reports, measuring actual results
against key performance indicators. There should also be similar quarterly and annual
reviews, after which new divisional plans should be prepared.
Essential features of a management by objectives process

Therefore, to ensure that such a process is effective it needs to have a number of essential
features, namely:
clarification with each manager of the key results and performance standards to be
achieved. These should conform to corporate and divisional objectives, but each

manager should contribute to the process of agreeing their key results and performance
standards, so as to win their commitment to them;
agreement with each manager, a job improvement plan, which will make a quantifiable
and measurable contribution to achievement of the plans for the department, branch or
organisation as a whole;
provision of conditions which will help managers to achieve their key results and job
improvement plans. For example:
- there must be an efficient and effective management information system to provide
feedback of results,
- there must be an organisation structure which provides managers with sufficient
flexibility and freedom of action,
- there should be a sense of team spirit and corporate purpose' within the
8
organisation;
a schematic performance review of each manager's results;
regular potential reviews for each manager so as to identify the individuals with
potential for advancement within the company;
development of management training plans to improve management skills;
motivation of managers b)' effective salary, selection and career development plans.
Linking the objectives to the corporate plan

Consequently, it is essential that management control procedures should be properly integrated
with corporate objectives. This control cannot be done mechanistically but depends on the
contribution of a flexible and skilled management team. Managers who get results should be
encouraged, and these people are not necessarily the ones who stand out for their
personalities. The only way to get the best out of managers is to identify and develop their
potential (through training) and win their co-operation and commitment (through participation in
planning decisions, salaries and career prospects).
A typical sequence of events for the introduction of a scheme management by objectives is as
follows:
The direction must come from the chief executive. A corporate plan and corporate
strategies must be identified, and the involvement of the chief executive is essential.
The objective of the sub-units of the organisation (branches, departments, sections
etc.) must be clarified.
An analysis must be prepared of the 'key results expected from each manager. These
key results are agreed in consultation between the managers themselves and the
manager's superior.
Top management assesses the unit objectives and the key results for each manager.
Since resources will no doubt be scarce, priorities for improvements will need to be
decided.
Top management expresses these priorities formally in a unit improvement plan. From
this, job improvement plans for individual managers are agreed.
Each manager must be given sufficient authority and opportunity to achieve the job
improvement plan. A timescale for achievement must be decided.
There must be a systematic performance review of each manager's results, together
with a performance review for the unit as a whole.
There must be a continuing management development programme (i.e. potential
reviews, training, career development, selection etc.).
There must be a continuing or cyclical revision of the unit and job improvement plans.
Annual budgets provide one method of continuity, although at a lower level of
management a shorter cycle might be more appropriate.

In many organisations today, the management by objective approach is the basis of their
performance management programmes.
Activity
Research the other control models listed In section A3, namely:
network diagrams;
closed-loop feedback system;
's'graph;
gantt charts; 9
and gain an appreciation of how they can be used.
Activity
Find out and identify the control methods used in your organisation and evaluate how
effective you think they are?
B Budgetary planning and control

Detailed plans covering all aspects of the organisation's activities are typically broken down on
a monthly basis for a total period of one year. Initially, the plans may be in quantitative terms-for
example, in a manufacturing enterprise, the number of workers to be employed, which products
to be made and in what numbers and the quantity of raw materials to be ordered. They also
need to anticipate costs and the amount of income derived from the products. These all have to
be translated into monetary amounts. Service industries have to follow a similar decision-
making process.
To do this, they use a tool called budgeting. Budgets for individuals or departments will show
allocated funds or resources and their financial objectives, expressed in terms of income and
expenditure.
We can define a budget as:
a financial or quantitative statement prepared in advance of a specified accounting period. It typically

covers a short period of months (up to a year).
It is important that the budgeting function should be carried out while taking account of the
company's strategic and other objectives within its corporate plan. If there is a five-year plan,
the budget for the forthcoming twelve months will need to reflect where the company expects to
be in financial terms at the end of that twelve-month period as part of its overall objectives.
In practical terms, a budget is most commonly a breakdown in written, tabular form of all of the
anticipated income and expenditure, usually month by month and category by category, which
will be earned and incurred when running a business over the period covered by the budget.

B1 Budgeting and control

As we have observed above, managers also need to be able to control the activities of the
organisation to enable it to meet its strategic objectives. To this extent, the budget is not only a
plan, but also a target and a tool that the managers use to exercise organisational control. The
budget must not, therefore, be seen as a one-off exercise at the beginning of the financial
period; it is a mechanism for monitoring the progress of the organisation in financial terms over
a period of time and it also, therefore, becomes a means by which performance will be
assessed at some point in the future.
Sometimes of course, events occur which are unexpected and are out of the managers' control.
Consequently, the financial outcome may turn out to be very different from that predicted in the
10
budget. Another important aspect of control therefore relates to the responsiveness of the
manager: the steps, which they take to monitor and address a situation. In the same way, a car
driver 'controls' the vehicle by slowing down at a bend in the road.
An important aspect of budgets is that they highlight any variances between the predicted and
the actual, so enabling managers to control or react in the light of the new circumstances.
Where, for example, costs have unexpectedly increased for reasons out of the organisation's
control (such as when the price of raw materials or fuel such as oil are suddenly inflated), the
manager needs to respond in some way. This may include raising prices or implementing cost-
cutting measures, to get back to as near the intended position as possible. On a personal level,
if we are faced with an unexpected bill, we may have to change our plans by deferring an
intended purchase.
Departments or individuals will usually be expected to pro\'ide reasons for any significant
variances and this activity is known as variance analysis (there is more on this in section 86).
What is a significant variance will be determined by senior managers or directors. Reports to
directors or managers may need to be explicit and comment upon each income and
expenditure section or alternatively they may only need to report by exception, giving
explanation only where differences are significant. Usually revised estimates of what will be
incurred by the budget year-end if current spending continues, i.e. taking account of the current
actual figures will also be required from budget-holders.
The information that the budgetary process provides will also enable managers to formulate
decisions relating to the allocation and use of resources. In the light of experience, it may be
apparent that some elements of the enterprise are more or less efficient or profitable than
originally planned, and merit more or fewer resources as a result. (There will probably be other,
additional measures of efficiency, some of which have been covered earlier in this chapter.)
A budget, therefore, provides a formalized, predictive step in the management process that is
inextricably linked to future planning and control of the organisation. Figure 3.2 shows the
integrated process of business planning and control in the form of monitoring and response,
which flows from the use of budgetary techniques. As you will note, this is in the form of a cycle,
that is, an ongoing and repetitive exercise. Initial aims and objectives, assumptions and
predictions are formalized into detailed plans and budgets (the anticipated results). In turn, as
the financial period develops, and throughout the period, actual performance is compared with
the plan and corrective action taken as necessary to attain the target.

Figure 3.2
Aim and objectives
Assumption
Prediction
Detailed plans and budgets 11
Corrective action Actual performance
Comparasion with plan
Budgets are used in service and manufacturing businesses as well as not-for-profit

organisations. You may have noticed the media frequently write articles about large
Government departments' budgets.
Similarly, we as individuals or groups may try to anticipate our weekly or monthly Income and
expenditure so that hopefully we have enough money to pay our bills and any social pursuits
while saving for holidays.
B2 Forecasting
As we have noted above, budgeting is usually for a relatively short period of time. Managers
are, of course, also interested in longer time perspectives so that they can make provisional
plans. This involves the activity known as forecasting.
Forecasting is the term used to describe medium-term predictions of an organisation's income
and expenditure. While budgets normally cover twelve-month periods, forecasts tend to cover
periods of up to three years. Forecasting is important because many organisations carry out
work which requires them to plan further ahead than twelve months.
For example, a retailer selling its own-label fashions may need to order finished clothing from
overseas factories more than a year in advance. Those factories will need to order enough raw
materials, organise dyeing of the unfinished textiles, plan for shipping of raw materials to the
factory, allocate factory time to the production of the goods and arrange for the labelled and
packaged goods to be shipped to the retailer.
During this long process, the business environment may change. Forecasts of changes in
currency values, workers' wage rates, retail prices at home, customs duties and tax rates, and
raw material prices will help the retailer to plan its medium-term activities.

As forecasting involves predictions, the results obtained cannot be fully guaranteed. The longer
forecasting horizon used, the less certainty there will be over the results obtained, so, if
managers want to rely on the figures from this activity as new information is obtained, they will
need to keep undertaking a re-forecasting exercise on a regular basis.
B3 Advantages of budgeting
Apart from showing the expected outflows and inflows of money for a business, the process of
budgeting will often bring a number of incidental advantages.
B3A Unification of effort

12
Budgeting unifies all employees' activities within an organisation. For example, the budget will
highlight whether the quantities of products which the sales department thinks it can sell can be
produced by the production department in the required period.
B3B Planning
Budgeting encourages planning. Without predicting where the organisation is heading,
managers cannot tell what resources they will need to get there.
B3C Motivation
Budgeting promotes motivation because each person in the organisation has a target to
achieve or exceed. This provides personal motivation throughout the budget period. Research
has shown that worker productivity and performance are likely to be lower without this kind of
incentive, and the organisation may lose its competitive edge. It also helps to harness the
efforts and motivations of individual employees who are working in a team, so that all of them
are focused on reaching the same goal at the same pace.
B3D Control
Budgeting provides a benchmark for measuring the actual performance of each department
against its predicted performance. Unless managers have a budget, they will not have a
standard against which they can measure how the business is actually performing month-by-
month and year-by-year.
B3E Financial awareness

Budgeting also makes everyone in the organisation aware that, at the end of the day, costs do
matter, and that individual and group performance is likely to be reflected in the financial
outcome. This awareness should prompt a desire for efficiency, such as questioning the value
of unnecessary work the reduction in the amount of waste and trying to get the best price for
components or products.
B3F Basis of comparison

Budgeting introduces a common basis and discipline for predictions and the measure of results,
which will apply throughout the organisation. This avoids a situation where departments have
their own measures of activity, which may not be compatible with those in other areas.
Consequently, budgeting gives the management an overall and consistent view of the
organisation as a whole.

B4 The budgeting process

A budget is expressed in monetary terms and shows the income and expenditure expected
during a financial period if a given corporate objective is to be achieved.
B4A Step-by-step approach

The budgeting process generally follows a series of logical and straightforward steps.
In essence, budgets are drawn up for individual departments and functions (e.g. the sales
budget and the production budget), as well as for capital expenditure, stock and cash flow. All
13
the budgets are inter-related and incorporated into the master budget, which includes a
budgeted profit and loss account and balance sheet for the organisation as a whole.
B4B Guidelines from the chief executive

At the beginning of the process, the chief executive Issues general guidelines for the master
budget to the principal heads of departments.
In larger organisations, a budget committee may be formed, made up of the functional or
departmental managers and chaired by the chief executive. The management accountant
usually assists in the preparation of the budget data provided by each manager.
The chief executive's guidelines may include a commentary on the organisation's performance
in the financial year which is just finishing, an explanation of any differences between actual
performance and budgeted performance for that year, and their view on expected changes in
the business environment in the coming year.
The chief executive usually covers plans for growth-especially for the proposed launch of any
new products in the coming twelve-month budget period-and may provide guidelines on an
acceptable range of target criteria for the coming period.
B4C Consultation and preparation

The process of preparing budgets for each of the functions and other activities in an
organisation can take a number of months and a variety of forms. These forms are covered in
greater detail in section 85.
Most budgeting methods require consultation between a manager and their subordinates or
superiors in order to gather information that is relevant to the prediction of future income and
expenditure amounts. After receiving the chief executive's guidelines, each department head
discusses them with the relevant members of their team. Each department then strives to put
together its own budget, ensuring that this matches the objectives of the master budget.
B4D Review by budget committee

Once complete, departmental budgets are submitted to the budget committee, or if one does
not exist, to the board of directors. The departmental budgets are reviewed by the committee or
the board to ensure that they:
conform to the policies of the master budget;

show how departmental objectives are going to be achieved; recognise any constraints
under which the department is working; are realistic;
reflect the financial responsibilities of the department concerned.

If so, they are incorporated into the master budget.
B4E Communication
Once the master budget and the departmental budgets have been decided and agreed, they
are communicated to managers before the start of the appropriate financial period, so that they
know what the plans are for their own departments and can implement them.
B4F Monitoring
As indicated earlier, once the budget is agreed for all the different levels, departments or 'cost
centers (where money is spent), the process involves continuous monitoring on a weekly or 14
monthly basis, to identify variances from the budget so that corrective action can be taken early
if necessary.
Reinforce
Before moving on, note down below the steps in the budgeting process and establish if this is
the approach used in your organisation.
B5 Methods and types of budgeting

There are various ways in which organisations can prepare budgets.
B5A 'Top-down' budgeting

Some organisations adopt a 'top-down' approach to budget setting. The owners or directors
decide on the individual plans for each department and function and these plans are given to
the individual managers to implement. (The example described above relating to the budgeting
process would reflect a predominantly 'top-down' approach.)
B5B 'Bottom-up' budgeting

Other organisations use a 'bottom-up' approach to budget setting. Individual department
managers construct their own budgets. These are then passed up to the managers and
directors, who incorporate the individual budgets into the organisation's master budget.
Both top-down and bottom-up methods can be fixed or flexible.
A fixed budget is not changed once it has been established, regardless of any alterations in the
organisations performance in reality. Projected figures are compared against actual figures at
the end of the budget period. This is an unrealistic way of budgeting as in reality, due to a
variety of factors both internal and external, companies in general do not perform over a period
as planned.
A flexible budget is changed in accordance with the organisation's real activity levels over time.
For example, if wage costs increase unexpectedly half-way through the budget period, the
budgeted figures for wage costs will be altered on the budget document, to show the true
picture. Wage cost figures for the coming months will also be changed accordingly. This
approach is based on the assumption that there is adequate knowledge of cost behaviour
patterns, e.g. which costs are fixed such as rent and so do not change with the level of activity
(and so do not need flexing/changing in the budget) and which costs are variable or semi-
variable and will change with the level of activity so will require flexing.

B5C Zero-based budgeting

The zero-based budgeting (ZBB) method relies on managers to justify their expenditure from a
fresh standpoint. Rather than looking at the amount of expenditure, which was budgeted for an
item in the previous budget period, ZBB requires managers to start from zero - that is, from a
position of having nothing in their budget for the item in question. Any amount that the manager
subsequently decides they need for that item must be justified and this justification will have to
go through a formal challenge process. This type of budget setting process involves senior
managers rather than the department's budget holders in making decisions about ZBB issues.
ZBB is the method of budgeting usually employed for costing individual and self-contained
areas of work such as research, machine maintenance and legal services. 15
In an organisation with a limited amount to spend on activities, ZBB has many advantages
when it comes to deciding on more marginal areas. Each ZBB activity can be ranked by senior
management according to its importance and its cost. For example, an organisation which has
to decide whether to enhance a machine or recruit a specialist member of staff as it cannot
afford to do both can use ZBB to help it compare the cost of one activity against the other.
B5D Rolling budgets

Rolling budgets are budgets that constantly look forward. With a conventional twelve-month
budget, monthly figures might be produced prior to a future budget period, which ran from
January to December.
With a twelve-month rolling budget, as you come to the end of each month a new month is
added at the far end of the whole twelve-month period. So, when they come to the end of April
in Year l, the managers would add April in Year 2 to the end of the twelve-month rolling period.
In this way, managers are always looking twelve months ahead, and make alterations to the
future budget on a regular basis.
B6 Variance analysis
A variance is the difference between actual and budgeted performance, and must be expected
unless the budget equates exactly to what has been budgeted, which is in reality unlikely due to
factors both internal and external to the business. For example, for an insurer the cost of paper
may go up which will mean that they have to pay more for marketing literature than planned.
There are two kinds of variance, the 'unfavourable variance' (budgets not met), and the
'favourable variance' (budgets exceeded). Alternative terms such as 'negative variance' and
'positive variance' may be used.
Where the variance is unfavourable, the reason for this may, if it is significant or continues to be
unfavourable for a period of time, need to be investigated so that preventative action can be
implemented to bring the spend back on budget or so that the effect can be minimised.
Likewise, a favourable variance may require investigation so that contributing factors can be
nurtured and the effect incorporated into future plans.
Example
An example might be the budgets of three Insurance salespeople, of whom one performs In
line with their budget, one under-performs and one over-performs. The under-performer can
be identified and action can be taken to prevent a recurrence, for example by giving further
sales training. The techniques of the over-performer can be shared with the sales force as a
whole.

It is important to note that favourable and unfavourable variances may be interlinked. For
example, if an insurance company decides, due to regulatory requirements, to change its sales
process and sell its insurance product non-advised rather than on an advised basis, this may
mean that staff time in selling policies i reduced compared to budget, i.e. there is a favourable
variance. However, due to staff not now giving advice, the number of policies is declining
compared to plan (budget), i.e. there is an adverse variance.
Be aware
It is important that In investigating variances managers review both adverse and favourable
variances to understand the inter-relationship between them.
16
Causes of variances
In order to stimulate improved performance managers need to understand the potential causes
of variances. In general, variances have four causes:
Inappropriate standard. If a standard is set at a level that does not reflect current
conditions then variances will be recorded even if the organisation is operating at the
required level of efficiency. For example, if price standards have not been updated for
innovation and expenditure variance is calculated against out-of-date price standards,
this will result in an adverse variance even when the organisation is purchasing
efficiently.
Inaccurate recording of actual costs and revenue. For example, if workers complete
timesheets inaccurately some departments will be overcharged with labour hours and
others undercharged. Tit is will lead to adverse and favourable labour efficiency
variances even though the departments are operating at the standard level of
efficiency.
Random events, which by their very nature are unlikely to occur again. For example, a
freak accident may damage the stock of insurance policy booklets, which would cause
adverse 'material' usage variances.
Operating efficiency. If the other three causes can be eliminated then the variance
must be due to this. Improving operating efficiency is the key to stimulating improved
performance. The variances caused by operating efficiency are potentially controllable
and management action can lead to improved organisational performance. Examples
may be using less skilled labour to create a favourable labour rate variance or where
some variable overheads have been misclassi6ed as fixed overhead, this would create
an adverse fixed overhead expenditure variance.
The effect-of inappropriate standards can be eliminated by the recalculation of variance based
upon revised standards. This Involves using hindsight to update standards for known,
uncontrollable changes in circumstances.
Investigating variance takes time. The concept of management by exception' will save the
allocation of unnecessary management time to investigation of variances. For example, an
acceptable variance can be set at, say, plus or minus 3% on sales volume. This respects the
fact that variances will occur naturally, no matter how capable the sales force is. The concept
ensures that management time is only allocated to investigation where really necessary; that is,
where some measurable and sustainable improvement could result.

Reinforce
Before moving on, remind yourself of the causes of variances. Make some notes below.
17
C Decision making
In the same way that an individual is regularly confronted with decisions that will alter the
course of their life, business managers are constantly forced to make important choices that
influence how their organisations develop.
Making the right decisions is a key management skill. However, there are times when making
any decision at all - whether it turns out to be the right or wrong one with hindsight - can be
essential to the future operation of the business. In business, the person who hesitates is lost.
There is a wide variety of methods which managers can use to help them make decisions but
each of them is a variation on a series of straightforward steps.
C1 Understanding why a decision must be taken

The best decisions are informed decisions. Understanding why a decision must be taken
includes knowing why the current situation cannot be allowed to continue, and collecting as
much information as necessary about what lies behind the original need to make a decision.
C2 Prior consideration and discussion of the options

This involves analysing and discussing the options available for changing the status quo, and
considering the impact of each potential decision. Contingency plans should also be formulated
at this point.
It may be necessary to obtain additional information In order to make an informed decision, and
some additional information (e.g. market research statistics) may be available at an additional
cost, while other information may be free and publicly available.
C3 Taking the most appropriate decision

The appropriate decision may not always be the obvious one. Decision makers must weigh up
the advantages and disadvantages of what they are about to decide, especially where the
decision's impact will affect many different people or areas. However, once the decision is
taken, it must be fully supported to be effective.

C4 Review
Once a decision has been taken, it may be appropriate to re,iew it to see whether anything can
be learned from the outcome it produced. Analysis of the effect of past decisions is instructive
when considering how to make a decision about the future.
C5 Five 'C's of decision-making

An alternative approach to the process of decision-making suggested by The Industrial Society
is the five 'C's of decision-making steps: consider, consult, crunch, communicate, and check. 18
The Industrial Society approach has much to commend it because it concentrates on the action
a manager must take and the involvement of staff in the decision process:
Consider- the preparation stage at which the problem is considered.
Consult- the stage at which initiatives are taken to involve those affected.
Crunch - the need to ensure that something is done.
Communicate - the stage at which what has been decided and why, is explained 19
staff.
Check - the need to go back and monitor the results of the decision.
Hierarchy of decision-making.
Firms are organised in different ways for decision taking. Often, within larger organisations
decision-taking levels will be explicit, linking authority levels to a monetary sum or range of
stated areas. For example, a head of department may be limited to giving verbal warnings only
to staff who act outside the terms of their employment contract, any further action being taken
by the central personnel function.
There may be areas that are not so clear cut. In smaller organisations the style of management
adopted by the chief executive will be important.
Within partnerships there may be formal agreement about decision taking.
Be aware
By law the action of any partner acting under apparent authority will be binding upon the
other partners.
D Management information
Information is essential to the successful management and control of an organisation because
(rational decisions are difficult to take without it. Organisations need to decide not only what
information is essential, how it will be gathered and to whom such information should be made
available, but also when and how that information should be given out.
D1 Essential management information

The term 'information' covers a broad spectrum of details and data that are available to provide
managers with a factual platform from which to take decisions. Some information is essential

for example the organisation's financial position, monthly sales revenue and the value of
reported insurance claims. Other information is interesting, but not essential to the
running of the business such as reports about markets that do not directly affect the
business.
In pinpointing the type of information that is essential for decision-making and the ease with
which that information can be used to support decisions, managers need to consider four main
areas.
D1A Information that a manager needs

Which information is used and in which of the company's business activities? For what kinds of
decision is information needed to help achieve corporate objectives? The following are 19
examples:
What resources are available?
What level of productivity is being achieved?
Are objectives being met?
Financial data to decide on recruitment.
Sales data to decide on marketing strategy.
Information about the property market to decide on whether to move office.
Information about foreign competition law to decide on overseas expansion.
D1B How the Information is structured

The manager needs to know how the information is structured now, and how it should be
structured in the future. For example:
Does the information come in the form of a ready-made system-derived report, a verbal
report from a department or trusted member of staff or a report from an external
consultancy or national statistical body?
Does it come in writing, in graphic form or in some other format?
How easy is it for managers to interpret the data as presented?
D1C Collection and collation of Information

The following questions need to be considered:
How often does the information arrive?
Does it come by fax, email or phone?
Is it in a consistent format?
Is it collected automatically from a reliable source or is it collected and collated
manually?
D1D Presentation of Information

The manager should consider the best ways of presenting the information to make it easily
understandable. For example the following questions should be asked:
Should it be interpreted and simplified, or left as raw data?
Should it be entirely in graphic form?
Should it form the subject of a meeting?
Should it be sent out to all interested parties in written form?

There are no standard answers to these questions, and information requirements vary from
organisation to organisation. Increasingly, management information is provided quickly and in
an accessible format by computers. Many accounting, marketing, sales and operations software
packages will allow managers to devise sophisticated, tailor-made reports that draw on an
organisation's internally generated data.
D2 Levels of information
Information within an organisation can be analysed into three levels:
Strategic information is used by senior managers to plan the objectives of their
organisation and to assess whether the objectives are being met in practice. Such 20
information includes: overall profitability, the profitability of different segments of the
business, future market prospects, the availability and cost of raising new funds, total cash
needs, total manning levels and capital needs. Much of this information must come from
external sources, although internally generated information will always be used. Strategic
information will be used for the management decision-making described as strategic
planning.
Tactical information is used by middle management to ensure that resources of the
business are employed (and the efficiency and effectiveness of their use monitored) to
achieve the strategic objectives of the organisation. Such information includes productivity
control or variance analysis reports and cash flow forecasts, manning levels and profit
results within a particular department of the organisation. A large proportion of this
information will be generated from within the organisation (i.e. as feedback) and is likely to
have an accounting emphasis. Tactical information is usually prepared regularly - perhaps
weekly, or monthly (whereas strategic information is communicated irregularly) and it is
used for the decision making referred to as management control.
Operational information is used by front-line managers such as supervisors to ensure that
specific tasks are planned and carried out properly.
Reinforce
Make sure you understand the specific uses of the three levels of Information by making some
notes below.
D3 Basic features of a management information system (MIS)

The provision of information occurs by means of a management information system. It is
useful to summarise the basic features of a management information system as follows:
Information flows horizontally and vertically. It is with the vertical flow (between superiors
and subordinate) that management information systems are most concerned.
Reports generated by an information system will range between:
o information for low-level management about the small area of the organisation
under their control;
o reports of a broader nature for top-level management concerned with overall
control.
The centre core of an MIS is likely to be tactical information for management control
although the MIS will have many sub-systems and sub-sub-systems providing information
ranging from operational through tactical to strategic.
The control cycle (i.e. the comparison of actual results against a plan and the production of

exceptional reports to show where control action may be needed) cannot he effective
unless the plan is carefully prepared.
A precise and carefully drawn-up specification at the areas of management responsibility is
essential. This specification is necessary to ensure that information will flow to the
managers who need it.
The information produced must be able to measure actual results against the plan in such a
way that control decisions can be taken at all levels of management. Data must also be
available to enable senior management to plan for the future and computers are of special
value in preparing forecasts from large quantities of data.
Today, within the insurance industry, the topic of management information systems is
21
inexorably linked to information technology.
D4 Accessing information
In some cases, information may be withheld by an organisation to avoid any possibility that its
competitors will discover confidential or sensitive details about it (there is more on confidential
and sensitive information in chapter 4, section H). On the other hand, information about the
company that is given out too early can lead to insecurity and confusion among recipients.
In all cases, the benefits of withholding information should be evaluated and compared with the
difficulties caused by not making the information freely available.
D5 Dissemination of information
The dissemination of information often constitutes the most difficult part of the whole process of
management and many organisations have difficulty with it. There is no simple formula that will
guarantee the effective dissemination of information. The releasing of the right information
depends entirely on each individual case. The following pointers will help managers to decide
what information should be given out:
The quality, quantity and clarity of information are often considered to be better by those
who give it out than by those who receive it. Managers need to communicate information as
clearly as possible.
Owing to different interests, backgrounds and levels of comprehension among recipients,
the content of information right down to the specific meaning of individual words will be
perceived differently at different levels within an organisation. Managers need to tailor their
communication of information to the recipients.
Communication of information about future strategy is brought about by more than words
alone. Managers should ensure that information relating to impending action genuinely
preempts the execution of that action.
Written information has the advantage of being easy and quick to distribute and is proof that
certain information has been given out. However, written information on its own is often
insufficient in that there is scope for misinterpretation and it may appear to be impersonal.
In many cases information is better given out at meetings since this indicates that managers
are willing to communicate with subordinates in person. Issues are then discussed openly in
the presence of all those involved. At meetings, people may be invited to ask questions and
misunderstandings can be promptly cleared up so that the information given out is clearly
understood.
Employees should always be given information about planned changes that will affect them
as early as possible.

Activity
Identify the management Information produced in your part of the organisation, how it is
disseminated and what it is used for?
E Knowledge management
Knowledge management is the compilation and redistribution of an organizations collective
skills and experience for the benefit of the organisation as a whole. Although the phrase was
22
coined in the 1980s, knowledge management is not a new business discipline. Owners of family
firms have passed their commercial wisdom on to their children, master craftsmen have taught
their trades to apprentices, and workers have exchanged ideas and know-how with their
successors on the job for hundreds of years.
As the foundation of industrialised economies has shifted from manufacturing and refining
natural resources to the provision of services and the creation of intellectual property,
executives have been compelled to examine the knowledge underlying their businesses and
how that knowledge is used. Advances in information technology (IT) have made it easier to
compile, codify, store and share certain kinds of knowledge more easily and cheaply than ever
before.
Since knowledge management as a deliberate management practice is so young, financial
services executives have lacked successful models that they could use as guides. Knowledge
lies at the heart of financial services organisations and it is surprising that many banks and
insurers were slow to adopt IT to capture and disseminate the knowledge they had
accumulated.
There are two main approaches to managing knowledge in financial services organisations. In
most, knowledge management centres on the computer. Knowledge is carefully codified and
stored in databases, where it can be accessed and used easily by appropriate employees. This
is known as the codification strategy.
In other, more specialised, financial services organisations, knowledge is closely tied to tile
person who developed it and is shared mainly through direct person.to-person contacts.
In these organisations, computers are used chiefly to help people to communicate knowledge to
others, rather than to store it. This is known as the personalisation strategy.
E1 Codification or personalisation?
A choice between one or other of the two strategies is intentional rather than accidental. It
depends on the way the organisation wants to serve its clients and on the economics of the
business.
Some large insurance organisations have pursued a codification strategy by developing
elaborate ways to codify, store and reuse knowledge and developed 'expert'/knowledge based
systems.
For example, historical underwriting statistics can be codified in documentary or electronic form.
Effective underwriting techniques are extracted rom the underwriter who has developed them,
made independent of that person by incorporation into a standard manual and then reused by
other underwriters. This approach allows many people to search for and retrieve codified
knowledge on their own, without having to contact the person who originally developed it. That

opens up the possibility of achieving scale in knowledge reuse and cutting down on wasted
time.
Other insurers have a personalisation strategy. They focus on the dialogue between individuals,
not knowledge objects in a database, for example, to make their personalisation strategies
work, underwriting syndicates build networks of employees who share knowledge not only face-
to- face but also over the telephone, by email and via video-conferences.
E2 Knowledge management and strategy

Knowledge management has an impact on two main areas of the organizations strategy as
follows: 23
Creating value for customers. The customer should benefit because the financial services
organisation can build a reliable, high-quality information system and solutions that are
proven to be successful.
Operational economies. These follow a codification strategy since they rely on the
economics of reuse. This is the idea that, once a manual or piece of software has been
developed and paid for, it can be used several times at very low cost, provided it does not
have to be substantially modified each time it is used. The knowledge can be employed in
many tasks by many employees because it is now contained in documentary or electronic
form. The reuse of knowledge saves work, reduces communication costs and allows a
company to take on more projects.
The important factors to bear in mind on the reusability of knowledge are as follows:
Standardized services such as handling insurance claims, providing tax return preparation
services or providing underwriting services are easier to fit into knowledge management
systems.
Codification strategy is more appropriate for mature services, while personalisation strategy
is better for innovative services.
It is easier to codify explicit knowledge such as historical claims data and underwriting
rating systems. Knowledge based on commercial judgment and personal experience is
most likely to be part of a personalisation strategy.
Activity
Find out how knowledge management is used and applied in your organisation and the value it
delivers.

Bab 4: Main Aspect of Corporate
Governance
Introduction
Corporate governance is commonly referred to as a system by which organisations are directed
and controlled. It is the process by which company objectives are established, achieved and
monitored. Corporate governance is concerned with the relationships and responsibilities
between the board, management, shareholders and other relevant stakeholders within a legal
and regulatory framework.
Transparency and accountability are the most important elements of good corporate
governance. This includes the timely provision by companies of good quality information and a
clear and credible company decision-making process.
The corporate governance framework in the UK operates at a number of levels:

through legislation particularly the Companies Act;
through regulation and in particular for listed companies through the Listing Rules, which
are the responsibility of the FSA (see section G7).
through the UK Corporate Governance Code (formerly the Combined Code) which is the
responsibility of the Financial Reporting Council (see chapter 8, section C1). It contains
general principles and more detailed provisions relating to the corporate governance of
listed companies and it is appended to the FSA's Listing Rules.
The focus of corporate governance is to establish effective and appropriate oversight of the
power that is given to the senior officers to run the affairs of the organisation. In recent times
this power has just always been used in the best interests of the shareholders, employees or
society in general. Examples of the abuse of power (e.g. Robert Maxwell) have illustrated this
and more recently there have been a number of high profile cases in the USA such as Enron
and WorldCom which have resulted in the collapse of a number of large corporations. The UK
insurance market has seen the collapse of Equitable Life (see section G6) and Independent
Insurance. In 2009 there was significant debate and new guidance on corporate governance
introduced following the banking crisis. Activity so included the publication of the Walker Review
(see section G2).
The problem with so much power concentrated into the central management of a company is
that it needs to be used with responsibility. This problem is made worse if poor quality or
inaccurate information is given to the organisation's stakeholders about its performance. So an
important check here is to have a number of board members who have independent status. As
we saw in chapter 2, these people are normally called non-executive directors (NEDs) and they
do not have any day-to-day management responsibility for the company's operation.
The appointment of these independent directors is seen as a means of ensuring that there is
appropriate challenge to the executive team. However, the danger of this system is that the
choice of who to appoint as non-executive directors remains with the company. It is for this
reason that the role of the non-executive director has been subject to several recent reviews
(see section G5).
Bab 4: Main Aspect of Corporate Governance
Corporate risk management

As mentioned in chapter 2, section A2, managing corporate risk is a key issue for directors and
senior managers. The directors have responsibility to:
determine the level of risk that is appropriate for the company to bear;
ensure that there is a sound system of internal control to safeguard shareholders'
investment and the company's assets;
ensure that regular risk assessments are made.
Clearly risk management is particularly important for an insurance company. In addition to the
normal corporate governance requirements the board of an insurance company has to ensure
that the company is compliant with the insurance regulations and has a particularly effective risk 2
management framework. These topics are discussed in chapter 11, sections A and B.
Directors also have a responsibility to ensure that the sensitive data that it owns is adequately
protected and that personal information that it holds (e.g. on customers and-staff is not divulged
to those people and organisations that are not entitled to receive it.
This chapter covers some of the fundamental aspects of business regulation and corporal
governance in the UK and the related directors' responsibilities.
A Regulatory structure
We will firstly look at the regulatory structure that facilitates the continuous monitoring of limited
companies and their corporate governance: a structure supervised by Companies House and
regulated by the Department for Business, Enterprise & Regulatory Reform. The main
legislation currently covering limited companies is the Companies Act 2006 (see also chapter 7,
section A1).
The Act includes regulations affecting:

company formation;
statutory reporting;
company meetings;
responsibilities of a company's directors and officers.
The steps which need to be taken to incorporate a limited company are set out in section B. As
we shall see, the directors of a company and its officers play key roles in this structure.
A1 Companies House
Companies House keeps the public records of companies registered in Great Britain. It lists its
three statutory functions as to:
incorporate and dissolve limited companies;
examine and store company information delivered under the Companies Act and related
legislation; and
make this information available to the public.
All company directors have a personal responsibility for making information about the capital
structure, management and activities of their companies available both to the members of the
company and to the public by filing the documents at Companies House.

Every registered company has the legal obligation to provide Companies House with an up-to-
date annual return and, in most cases, annual accounts including a directors' statement. These
statutory reporting requirements are covered in more detail in section C.
B Incorporation of businesses
B1 Company registration
To gain official recognition, a company must be registered with Companies House. Until the
company is registered, it has no legal existence. It therefore cannot enter into contracts or
undertake any business.
3
The majorities of companies are private companies and may be formed by one or more
individuals subscribing to the memorandum of association and complying with the registration
requirements of the Act.
If the company is to issue shares to the public it must register as a public company and comply
with certain additional rules such as having allotted share capital of at least 50,000.
B1A The registration documents
The registration documents set out:
the company's name;

whether the company is a private or public company;
whether the liability of the members of the company is to be limited, and if so whether it is to
be limited by shares or by guarantee;
whether Its registered office is situated in:
- England and Wales (i.e. it may be situated in either),
- Wales,
- Scotland; or Northern Ireland.
the company's registered office;
the statement of the proposed officers;
and the proposed articles of association.
If the company is to be limited by shares the document must also include a statement of capital
and the initial shareholdings.
B1B Articles of Association ('the Articles')
The Articles of Association are an important part of the company's constitution. Model articles
are set out for private and public companies and companies may choose to adopt these if these
choose.
The Articles of Association contain the main provisions governing the relationship between the
shareholders and the company, as well as moderating the balance of power between the
shareholders themselves.
The Articles comprise this regulations for the running of the company's internal affairs and they
specify how many members must be present if the proceedings at meetings art to be regarded

as valid. This is called a quorum, and it is usually necessary to have a quorum before a meeting
is valid.
Reinforce
Take a moment now to make sure that you understand what information must be given to the
registrar before a company can become incorporated before moving on. Without referring back
to the text, make some notes on what the requirements are.
C Statutory reporting requirements

In section A1, we noted the documents that companies are legally required to submit to 4
Companies House as part of statutory reporting requirements. They are now covered in more
detail in the following sections.
C1 Annual return
The annual return contains a range of information including the company's registered office
address, the principal business activities of the company, details about the company's directors,
company secretary (where applicable), shareholders and the company's share capital.
Every company must deliver an annual return to Companies House at least once in every
twelve months. The company has 28 days from the date to which the return is made to do this.
The return is a summary of the company's details at a particular date (the 'made up date'). The
latest date to which it may be made up is the anniversary of the previous return or, in the case
of a new company, the anniversary of its incorporation.
C2 Annual accounts or financial statements

The Companies Act requires that every company must keep accounting records which are
sufficient to show and explain the company's transactions, and as such to:
disclose with reasonable accuracy, at any time, the financial position of the company at that
time; and
enable the directors to ensure that any accounts required to be prepared comply with the
requirements of the Act.
The Act goes on to state that the accounting records should contain:
Entries from day to day of all sums of money received and expended to the company, and
the matters in respect of which the receipt and expenditure takes place and a record of the
assets and liabilities of the company.
The annual accounts are useful for investors and other stakeholders who want to know the
condition of the company in which they have invested their capital and to assess the
performance of its directors. Annual accounts may also help creditors to obtain reassurance
that their debts will be paid, or alert them to the possibility that they will not be paid. Chapter 7,
section C looks at the information requirements of users of financial information in more depth.
By law, a company's annual accounts must give a true and fair view of its economic state. To
aid this process, companies are required to comply with accounting standards. for instance, in
preparing their consolidated accounts, companies listed on the London Stock Exchange have to

follow International Financial Reporting Standards (IFRS). These standards and others currently
used are discussed in chapter 8.
These standards are aimed at establishing a uniform approach to methods of accounting, so

that a consistently true and fair view of every company's financial state can be presented.
For most companies the annual accounts will include:

an income statement (also called a profit and loss account);
a balance sheet signed by a director;
a directors' report signed by a director or the company secretary.
The entire set of required documents is sometimes grouped together and called the Annual 5
Report and Financial Statements. The income statement and balance sheet are both discussed
in chapter 7 (sections F and G). Some companies require an external auditor's report and this is
covered in section D of this chapter.
C2A Directors report
The directors' report is required by the Companies Act to include a business review, unless the
company is subject to the small companies' regime. This review should be a 'fair review of the
company's business and a description of the principal risks and uncertainties facing the
company'. The review is required to be a balanced and comprehensive analysis of the
performance of the company, using key financial reporting indicators, consistent with the size
and complexity of the company.
In the case of a quoted company the business review must include:
the main trends and factors likely to affect the future development, performance and
position of the company's business;
information about:
- environmental matters (including the impact of the company's business on the
environment),
- the company's employees, and
- social and community issues,
including information about any policies of the company in relation to those matters and the
effectiveness of those policies; and
- information about persons with whom the company has contractual or other
arrangements which are essential to the business of the company.
C2B Directors' remuneration report
The directors of a quoted company must prepare a directors' remuneration report which must
be approved by the board of directors and signed by a director or the secretary of the company.
A statement of the company's policy on directors' remuneration should be provided and this
must include a detailed summary of any performance conditions for share options and long-
term incentive schemes and why such performance conditions were chosen.
Details must be given of directors' service contracts, salaries, fees, bonuses, share options,
long- term incentive schemes, pensions, retirement benefits, compensation for past directors,
and sums paid to third parties for directors' services.

At the annual general meeting (see section El) a resolution must be put to the meeting
approving the directors' remuneration report for the financial year.
The Association of British Insurers (ABI) has been active in influencing quoted company
directors' remuneration since the 1970s when the organisation published its first guidelines on
the subject. The latest guidelines were published in September 2011 and are generally
regarded as best practice. In addition, during 2009, the Walker Report (see section G2) has
commented on executive remuneration as has the FSA.
Activity
Visit the following website for more detail on the guidelines:
http://www.ivis.co.uk/ExecutiveRemuneration.aspx
6
C2C Chairman's statement
Sometimes a chairman's statement is included in the annual report. This is normally a broad
statement about the company's activities attributed to the company's chairman. Such a report is
optional and is not required by the Companies Act.
The external auditors are not required to judge whether the content of either the directors' or
chairman's statements provides a 'true and fair view'. They would, however, be obliged to report
to the shareholders any inconsistency that arose between these statements and the rest of the
annual report.
C2D Submission of annual accounts
There are special rules for the format of annual accounts for small and medium-sized
companies, but all companies have to keep accounting records and all limited companies must
send their accounts to Companies House. Private companies must file their accounts within
nine months of the year end and public companies must file within six months. In addition
quoted companies must ensure that their report and accounts are available on a website.
Late delivery of accounts to Companies House is likely to result in penalties. Failing to deliver
accounts on time is also a criminal offence for which company directors and the company
secretary mar be prosecuted.
Activity
Take a look at the financial statements issued by companies such as:
Legal and General www.legalandqeneralqroup.com;
Standard Life www.standardlife.com;
Aviva www.aviva.com; and
Brit www.britinsurance.com.
C3 Company secretary's role

As stated in chapter 2, the Companies Act 2006 requires all public companies to have a
company secretary, although a private company need not have one.
The 2006 Act imposes a duty on the directors of companies to:

take all reasonable steps to secure that the secretary... or the company is a person
who appears to them to have the requisite knowledge and experience to discharge
the functions of secretary of the company.
The Act sets out a list of acceptable qualifications for the post of company secretary, including a
chartered secretary and a number of accountancy professional and legal qualifications.
However, these qualifications are not exclusive and the secretary may be a person who:
by virtue of his holding or having held any other position or his being a member of
any other body, appears to the directors to be capable of discharging the functions
of secretary of the company.
7
The company secretary's responsibilities are not specified by the Companies Act but are usually
contained in their contract of employment. It is common practice for the Secretary to ensure that
the documents that a company must send to Companies House are accurate and are sent on
time (see below). As the company secretary is an officer of the company they may be criminally
liable, for example, for omitting to file changes in the directors' and company secretary's details
in the company's annual return within the time allowed.
Because of the increasing complexity of requirements to disclose company affairs in this way,
the role has become considerably more important and complex. Depending on their contract of
employment, the company secretary's other duties may include some of those listed below.
C3A Maintaining the statutory registers
The statutory registers are:
register of members (i.e. the shareholders);

registers of directors and secretaries;
register of directors' interests;
register of charges;
register of interests in shares (for public companies).
C3B Notice of the annual general meeting
Giving notice involves providing company members and the company's auditors with 21 days'
written notice of an annual general meeting (see section E 1) and 14 days' notice of a meeting
other than an annual general meeting or of a meeting to pass a special resolution. Note that a
private company no longer needs to have an Annual General Meeting unless the shareholders
require .one to be held.
C3C Special and extraordinary resolutions
Ensure that Companies House is sent copies of every special or extraordinary resolution or
agreement of the company's directors.

C3D Ensuring that statutory forms are filed promptly
Companies House requires changes in company information to be notified to it, using its own
special forms and within a specified period. These changes in information include the
particulars {names and addresses) of directors and company secretaries.
C3E Accounts
Supply every member of the company with a copy of the annual accounts 21 days before a
meeting at which the accounts are to be laid.
8
C3F Minutes of directors' meetings and general meetings
Keep minutes of the directors' meetings and the general meetings.
C3F Making accounts and documents available for Inspection
Supplying copies of the company's accounts and other documents to the appropriate people
and ensure that members of the company and members of the public can inspect the
company's records. For example, where a poll is taken at a general meeting of a quoted
company, the company must ensure that the results of the poll be made available on its
website.
D The external and internal audit functions

In this section we shall examine the differing roles of the external auditor and the internal
auditor, and the relationship between the two.
D1 The external auditor's role

Most limited companies must appoint an external auditor (sometimes referred to as an
independent auditor), and the directors are responsible for appointing th m.
Be aware
Small companies and dormant companies are allowed by company legislation to pass a special
resolution themselves from the normal requirement to external auditors.
It is the directors' responsibility to prepare the annual report, the directors' remuneration report
and the financial statements in accordance with the relevant legislation and applicable
accounting standards. The external auditor's job is to report whether the financial statements of
a company have been properly' prepared under the appropriate accounting rules and whether
those accounts give a true and fair vie\\' of the state of the company's affairs.
More specifically, the external auditor must check whether:
the financial statements give a true and fair view and comply with the relevant legal and
regulatory requirements;
the information given in the directors' report is consistent with the accounts;

the specified parts for the directors' remuneration report comply with the legislation;
the company has kept proper accounting records.
For quoted companies the external auditor also reviews whether the corporate governance
statement reflects the company's compliance with the provisions of the UK Corporate
Governance Code (see section G 1) specified for their review by the Listing Rules of the FSA.
The auditor is not required to consider whether the board's statements on internal control cover
all risks and controls, or form an opinion on the effectiveness of the company's corporate
governance procedures or its risk and control procedures.
9
D2 Internal audit function
Those working within an internal audit department are usually employees of the organisation
being audited. The Chief Internal Auditor (CIA) would normally propose a plan of activities
to be reviewed each year for consideration by a Company's Audit Committee (see section G4)
and, as a safeguard, the CIA normally has a direct reporting line to the audit committee. The
Turnbull Report (sec section G3) emphasised the importance of internal audit, stating that its
main role is to evaluate risk and monitor the effectiveness of the systems of internal control.
The increasing demands placed on management for monitoring and controlling its activities in
the context of regulatory regimes has brought about a need for internal audit activities. The
scope of internal audit activity goes far beyond the requirements of financial audits, primarily
conducted to address the needs of legal/accounting requirements. Internal audit can contribute
to good corporate governance by advising management on how an effective and efficient
system of internal control can be maintained.
Internal audit can assist the directors with the implementation of good corporate governance by,
for example:
Maintaining a sound system of internal control by reviewing how a company identifies

and manages risk.
Reviewing board report; to ensure that they present a balanced and understandable
viewpoint.
Ensuring the directors are up t9 date with new accounting and auditing Issues, e.g.
international accounting standards.
Communicating with the external auditors and ensuring a unified approach to work.
Ensuring that the board receives the correct communications and information required
from the external auditors.
Many companies now appoint compliance officers, which is a function that is quite separate
from internal audit, to ensure all the necessary regulations, in particular the insurance company
regulations, are met.
D3 Similarities between internal and external audit

The internal and external auditors should work closely together and co-ordinate activities to
maximise effectiveness and ensure that the most efficient use is made of both functions. This
will include co-ordination of planning activities and the sharing of audit results. External audit,
where appropriate, can rely on the work of the internal audit team.

E Meetings and their functions

The Companies Act governs the number and type of meetings that limited companies must
hold.
E1 Annual general meeting

The Companies Act 2006 no longer requires private companies to hold an annual general
10
meeting (AGM). However all companies have to ensure that they communicate effectively with
their shareholders on a regular basis. Shareholders can have a great deal of power and
influence over how the company is run and may insist on the company holding an AGM. The
AGM tor a public company must be held within six months of the 'accounting reference date'
being the date the accounts are made up to (i.e. the balance sheet date).
The business dealt with at an AGM typically consists of:
the adoption of the annual accounts;

the appointment and remuneration of auditors for the future;
the directors' report, which include the directors' recommendation for the dividend to be paid
to shareholders - a resolution will be proposed that the amount recommended be paid by
way of dividend;
appointment of directors if some are retiring.
E2 Extraordinary general meeting

The directors may convene an extraordinary meeting of members if important special business
requires a meeting of members.
E3 Notice of meetings
If a private company holds an AGM it must give 14 days' notice and a public company must give
21 days' notice. For other meetings the requirement is to give 14 days' notice.
F Agenda, minutes and related documentation

F1 The agenda
The agenda for a meeting is a list showing the order in which items of business will be
discussed at that meeting and sometimes the time allocated for each topic. It is a methodical
way of ensuring that all the topics that need to be discussed are discussed. The items
themselves may appear regularly as topics for discussion at meetings, or they may be one-off
issues.
The agenda is not usually set in stone; it sometimes happens that the discussion of some
agenda items is postponed until a later meeting, either because of time constraints, or because
there is insufficient information available to make an informed decision.

F1A Order of agenda
There is no common set agenda for meetings since meetings are arranged for many different
reasons and to cover many different subjects. A normal agenda for a board meeting might
contain some of the following items:
apologies for absence;

noting that there is a quorum for the meeting and whether directors have any conflicts of
interest in the topics to be discussed;
approval of the minutes of the previous meeting and then signed by the chairperson;
11
matters arising from those minutes;
matters adjourned from previous meeting (if any);
routine matters for consideration (e.g. management accounts, reports of sub-committees
and working parties);
new matters for consideration;
any other business (AOB);
date of next meeting.
Be Aware
Only minor points should be allowed under the AOB item. Significant items should have been
previously notified and those that have not should therefore be held over until the next meeting.
Often the chairperson of the meeting will request topics for AOB after signing the minutes of the
previous meeting so that those present may give at least some thought to the Items In advance.
F1B Agenda-planning Issues
An effective agenda needs to address the following issues:
time constraints at the meeting and prioritization of points;

differentiating routine matters from special matters;
ensuring that agenda items are agreed by all parties in advance.
F1C Agenda preparation and supporting documents
Each item on the agenda is normally numbered. When an item is continued from a previous
meeting, it is helpful to quote the minute number and date of the meeting. Significant items
should be arranged in logical sequence so that discussion at the meeting progresses in an
orderly way. Agenda items with supporting documents need to be cross-referenced against the
relevant item of business. Wherever possible, supporting documents should be issued along
with the agenda a week or so before the meeting so that the meeting's time is not taken up
purely with dissemination of information. The agenda should also contain an item to fix the date,
time and place of the next meeting although regular meetings, such as board meetings, usually
have dates arranged for a rear at a time.

F2 Minutes
The Companies Act specifies a number of rules concerning minutes which include:
Every company must prepare minutes of all proceedings at board and general (i.e.
shareholder) meetings.
Minutes must be kept for at least ten years.
Company legislation recognises the importance of taking minutes. Of course, minutes are not
the sole preserve of directors' and shareholders' meetings. At any meeting where significant
decisions are made, it is important to record how the decision came about, what final decision
was reached and who is responsible for any action. 12
Minutes provide the background to a committee's business. Their permanence in written form
reduces the possibility of disagreement over exactly what was discussed and decided, when
and by whom. Normally taking minutes at board meetings is the responsibility of the company
secretary or a secretarial assistant, but in the absence of anyone either authorised or willing to
do so, the task may be allocated to anyone who attends the meeting.
F2A Producing minutes
Minute-writing is straightforward and follows certain conventions. Figure 4.1 sets out some
useful guidelines.
Figure 4.1: guidelines for writing minutes
Before the meeting

Familiarize yourself with the usual pattern of the minutes by looking at previous sets of
minutes. Check with the chairperson if there is a particular house style.
During the meeting

Do not try to chair the meeting and take notes.
Ensure your reference notes are clear and legible.
Record the date, time and place of the meeting.
Record the names of those present, those absent without apology, and those from whom
'apologies for absence' have been received.
Give each minute a consecutive reference number linked to the agenda item number and
use the agenda to guide you in categorising topics of discussion.
Make a note of each topic under a separate heading.
Summarise discussions concisely, bringing out:
the main points (don't go Into unnecessary detail); the decision taken;
the action required by when and by whom.
Keep up with the thinking of the meeting.
After the meeting

Draft the minutes as soon as possible, while events are still fresh in your mind.
Check your draft with another person who was present.
Ask anyone who was present about anything you did not understand at the meeting.
After they have been typed, proof-read the minutes carefully.
Send the minutes to all who were invited to the meeting, and keep a copy for the central
file or minutes.

File the minutes carefully.

Some minutes are required to be kept by law.
Grammatical style of minutes

Because minutes are a record of past discussions, and therefore consist mainly of reported
speech, all tenses move back one stage in time; e.g. 'has' becomes 'had, 'is' becomes 'was
and 'was' becomes 'has been.
Use the third person ('he, 'she' or 'it. never the first or second person: 'we' or 'you').
It is important to use plain English and to record faithfully what was decided at the meeting.
Where an individual agreed to take action, this should be noted. Indeed, unless there is a legal
or corporate requirement for formal minutes, a list of action points may be more useful than a 13
more detailed record of everything that was said. This should identify timescale and the person
responsible for taking the action.
F2B Related documentation
Some agenda items may refer to other papers or documents that contain background
information. Those attending the meeting will be expected to read the documents which support
the agenda items, since those papers will give them the foundation for making an informed
decision.
Additional documentation is normally cross-referenced to the appropriate agenda item by using

the same item number in the heading of the papers.
G Key governance reports and requirements

G1 The UK Corporate Governance Code
As mentioned in the introduction, the UK Corporate Governance Code (formerly the Combined
Code) is a key document setting the corporate governance standards for the UK. It sets out
standards of good practice in relation to issues such as board composition and development,
remuneration, accountability and audit and relations with shareholders.
The UK Corporate Governance Code contains broad principles and more specific provisions.
The Code is appended to the FSA's Listing Rules (see section G7) and requires listed
companies to report on how they have applied the main principles of the Code, and either to
confirm that they have complied with the Code's provisions or - where they have not - to provide
an explanation. The UK Corporate Governance Code was first issued in 1998 as the Combined
Code and has been updated at regular intervals since then. The latest edition was issued in
May 2010 (when it was renamed the UK Corporate Governance Code) which applies to
accounting period beginning on or after 29 June 2010.
The main principles are shown in the appendix to this chapter
G2 Walker Review
In February 2009 Sir David Walker was asked by the Prime Minister to review corporate
governance in UK banks in the light of the experience of critical loss and failure throughout the

banking system. The terms of reference were subsequently extended so that the review should
also identify where its recommendations are applicable to other financial institutions.
When the recommendations were published in November 2009 Sir David Walker said:
The fundamental change needed is to make the boardroom a more challenging

environment than It has often been in the past. This requires non-executives able
to devote sufficient time to the role in order to assess risk and ask tough questions
about strategy. Institutional investors should be less passive and prepared to
engage earlier if they suspect weaknesses in governance. They enjoy the privilege
of limited liability whereas taxpayers have ended up assuming unlimited liability in
respect of the big banks. Early preventive medicine through shareholder
engagement can save everyone substantial time and money later on. 14
On pay the Walker Review recommends extending the role of the remuneration committee to
cover firm-wide remuneration policy as well as giving the committee direct responsibility for the
pay of all highly-paid employees. At least half of variable pay or bonuses should be paid in the
form of a long-term incentive scheme with half vesting after three years and the rest after five
years. Two-thirds of cash bonuses should also be deferred.
Other specific recommendations in the report include:
active investors to sign up to a new independently-monitored Stewardship Code;

Financial Reporting Council to sponsor Stewardship Code;
FSA to monitor investor conformity with Code;
Chairman of board to face annual re-election;
Chairman of remuneration committee to face re-election if report gets less than 75%
approval;
Most non-executives to spend substantially more time on the job;
Induction process for all non-executives and regular training;
Non-executives to face tougher scrutiny under FSA authorisation process;
Banks should have board level risk committees chaired by non-executive;
- Risk committees to scrutinize and if necessary block big transactions.
- Chief Risk Officer to have reporting line to risk committee.
- Chief Risk Officer can only be sacked with agreement of board.
- Remuneration committees should disclose right of high-paid employees to receive
enhanced benefits.
Sir David said:
We need to get governance back to center stage, or course major regulatory

issues need to be addressed to assure the soundness or the financial system but
there will be significant downside if the regulatory pendulum swings too far. It could
harm the ability of banks to provide customers with the financial services they need
and lead to substantial increases in fees and charges. Improved governance can
play an important complementary role by instilling greater confidence in the way
banks are being run by their boards and overseen by their owners. This should
help regulators to strike the right balance.
The full text of the report is available from: http://webarchive.nationalarchivcs.gov.uk/+/http://

www.hm-treasury.gov.uk/walker_review_information.htm

G3 Turnbull Guidance
The Turnbull Guidance sets out best practice on internal control for UK listed companies, and
assists them in applying the section of the UK Corporate Governance Code that deals with
internal control.
The Turnbull Guidance was originally published in 1999. In July 2004 the Financial Reporting
Council (FRC) set up a group to review the Guidance and update it where necessary, in the
light of experience In implementing the Guidance and developments in the UK and
internationally.
15
Following the review the FRC published updated guidance in October 2005. It applies to listed
companies for financial years beginning on or after 1 January 2006. The Guidance states that
the board should consider the following factors:
the nature and extent of the risks facing the company;

the extent and categories of risk which it regards as acceptable for the company to bear;
the likelihood of the risks concerned materialising;
the company's ability to reduce the incidence and impact on the business of risks that do
materialise; and
the costs of operating particular controls relative to the benefit thereby obtained in
managing the related risks.
In reviewing the effectiveness of internal control the board should:
consider what are the significant risks and assess how they have been identified, evaluated
and managed;
assess the effectiveness of the related system of internal control in managing the
significant risks, having regard in particular to any significant failings or weaknesses in
internal control that have been reported;
consider whether necessary actions are being taken promptly to remedy any significant
failings or weaknesses; and
consider whether the findings indicate a need for more extensive monitoring of the system
of internal control.
In December 2010, the FRC announced that it was deferring its latest planned review of the
guidance because it wanted first to explore how companies were responding to the new
Principle in the UK Corporate Governance Code that boards were responsible for determining
the nature and extent of the significant risks they were willing to take in achieving their strategic
objectives. The FRC will be holding a series of meetings with companies, investors and
advisers during 2011 to discuss this issue before deciding how to proceed.
G4 FRC Guidance on Audit Committees

In 2003 the FRC published guidance on audit committees, which was called the Smith Report.
This guidance was last updated in December 2010 and it is now referred to as the FRC
Guidance on Audit Committees. The latest version came into force on 30 April 2011 and it is
intended to assist company boards when implementing the sections of the UK Corporate
Governance Code dealing with audit committees and to assist directors serving on audit
committees in carrying out their role.

The Guidance states that the board should establish an audit committee of at least three, or in
the case of smaller companies, two members. The main role and responsibilities of the audit
committee should include:
the monitoring of the integrity of the financial statements of the company and any formal
announcements relating to the company's financial performance, reviewing significant
financial reporting judgments contained in them;
reviewing the company's internal financial controls and, unless expressly addressed by a
separate board risk committee composed of independent directors or by the board itself, the
company's internal control arid risk management systems;
monitoring and reviewing the effectiveness of the company's internal audit function; 16
making recommendations to the board, for it to put to the shareholders for their approval in
general meeting, in relation to the appointment of the external auditor and to approve the
remuneration and terms of engagement of the external auditor;
reviewing and monitoring the external auditor's independence and objectivity and the
effectiveness of the audit process, taking into consideration relevant UK professional and
regulatory requirements;
developing and implementing policy on the engagement of the external auditor to supply
non-audit services, taking into account relevant ethical guidance regarding the provision of
non-audit services by the external audit firm;
and to report to the board, identifying any matters in respect of which it considers that action or
improvement is needed, and making recommendations as to the steps to be taken.
G5 Guidance on Board Effectiveness

In March 2010, the FRC published the 'Guidance on Board Effectiveness', which relates
primarily to sections A and B of the UK Corporate Governance Code on the leadership and
effectiveness of the Board. The guidance was developed by the Institute of Chartered
Secretaries and Administrators (ICSA) on the FRC's behalf and it deals with the following
topics:
The Role of the Board and Directors.

Board Support and the Role of the Company Secretary.
Decision Making.
Board Composition and Succession Planning.
Evaluating the Performance of the Board and Directors.
Audit, Risk and Remuneration.
Relations with Shareholders.
Be aware
While company boards are not required to follow this guidance. it is Intended to assist boards
when the relevant provisions of the UK Corporate Governance Code.
G6 Penrose Report
The Penrose Report (2004), into the collapse of Equitable Life, recommended that it is not
sufficient for a board of directors merely to accept information that is presented to them by the
company executives or other experts. It is their duty to:

obtain a proper understanding of the issues being considered;

question effectively (and if necessary challenge) the recommendations being put forward,
and where.' this relates to extremely complex and technical issues (such as in the Equitable
Life case) the board must dedicate sufficient time to acquire the necessary understanding of
the issues before making decisions.
While this report is not binding on companies in general, the essence of its recommendations
has been incorporated into the UK Corporate Governance Code.
Note: Sections G1-G6 are based upon material available from the FRC website and are
copyright FRC 2011.
17
G7 Financial Services Authority

As well as having responsibility for regulating the insurance industry the FSA also has
responsibility for setting the eligibility criteria for companies that would like to be listed on the
London Stock Exchange, the listing application procedures and the ongoing obligations of listed
companies. These regulations are set out in the Listing Rules and it is the Listing Rules that
requires listed companies to comply with the UK Corporate Governance Code.
The June 2008 edition of the Combined Code took effect at the same time as new FSA
Corporate Governance Rules implementing EU requirements relating to corporate governance
statements and audit committees. The rules make it clear where there is overlap and state that
companies complying in full with the Code will satisfy the requirements of the Disclosure and
Transparency rules.
G8 European Commission
The European Commission considers harmonisation of the rules relating to company law and
corporate governance, as well as to accounting and auditing, as essential for creating a single
market for financial services and products.
In the fields of company law and corporate governance, objectives include:

providing equivalent protection for shareholders and other parties concerned with
companies;
ensuring freedom of establishment for companies throughout the EU;
fostering efficiency and competitiveness of business;
promoting cross-border co-operation between companies in different Member States; and
stimulating discussions between Member States on the modernisation of company law and
corporate governance.
The EU has influenced corporate governance requirements In the UK and, as mentioned above
in section G7, the FSA adopted the latest requirements In June 2008.
In April2011, the Commission issued a Green Paper launching a public consultation on possible
ways to improve the corporate governance framework in Europe and responses were due in by
22 July 2011. Their view is that the lessons of the financial crisis will eventually lead to better
supervision of financial institutions and that there are a number of findings that indicate there
being room for improvement in different areas of corporate governance, such as diversity in

boards, shareholder engagement and the quality of corporate governance statements.
G9 Sarbanes-Oxley Act 2002 (USA)

Companies with a listing on a stock exchange in the USA, such as the New York Stock
Exchange, are required to comply with the requirements of the Sarbanes-Oxley Act 2002
(SOX). Hence this legislation is relevant for a number of UK listed companies.
The USA, due to its own governance issues, enacted the legislation, the purpose of which is to
protect investors by improving the accuracy and reliability of corporate disclosures. This is an
extensive piece of US legislation which is aimed at overcoming corporate scandals such as
Enron and World Com. The need for auditor independence, corporate responsibility and
18
enhanced financial disclosures feature heavily in this Act. While the punitive aspects of SOX are
aimed at senior executives it remains important that staff at all levels have an appreciation of
the importance of SOX compliance.
Two key provisions are ss.302 and 404. Section 302 mandates a set of internal procedures
designed to ensure accurate financial disclosure. The signing officers must certify that they are
'responsible for establishing and maintaining internal controls' and 'have designed such internal
controls to ensure that material information relating to the company and its consolidated
subsidiaries is made known to such officers by others within those entities, particularly during
the period in which the periodic reports are being prepared: The most contentious aspect of
SOX is s.404, which requires management and the external auditor to report on the adequacy
of the company's internal control over financial reporting. This is the most costly aspect of the
legislation for companies to implement, as documenting and testing important financial manual
and automated controls requires enormous effort.
G10 Accounting bodies

All accounting bodies including the Association of Chartered Certified Accountants (ACCA) and
the Institute of Chartered Accountants in England and Wales (ICAEW) are embracing the
principles of corporate governance and are very active in promoting and commenting on
corporate governance issues.
H Confidentiality
Following the announcement by the Information Commissioner's Office (ICO) of its first fines for
breaches of the Data Protection Act, KPMG's 2010 Data Loss Barometer (DLB (for more
information, see http://www.datalossbarometer.com), which considers lost and stolen
information worldwide has found that a fifth of reported data loss incidents in the first half of.
2010 came from malicious attacks made from inside the organisation.
The growth of the threat from within has been rapid rising from only 4 percent of all incidents in
2007, to 20 percent in 2010. Since 2007, 23 million people globally have been affected by data
breaches involving the threat of a malicious insider, according to the DLB.
In April and May 2011, Sony announced that personal information from more than 100 million
customers had been stolen. This included almost 13.000 credit or debit card numbers and
expiration dates and nearly 11,000 direct debit records. Clearly, this could lead to severe
reputational damage as well as claims for financial loss. (Source KPMG.)

Data loss can be highly damaging for a company, giving rise to loss of customers and
significant claims from injured parties as a company has a duty to not divulge confidential
information unless it has permission to do so.
In addition a company will also have a need to protect sensitive data that it owns such as
information that the company relies on to give it a competitive edge. Such confidential
information can be the most valuable asset of a business.
In this section we shall discuss how data can be safeguarded and review the Data Protection
Act 1998 and the regulations on insider dealing.
19
Think
Consider the information that you handle or come in to contact with as part of your job. How
much of it would be considered confidential or personal information?
Is there a formal policy for its handling and/or destruction?
H1 Safeguarding confidential and personal information

Organisations need to safeguard confidential and personal information from the prying eyes and
ears of parties who are not entitled to it. There are several ways of doing this.
H1A Confidential records on paper
Confidential information which is in paper form, such as certain reports and records, should be
marked 'private and confidential' and stored in a secure, preferably lockable, cabinet or desk.
Access to the safe storage area should be restricted to individuals who can be trusted to treat
the information properly by not disclosing it to any unauthorized parties.
Due to the growing incidence of identify fraud it is now essential that all office waste that
contains any customer information is treated in a similar manner to confidential records that are
no longer required. This means they must be disposed of carefully, either by putting them
through a shredding machine or having them collected by specialist confidential waste
contractors. Customer information must not be left in office waste bins and just put out for
general waste collection.
In 2009 the FSA fined HSBC 3m for failing to properly look after its customers' information and
private data. The FSA investigated the bank and found unencrypted customer details on open
shelves and unlocked cabinets. Customer details were also sent via the post or couriers to third
parties, and staff are not trained in dealing with risks associated with identity theft.
H1B Confidential computer records
Clearly large amounts of data about corporations and about private individuals are stored on
computers. The same rule applies as for confidential paper documents: give access to
trustworthy individuals only. As a general rule, confidential information on computers can be
protected by limiting access to it to those individuals who need it and can be trusted to treat it in
confidence.

Limiting access to computer files can be achieved through password systems and the
encryption coding of information. Encryption is used in particular when confidential information
is transmitted through the internet. The information is encoded during transmission and
decoded when it arrives at its intended destination. This protects the information from being
understood by any unauthorised person who intercepts it.
Regular reminders about the need for confidentiality within the organisation will help to stimulate
awareness.
As an additional measure for encouraging personal information about people to be kept

confidential, the Data Protection Act 1998 (see section H2) prohibits the unauthorised
disclosure of records stored in any way (including on a computer database) to third parties.
20
With regard to computer records companies must guard against hacking into their databases so
anti-hacking devices, anti-virus and fire wall protection is essential.
H1C Confidentiality agreements and confidential discussions
It is common for businesses to sign confidentiality agreements, or to require others to sign such
agreements, when one or both parties want to disclose confidential information associated with
transactions such as purchases or sales of businesses or portfolios, joint venture agreements
and outsourcing arrangements. Clearly it is important to ensure that those people dealing with
confidential information subject to a confidentiality agreement are aware of the importance of
keeping the information confidential.
As with confidential papers and computer records, confidential conversations, whether face-to
face or on the telephone, should be conducted in a secure environment where they cannot be
overheard by unauthorised parties. Any notes of such conversations must be treated as if they
were confidential documents.
H1D Insider dealing
The misuse of confidential information by making investment decisions using information that
should be confidential is called Insider dealing or insider trading. It is a civil offence, as defined
in s.ll8 of the Financial Services and Markets Act 2000 and includes the following behavior:
Insider dealing when an insider deals, or tries to deal, on the basis of inside
information.
Improper disclosure - where an insider improperly discloses inside information to
another person.
When a company is considering a transaction, such as the purchase or sale of a business, an

'insider list' should be maintained which records the names of all those allowed to know about
the transaction under consideration. Recommended guidelines that are to be followed in these
circumstances include:
Limit the number of people who need to know about a deal to the practical minimum and a
requirement to justify adding people to the insiders list/senior level sign off.
Not passing information to individuals unless they are first clearly made aware of their
responsibilities for handling sensitive information.
If staff are identified as needing to know some, but not all of the deal information then, as
far as practical, limit their knowledge to only those parts that are necessary, rather than

allowing them access to all information that is available.

Where appropriate, communicate to all other insiders when someone is removed from an
insiders' list.
Where practicable, geographically separate deal teams from other parts of the business. This
could be accomplished by placing the deal team on a separate floor, area or room.
In March 2010, a former equities market maker at a leading firm of stock brokers was found
guilty on five counts of insider dealing. He made over 100,000 profit from the trades that took
place between June 2003 and October 2004.
The case is the third successful prosecution for insider dealing brought by the Financial
Services Authority (FSA) and is part of its ongoing drive to tackle market abuse and promote
21
efficient, orderly and fair market practices.
H1E Home workers
Many companies allow some employees to work from home and also use experienced people
working from home who cannot easily travel to the office. In many cases the home worker will
be supporting the office in handling, say, telephone calls and accessing computer information or
doing data entry.
The risk is that confidential information that has left the company's control environment, via
laptops or downloaded to a home workers own PC, is therefore at greater risk of unauthorised
disclosure or loss.
To ensure good corporate governance is maintained the organisation needs to implement

effective controls and policies and procedure for all their home workers and to protect against
unauthorised access of the company's records and ensure that these policies and procedures
are regularly reviewed.
H2 Data Protection Act 1998

The Data Protection Act 1998 (DPA) defines a legal basis for the handling in the UK of
information relating to living people. It is the main piece of legislation that governs protection of
personal data in the UK. Although the Act does not mention privacy, in practice it provides a
way in which individuals can enforce the control of information about them.
Compliance with the Act is overseen by an independent government authority, the Information
Commissioner's Office (ICO). The ICO maintains guidance relating to the Act.
The Act defines eight principles of information-handling practice (see section H2B) including
ensuring that companies do not keep data unnecessarily.
The DPA is a large Act, and has a reputation for complexity. Whilst the basic principles are
honored for protecting privacy, interpreting the Act is not always simple which can lead to
abuse, for example, some companies through either misunderstanding or fear of non-
compliance hide behind the Act and refuse to provide even very basic, publicly available
material quoting the Act as a restriction.

H2A Key Issues
The following are some of the key issues relevant to the legislation:
directors, managers or similar officers of a body corporate can be held liable for
offences committed by their institutions;
individuals can go directly to court if they believe that their rights under the Act have
been breached;
personal data may only be transferred to non-EU/EEA (European Economic Area)
nations If certain conditions are met;
subject access requests made on behalf of third parties to determine criminal or
medical histories are forbidden. 22
This Is an important Act for managers as it is concerned with the holding and processing of
personal data, i.e. information in machine-readable form and manual filing systems which relate
to a living person (the data subject) who can be identified either from the information alone or
when it is taken together with other information (not necessarily in machine-readable form) in
the possession of the data user.
H2B Data principles and data registration
The Act does not prohibit the use of personal data but only seeks to control and register its use.
The Act sets out eight principles which must be observed in the use of personal data. These
are:
1 The information to be contained in personal data shall be obtained, and personal data shall
be processed, fairly and lawfully.
2 Personal data shall be held only for one or more specified and lawful purposes.
3 Data held for any purpose or purposes shall not be used or disclosed in any manner
incompatible with that purpose or those purposes.
4 Personal data held for any purpose or purposes shall be adequate, relevant, and not
excessive in relation to that purpose or those purposes.
5 Personal data shall be accurate and, where necessary, kept up to date.
6 Personal data held for any purpose or purposes shall not be kept for longer than is
necessary for that purpose or those purposes.
7 An individual shall be entitled
at reasonable intervals and without undue delay or expense:
(a) to be informed by any Data User whether he holds personal data of which that
individual is the subject, and
(b) to access any such data held by a Data User, and
where appropriate, to have such data corrected or erased.
8 Appropriate security measures shall be taken against unauthorised access to, or alteration,
disclosure, or destruction of personal data and against accidental loss or destruction of
personal data.
The first seven principles apply to personal data held by data users. The eighth principle applies
both to data users and to persons providing a computer bureau service.
All use of personal data must be covered by an entry in the Data Protection Register. Since
registration can only be made by an appropriate legal entity to be known as the Data User,
companies that use personal data as described by the Act must set up appropriate procedures
to ensure that all such use of data is correctly registered. One possibility is that each operating

unit or subsidiary appoints a Data Protection Officer (DPO) to take responsibility for data in that
unit.
The DPO in each unit should be asked from time to time to verify that the existing registrations
still meet its needs. It is important that all data users ensure that their personal data holdings
are included in the parent return since any case of unregistered data anywhere in the business
could be sufficient cause for the Registrar to suspend all processing under the appropriate
registration throughout the business.
H2C Who does it affect?
The Act affects anyone who holds or processes personal data as defined. It even applies in 23
cases where the machine-readable data does not identify individuals, providing the data user
has the relevant information elsewhere in their possession. The Act does not distinguish
between confidential and publicly available personal data except in the case of information
(such as the Register of Electors) which has to be made public by law. It therefore applies to
things like bibliographies and files of electronic mail messages containing the user identifiers of
the sender and recipient, as well as more obviously personal data.
H2D Principle definitions
Data means information:

- stored in a form capable of being processed by computer or other automatic equipment
(such as most computer files, including word processor, database and spreadsheet
files);
- recorded in any form for later processing by computer or other automatic equipment
(such as information collected from registration forms; CCTV pictures);
- stored as part of a relevant filing system or intended to be included in one in the future
(including card files or filing cabinets structured by name, address or other identifier;
Rolodex; non-automated microfiche);
- not covered by the above but part of an accessible record under s.68 DPA 1998 (such
as a set of doctor's notes relating to a named patient or certain (non-higher education)
educational records).
Personal data are data which relate to a living individual who can be identified from that
information, or from that data and other information in the possession of the data controller
or which is likely to come into their possession. These include any expression of opinion
about the individual and of the intentions of the data controller in respect of that individual.
Ordinary personal data includes name, address and telephone number.
Sensitive personal data includes information relating to racial or ethnic origin, political
opinions, religious beliefs, trade union membership, health, sex life and criminal convictions.
Under the Act the processing of such data is subject to much stricter conditions.
Data subject is any living individual who is the subject of personal data.
Data subject access is the right of an individual to access personal data relating to them
which is held by a data controller.
Data controller is any person who makes decisions with regard to particular personal data,
including decisions about the purposes for which the personal data are processed and the
war in which the personal data are processed.
Data processor is a person who processes the data on behalf of the data controller, but who
is not an employee of the data controller.
Processing is not confined to technical processing operations on data, such as

organisation, retrieval, disclosure and deletion. It also includes:

- obtaining and recording data;
- the retrieval, consultation or use of data:
- the disclosure or otherwise making available of data.
H2E Subject access
Data subjects are entitled to apply for a copy of the Information held about them under any
particular registration. A reply usually has to be made within 40 days, during which normal
updating is allowed (including the deletion of data If appropriate), but not special adjustments,
e.g. to make the copy record more acceptable to the data subject. Coded information must be
translated.
24
An important exemption to the subject access provisions of the Act (but not from the need to
register) concerns data held only for preparing statistics or for carrying out research. Providing
that the data is not used or disclosed for any other purpose and that the results are not made
available in a form which identifies any of the data subjects, it is exempted. Care must be taken
that individuals with distinctive characteristics are not identified implicitly in the published
results.

Bab 5: Marketing
Introduction
Within this chapter we will look at marketing, a key function of insurance organisations.
In chapter 1 we identified that the marketing function deals with all the activities that relate
directly to the relationship between the business and the customer. They involve market
research and using the information to develop products or services, pricing, promotion and
ensuring that the product/services reach the consumer.
A The marketing function and business

Every day, around the world, managers of organisations, which produce goods or services,
interact with the people or organisations they serve; this interaction should seek to understand
what their customers want and need. This whole process of understanding the needs and wants
of existing and potential customers, and persuading them that you can satisfy their
requirements, has developed into a business discipline known as marketing; this chapter aims
to explain and illustrate the various components of that process. 'Marketing' is therefore an
important aspect of business development, without which producers would stagnate and
eventually disappear.
Despite its very common use, the term 'marketing' remains unclear to many. For some, it
merely means sending out corporate Christmas cards every year, while for others, it just means
'advertising. These activities certainly incorporate elements of customer interaction and
understanding that may or may not lead to the generation of business or to the achievement of
other measurable aims. However, marketing in the wider sense involves other, additional
activities, which should be intended to enable the organisation to achieve its strategic
objectives. Essentially it involves knowing what the customer wants so as to deliver the right
product at the right price to the right person at the right time and in the right place. The
additional activities include:
market research;
competitor research;
customer profiling, target markets or segmentation;
development of strategic marketing plans;
development of operational marketing plans;
advertising:
media relations;
public relations and sponsorship;
product development:
relationship management including sales management and customer service.
We shall consider in this chapter how these concepts contribute to the marketing effort of an
organisation. For the purposes of this course, how can we define marketing?
Here is one definition:

Bab 5: Marketing
Marketing is a series or management processes based on a person's or

organisation's interaction with, and understanding or, existing and potential
customers, which enable it to provide them with what they need and want.
Some definitions of marketing include a reference to the fact that this provision to customers of
what they need and want should be 'at a profit. This is certainly true of insurance and financial
services companies. However, the phrase has not been included here because our definition of
marketing extends to cover all enterprises, including people and organisations that do not aim
to make a profit.
We have noted above that an organisation's marketing efforts should be part of and in
accordance with its corporate strategy. Otherwise, the best-laid plans for human resources, 2
finance, administration, production and operations will have little value for the company without
marketing and sales activities to help the generation of income.
B Key marketing concepts

In order to help us to understand better the role and function of marketing, it is useful to clarify
some of the main key concepts on which it relies.
B1 Goods and services

The marketing strategy and effort will depend on whether the organisation is providing products
or services. 'Products' are physical, visible, tangible, perishable or durable, depending on their
individual characteristics. Shoes, newspapers and furniture are all 'products.
'Services' are those activities that do not have a physical dimension, such as insurance,
accountancy or dry-cleaning.
Firms must produce products and services that have qualities and features for which the
customer is willing to pay. Marketing will therefore consider and incorporate the design and
provision of products and services, for example, their functionality and suitability, their ease of
use, the extent to which they are available and their price.
B2 Needs and wants

To understand the concept of marketing, we first need to appreciate that individuals and
organisations have unsatisfied needs.
Needs are the basic forces that drive people and businesses. They can be categorized as
follows:
Human needs stem from our basic biological and psychological make-up. The 'need' may
be for something basic such as water or food, experienced by thirst or hunger, or for
something subtler, unrealized or less obvious, for example social acceptability or the
satisfaction of the thrill of parachuting.
Organizational needs are shaped by organisations objectives and may include funding,
equipment, supplies and services in order to meet those objectives.

Bab 5: Marketing
An unsatisfied need is a sap between an entity's actual state and its desired state. Marketing
anticipates and measures the importance of the needs of the customer and raises their
awareness of a need which becomes something they 'want: A 'want' is a desire on the part of
the customer to acquire or achieve something physical or conceptual, which may have been
promoted by the suggestion that an unsatisfied 'need' exists. Marketing is a process that
matches the supplier's capabilities with the customer's needs and wants.
Needs or the want of a product or a service will vary from buyer to buyer, and will depend on
the situations in which products and services are used, the purposes they serve and the needs
they fulfill. Because different customers seek different benefits, different features will individually
attract them; they will use different choice criteria and attach different importance to product
features when choosing models and brands within a product or service category (e.g. size, cost,
3
colour, durability, ease of operation etc.). It is the function of marketing to respond as far as
possible in a business setting to all these variables.
Example
Through marketing consumers received the message that Coca-Cola is a great way to quench
one's thirst even though water would be just as good and cheaper.
Another example Is the way a market has been created for bottled water.
B3 Marketing and market segments

We have defined marketing as a range of activities concerned with the provision of goods and
services to customers.
A market consists of individuals and organisations who are interested in buying, and who are
willing to buy, a particular product or service to obtain benefits that will satisfy a specific need or
want and who have the resources to engage in such a transaction. The market may be in a
particular location where buying and selling take place of a range of goods such a fish, fruit,
vegetables and flowers or, In London, insurance and financial services. A market may also be
more widespread or global. For example, oil, coal and metals are trade on an international scale
and not necessarily in a particular location.
There are also 'niche' markets, where there are relatively few buyers and sellers, for example in
the aviation insurance market, or the trade in rare stamps.
Increasingly, markets are more 'virtual: or not dependent on a particular physical forum,
especially as the internet provides an 'on-line' medium whereby goods and services can be
bought or sold, ranging from insurance, cars or holidays. Accordingly, organisations need to
adapt their marketing strategies to a more competitive and demanding environment.
A market segment is a group of people with relatively uniform demands and needs compared
with the rest of the market. Each segment contains people who are similar in their needs and
wants, and in the product benefits they seek. Each segment seeks a different set of benefits
from the same product category, and some segments may be broken down further into sub-
segments.
For example, using the definition of 'market' above can identify the market for cars. There are
however, many possible segments and segment combinations; for example, people who like
luxury cars, economy cars, inexpensive cars, family cars, sports cars, estates, blue cars,
automatic cars, left-hand-drive cars, second hand cars, classic cars, convertibles, four wheel
drives, Japanese cars; these are all segments of the motor car market.

Bab 5: Marketing
While the total market may be large and composed of groups with different needs, the aim of
segmenting it is to enable the producer or provider to identify a customer group - a segment
which Is suitable for the producing or supplying company - meaning that it has a better
background for competing in the segment selected than in other parts of the market. In other
words, it is a matter of arriving at a segment in which the producer or supplier's strengths can
be exploited and its weaknesses become less important.
Because people or organisations often seek different benefits to satisfy different needs and
wants from the same type of products, the total market for a given product category is often
fragmented into several distinct sectors. These are called market segments.
4
B4 Marketing mix
The concept of the marketing mix is central to the whole concept of marketing. It is commonly
referred to as the six Ps of marketing.
The term is used to describe the combination of controllable marketing variables that a manager
uses to carry out a marketing strategy in pursuit of the firm's objectives in a given target market
(see table 5.1).
Table 5.1: the marketing mix for goods and services

Product The product / service being offered
Price The price or fees charged and the terms associated with marketing the
product or service
Promotion The communication programs associated with marketing the product or
service
Place The distribution and logistics involved in making the product/service
available
People Since people are an essential element in the production and delivery of
services, the quality of the service is largely determined by the quality and
behavior of the organizations staff this particularly true for jobs involving
high levels of customer contact
Process The procedures, routines, and policies which are used to deliver a service
to customers determine how customer friendly the organisation is
perceived to be
Managers make dozens of specific tactical decisions in designing strategic marketing

programmes and coping with changes in the market. They use the combination of the six Ps to
arrive at the product or service they wish to provide. For example, if we consider the marketing
of motorcars, we can see that the combination for a luxury saloon will be very different from
those for a family car. The marketing programme (or 'mix') will take account of, in each case,
who the customer is, how much they can afford, where and how they can be reached (for
example, by newspaper advertisements or at fashionable sports events), the servicing,
warranties and other aspects of the 'package' they are being invited to purchase. These are
related to the six major marketing variables of the marketing mix that they have some ability to
control over the short to medium term.
Collectively, these decisions determine the design of the marketing plan. Organisations can
alter any or all of the components of the marketing mix to stimulate a different reaction from the
market.

Bab 5: Marketing
C Market research and product development processes

Think
Write down In this box why you think market research Is Important to organisations and
compare your answer with the following text
It is impossible to satisfy the needs of the whole market, or of a market segment, unless you
know what those needs are. It is usual therefore for organisations to carry out market research
to learn more about them. Organisations rely on market research particularly to:
develop marketing plans;

identify target markets; 5
formulate marketing strategy;
control marketing operations;
monitor the success of products or services.
Understandably, market research that provides accurate market measurements (both present
and future) will be critical to the organisation's success.
C1 Market research process

Market research is methodical and typically follows an ordered series of six steps or stages, as
follows.
Stage 1 Identifying the missing information needed for analysis.

Stage 2 Determining data needed, over which period of time and where it can be obtained.
Stage 3 Design of research methods, e.g. questionnaires, interviews.
Stage 4 Design of sample size and characteristics; how many people will represent an
adequate sample; and their characteristics such as age, gender, income levels.
Stage 5 Data collection; how it will be collected and stored.
Stage 6 Techniques used in analysis and presentation of results.
Once analysed, the information can be used to help the organisation to develop a new product
or adapt an existing product that will satisfy the needs of the market.
Many large organisations have their own market research department to carry out research on
products and markets. Smaller organisations will often commission independent market
research companies to conduct project-based market research for them prior to taking
important marketing decisions.
There are many sources of background market information, including the organisation's own
internal data. Some external data will also be available, normally in the form of an industry- or
sector-wide survey by other organisations such as:
Government departments;
trade associations;
commercial researchers;
trade publications.
For more specific information about the proposed product or service, there are two main
methods of collecting market information for later analysis. The more common of the two is

Bab 5: Marketing
questioning, and the less common is observation.
Each method uses a variety of different methods, depending on the required quality of
information, quantity of information, ability to control the sample, time available and the cost of
the research.
Focus groups normally comprise six to twelve consumers brought together to discuss a topic
related to a given product or service. They can combine questioning with observation.
Many research organisations have facilities that permit focus group discus ions to be tape-
recorded or video-taped with the group's consent, or allow marketing executives to watch the
proceedings on closed-circuit TV or through one-way mirrors to gain important feedback from
6
consumers.
Another important aspect of research is, of course, the activities of competitors. Organisations
need to be aware of how competitors' products or services compare with their own, in particular
where there are differences in design, specification, dimensions, conditions where it is suitable
(where appropriate), as well as quality of the product or service, price and 'after-sales' services.
By combining information from government reports, trade association newsletters, independent

company financial reporters such as Dun & Bradstreet, annual reports, commercial surveys,
directories, industry experts and consultants, and the media, an organisation can generate
reasonably accurate data about areas of the whole market such as:
sales volumes;
market share-of competitors;
their profitability;
product history and development;
recent performance in comparison to earlier periods.
Market research has an important part to play in product development. As we will see,
customers' tastes are constantly changing, and in the absence of relevant intelligence, the
provider of goods or services may find that suddenly, or gradually over a period of time, there is
a declining customer base. The task of marketing therefore is to find this out and to recommend
a new strategy appropriate to the customers' needs. This may involve replacement of the
product or service, or its enhancement, or a different marketing 'mix.
Activity
Research and identify the market research that your organisation undertakes and how it is
used.
C2 Product development
The product is one of the most important elements of the marketing mix. The term product in
the context of the marketing mix may also mean 'service', depending on whether the
organisation is producing hard products or providing services for its customers.
Firms must produce products and services that have qualities and features for which the
customer is willing to pay. Markets are, however, constantly changing. Customers' needs, and
the ability of an organisation to satisfy them, can be influenced by six factors outside the
organisation's control, which are always in a state of flux, namely:

Bab 5: Marketing
Factor Example
The economy High unemployment leads to less disposable income and
depressed retail sales
Government regulation New legislation bans all tobacco advertising
Competition Competitor goes out of business
Consumer lobbying Consumers call for a ban on genetically modified foods
Technology Technological advances make a new product possible
Social or cultural influences Certain religions prohibit work on some days of the week or at
certain hours of the day
A business risks losing contact with its customers' (existing and potential) needs as a result of
these influences. Competitors with a better understanding of the market will attract more 7
customers, taking custom and consequently revenue away from the organisation, which has
become out of touch.
Because markets are continually changing, organisations need to identify opportunities for new
products that will satisfy new customer needs.
Ideas for new products can come from a wide range of sources, such as:
existing customers;
the organisation's staff;
suppliers or agents;
competitors;
the Government;
the media;
trade associations.
To exploit the market's potential, new ideas must be converted into new and commercially
successful products.
C2A New products
As with all good marketing practice, new product development must follow a disciplined route.
There are usually five stages as set out in figure 5.1.
Figure 5.1: Market development
Market research
Product design
Test the prototype
Make necessary amendments
Commercial production

Bab 5: Marketing
C2B Existing products and the product life cycle
Think
We are now going to talk about 'product life cycle: however, before reading on, what do you
think the term means?
Once a product is in existence, its success can be tracked according to its profitability over
period of time. Its progress will continue to be affected by ever-changing markets; and
experience has shown that most products typically follow a similar pattern of development. This
is known as the product life cycle (see figure 5.2).
8
Figure 5.2: the product life cycle
The concept of the product life cycle assumes that all products have limited lives during which
they pass through a series of stages, all of which have Implications for their sales performance
and profitability:
During the development phase, money is spent on research, development and testing,
which will mean that the organisation incurs expenditure on the product rather than
generating income from it.
During the introduction phase, the product or service is introduced to the market. Sales
revenues are normally low while both consumers and distributors become aware of the
product and decide whether or not to adopt it
During the growth phase, there is a rapid acceptance of the product and a dramatic
increase in revenue. This is generally sustained by improved distribution, product
improvements and even price reductions.
Success attracts interest from other producers. The market opens up to more and more
competition as it gradually reaches maturity. At this stage, copy-cat products are also
available. Sales and profits are still high, but so are the costs of maintaining the business.
Increased competition puts pressure on profits.

Bab 5: Marketing
The decline phase is marked by a falling-off in sales. This is usually caused by the
introduction of technologically superior substitutes or attractively priced competition or
because of a shift in consumer tastes, values and beliefs.
C2C Changing markets
There are four important areas, which should be monitored regularly:
competitors' activities;
changes in customers' needs;
improvement of product quality;
9
new technology.
Keeping abreast of market changes is normally the responsibility of senior managers. A periodic
market analysis helps firms to determine how well their product lines are satisfying their
customers. The options for deciding how to react to those changes will be based on the
financial implications of adapting to market needs or leaving the market to other producers.
Managers must choose the appropriate reaction to any changes in the market.
D Communications and promotion

When we examined the 'promotion' element of the marketing mix earlier, we saw that there was
a range of ways in which insurance organisations could promote their businesses to existing
and potential customers.
These include impersonal communication methods, where they are not directed at any
individual in particular, such as advertising, direct marketing, special sales promotions and
public relations. These methods are often intended to raise awareness of the product or service,
or the profile of the provider, to the public at large, as seen at important sporting events.
Personal communications methods include personal selling, servicing and monitoring. These
methods are often directed at individuals, with the intention of selling the goods or service, or
maintaining the custom of the individual.
In addition to being aware that these various communication channels exist, marketing
managers need to know when and how to use them best to communicate their messages.
Be aware:
Marketing Is far more than just developing a good product or service, offering it to the target
market at the right price and making it readily available. Organisations must also communicate
information about themselves, their products, their price structures and their distribution
systems to a variety of audiences Including consumers, intermediaries and the media.
Communication can be a distinct advantage that separates an organisation's product or service
from Its competitors'. As a complement to the experience of buying the product or service In
question, communication gives clues to the whole market about what customers can expect
from the organisation.
D1 From communication to customer acquisition

Communication strategy is a controlled, integrated programme of communication methods and

Bab 5: Marketing
materials designed to present an organisation and its products in a consistent and clear way to
prospective customers. Inevitably, the development of effective communications depends
heavily on how well the organisation has carried out earlier steps in the marketing management
process - especially those concerned with understanding buyers behavior, market
segmentation or targeting a particular market, competition analysis, and the positioning of the
product in the market place In relation to its competitors.
The basis of any successful communications programme is a clear understanding of the

communication process, seen from the customer's viewpoint, as figure 5.3 illustrates.
Figure 5.3: from communication to customer acquisition

10
Unawareness
Awareness
Comprehension
Conviction Action
When it comes to winning customers, the first task of communications is to make unaware
consumers aware of the service on offer. Having brought consumers to that stage, it is
important that they understand what the product or service will do for them. Next, they need to
be convinced that what is said is true and that the product or service will satisfactorily meet their
needs. Finally, the consumer needs to be sufficiently motivated to buy the product or service.
There are five essential elements in any individual communication. These are:
A source - usually the organisation.

A message - usually information about the product or service.
A medium - the communication channel, e.g. TV, radio, internet, publication, a brochure, a
conference or seminar.
A receiver - the person or business receiving the communication.
A response - a reaction to the message.
D2 Communication methods
As is shown in table 5.2 each component of the 'promotion' element of the marketing mix has its
advantages and disadvantages over the others in communicating with the customer.
Table 5.2: promotion elements advantages and disadvantages

Scope Cost per contact Advantages Disadvantages
Advertising Mass Inexpensive Control over the Hard to measure
message result
Personal selling Personal Expensive Flexible Very expensive
presentation
immediate result
Sales promotion Mass Can be Gains attention Easily copied
expensive immediate effect

Bab 5: Marketing
Public relation Mass Inexpensive Very believable Lack of control
Direct marketing Mass/personal Moderately Consistent Lack of control

expensive
We shall look at two of the impersonal promotional communication methods in a little more
depth; these are advertising and public relations.
D3 Advertising
Advertising can be defined as any form of impersonal presentation and promotion of ideas,
goods or services by an identified organisation that must be paid for. It arises in: printed 11
advertisements (newspapers and magazines) radio, television, direct mail, billboards and
catalogues, internet, signs, in-store displays, posters and cinema.
Most advertising efforts are concerned with stimulating the demand for a particular brand of
product or service by breaking down the barriers in communication which convert a customer
from their state of being unaware of the product or service to the state of buying or using it. As
noted earlier, an advertising campaign may be aimed at the public at large for the purposes of
enhancing awareness of the product, service or the provider. The creation of a 'need' is often a
feature of advertising.
Advertising can work on several levels to break down barriers to communication. These are
illustrated in table 5.3.
Tabel 5.3: how advertising aids customer communication

Between and It:
Unawareness Awareness It grabs attention and makes an impact
It states that the product or service exist
It jogs the memory
Awareness Comprehension It explains service or product feature
Comprehension Conviction It explains service or product benefits
It establishes credibility
It demonstrate appropriateness
Conviction Action It encourages participation
It generates demand
It persuades the receiver to take action
Appropriate advertising is needed for each stage of the process. A new product will have to
start at the beginning with advertising that concentrates on creating awareness. By contrast, an
existing, well-established product will need to use advertising that encourages more people to
buy it.
In the insurance sector it is interesting to note that advertising was the principal means by which
the direct writers acquired a very significant share of the total UK private motor insurance
market. Their new approach of a single-telephone-call transaction to deal with all aspects of
placing private motor insurance was revolutionary at the time. It required massive advertising
costs to woo the public towards this new method (and was no doubt supported by market
research). Major companies entering that sector traded at substantial losses initially but within
two to three years had established themselves firmly in the market, in some cases producing
much better results than the market norms.

Bab 5: Marketing
D4 public relations
Building a recognizable corporate image is of increasing importance as consumers,
shareholders, suppliers, and commentators become more media-savvy. The first three groups
want to know as much as possible about the company with whom they will be entering into a
relationship with. Media commentators are always hungry for news, which they can publish or
broadcast.
Public relations is exercised in newspaper and magazine articles/reports, TV and radio

presentations, charitable contributions/sponsorship, speeches and seminars.
At its simplest level, public relations (PR) can be described as the projection of the personality 12
of the organisation to the outside world. Unlike advertising, PR does not generally involve any
direct payment for the media channels it uses to communicate its messages. However, some
channels are paid for indirectly, for example by sponsorship, where one organisation sponsors
another in return for publicity.
In his book All about PR (1987) Roger Heywood states:
The personality of an organisation, demonstrated through the attitudes it adopts, is

a critical factor in its success- or failure. It can be more important than, for example,
the price of the products it offers, or... the worthiness of its cause.
Like a person in a community or in society as a whole, an organisation needs to project its

personality so that others can recognise its traits and culture, and predict the way It will react to
certain situations. The name often given to this corporate personality is image.
Another more technical definition of PR is that it is the organised two-way communication

between an organisation and the audiences critical to its success. Such organisational,
communication is designed to create widespread understanding and support for the
organisation's aims, policies and actions.
Be aware:
An organisation's Image Is Important because It helps to differentiate it from Its competitors, to
project a consistent and homogenous style of doing things to everyone who deals with It, and to
encourage empathy from Its supporters and potential supporters.
In large organisations, there may be an in-house PR department. Smaller organisations may

employ external PR companies to handle particular image-building projects as and when they
arise.
The tasks most commonly addressed by PR are:
motivating the organisation's workforce by fostering pride in its public face;

handling a specific problem or issue, e.g. a health scare or oil spill;
building or maintaining the corporate image;
influencing particular audiences or market segments;
supporting other communication activities, e.g. an advertising campaign;
assisting in the launch of a new product or service.

Bab 5: Marketing
D5 Relationship marketing
Marketing also includes the maintenance of the customer base and the management of the
processes that facilitate this concept. With the development of sophisticated database
management software has come the ability to store and retrieve detailed information about
customers, including historical records of their individual buying patterns. Relationship
marketing uses information about individual customers as a device for building up a strong
relationship between an organisation and its clients by pre-empting a customer's buying needs
on the evidence of past purchases. As a communication tool, relationship marketing stresses
the importance of trust between buyer and seller. Some schemes, such as supermarket loyalty
clubs and airline executive clubs have been very successful in forging strong organisation-to-
customer ties. Similarly, insurance companies that have sold motor insurance can offer those 13
customers other financial services to suit their needs.
A feature of successful customer relationship management is the dependency on knowing the

customer and their needs or preferences, based on previous sales. Personal communication
methods are likely to be more effective than those of a mass-appeal, impersonal nature.
Ultimately, the longer a customer stays with an organisation, and the more they buy, the greater
opportunity the organisation has of recouping the cost of acquiring that customer in the first
place. The basis of one-to-one marketing is that it concentrates on the relationship between the
organisation and the individual customer.
Activity
Identify the marketing communication methods used by your organisation and consider how
effective think they are.
D6 Market planning
At the same time as formulating its communications strategy and the extent and manner in
which it will 'promote' the goods or services, the organisation needs to draw up a market plan,
which will reflect the 'places' and 'processes' of the marketing mix. The plan considers how the
organisation is going to enter the market and stay in it. The plan will incorporate:
allocation of responsibilities;
sales targets by area, outlet;
budgets;
delivery and availability of the goods or services according to the 'launch date';
timescales;
feedback on progress of sales in relation to the target;
arrangements for receiving and responding to customers' complaints, and 'returns' or
replacement policy.
The 'people' part of the marketing mix equation should address:
staffing levels;
manpower planning;
duty rotes;
training and development, especially in those activities which require conformity to
regulatory requirements.

Bab 5: Marketing
D7 Role of the FSA

As the insurance industry is regulated by the Financial Services Authority (FSA), the extent of
the FSA's influence extends to the nature and role of advertising as practiced by the members
of the insurance community.
The FSA is responsible for setting the rules on 'financial promotions: This means that all the
adverts firms put out should be clear, fair and not misleading. It monitors published adverts to
check that firms are sticking to its rules. 'Financial adverts' means all the various types of
promotional material covered by their financial promotions rules, such as:
adverts in newspapers and magazines (including leaflet inserts); 14

product brochures, leaflets and other sales literature;
direct mail shots;
posters;
TV and radio adverts;
promotional emails and text messages;
adverts on websites, including product providers' own sites.
If it finds an advert it believes is against the rules it can:
tell the firm to amend the advert, or withdraw it;

if people are likely to have been seriously misled, it can ask the firm to contact customers
who have bought the product after responding to the advert and offer them the chance to
pull out at no cost;
for particularly serious or persistent breaches of the rules, the FSA may fine or publicly
name the guilty firm. In practice, it deals with most cases by requiring the firm to amend or
withdraw the advert in question. This is usually the quickest and most effective way of
reducing the risk of people being exposed to misleading adverts.
Activity
Before moving on, be sure you fully understand the role the FSA has with regard to marketing.
To help in this, access the FSA website, conduct a search under 'financial promotions' and in
particular review the following:
The 2009 joint OFT/FSA pdf guide.

The insurance pricing update pdf.
Examples of good and bad practice.
Key issues for firms to avoid.

Bab 5: Marketing
Question answers
1. Any three of the following:
Services are intangible.

Services are almost always temporary, or have a lifetime mutually agreed by the
provider and the recipient.
Some services, such as hairdressing, do not necessarily conform to a recognizable and
consistent specification. Others, such as the preparation of statutory accounts or the
provision of electricity, do. Some services, such as state education, are subject to
official government regulation. Others, such as window cleaning, are not. 15
To be bought and sold, services are most often reliant on personal interaction between
the receiver and the provider of the services, or the engagement of an Intermediary
between them. To be attractive to buyers, services rely less on their Inherent qualities
and more on the qualities of the people who supply them. Services require no physical
distribution channel to allow them to pass from seller to buyer.
The value of a service is most commonly assessed on Its completion, and there must,
therefore, be a higher degree of trust between seller and buyer.
2. The five essential elements in any Individual communication are:
A source -usually the organisation.

A message -usually Information about the product or service.
A medium- the communication channel, e.g. TV, radio, internet, publication, a brochure,
a conference or seminar.
A receiver- the person or business receiving the communication.
A response -a reaction to the message.

Bab 6: Human Resources
Introduction
In chapter 2, we stated that although management involves the effective use of an
organisation's machinery and property, it is mostly concerned with the deployment and
supervision of its people. Human resource management is the management of the people
employed by an organisation in order to achieve that organisation's objectives.
Managers may see employees as a resource comparable to other resources like buildings and
machines except for the fact that they are human. They need to utilize them as they do other
resources as effectively as possible in pursuit of the business's aims. This is an engineering
approach as it considers what the human is most and least capable of, and organizes work to fit
the qualities .and limitations of this specific resource, namely the human being at work.
A Human resource management function

A1 Development of human resource management
Think
What do you think the term human resource management means and how did it develop as a
function?
In the past, 'personnel management' was the title generally given to the management of people
in organisations. It included many of the roles which are found in human resources
management today, such as manpower planning and control, recruitment, selection, training
and development, industrial relations, pay administration, job and organisational design, and
handling grievances and disputes between the organisation and its employees.
Personnel management has undergone many changes in the last half of the twentieth century.
Originally concerned with many of the administrative aspects of employment, its scope has
become wider because of managers' changing perception of people in the workforce.
Firstly, since the 1950s workers have changed in many respects. They have become better
educated and prepared for their jobs, more aware of their rights, and generally better informed.
Their life aspirations have increased.
Secondly, an increasing number of personnel issues including conditions of employment, work-

and remuneration - are regulated by legislation or have become the subject of collective
agreements between workers' and employers' organisations. This has clearly reduced much of
the importance of the administrative personnel function.
Thirdly, the workforce has increasingly come to be viewed as the most valuable resource of an
organisation. As such, it needs to be motivated, trained and developed to perform as efficiently
as possible so that it conforms to business values and contributes to management strategy.
As a reflection of the way that the perception of the workforce has changed, a national standard
called Investors in People was developed in the UK in 1990 to establish a regime of good
practice in training and development of people to achieve business goals.
The National Training Task Force originally developed the standard in collaboration with a
number of the UK's leading business, personnel, professional and employee organisations.
Investors in People is intended to provide a national framework for improving business
performance and competitiveness through a planned approach to selling and communicating
business objectives and developing people to meet these objectives. The idea is that what
people can do, and are motivated to do, match what their organisation needs them to do.
Companies can apply to gain Investors in People accreditation. Accreditation is achieved
through assessment by independent assessors, which will verify whether the prescribed
standard has been met. Similar national standards operate in many other countries.
Because of all these changes, 'human resources management has gradually replaced the title
'personnel management.
2
A2 Scope of human resource management

It is not easy to produce a clear definition of human resource management. Many would argue
that it is nothing more than a fashionable term (or new jargon) for personnel management.
However, there are some definite differences between human resource management and
personnel management.
Some of the significant characteristics that appear to distinguish human resource management
from personnel management are:
It has a strategic focus. Human resource management is concerned with the formulation
and implementation of a people strategy specifically designed to support the overall
business strategy.
It is concerned more with enabling than with control. Human resource management is
focused on identifying the help required by the organisation, its managers and employees in
achieving corporate and individual goals. It is supportive of others rather than seeking their
compliance with systems and procedures.
Human resource management is proactive. The concerns of human resource management
are change and growth. Those involved keep closely in touch with the business and its
managers and anticipate people-related needs, developing policies to meet these needs in
advance of their arising.
A3 Human resource management functions

Human resource management is extremely broad in its scope and covers areas including:
recruitment and selection;

reward systems;
organisation and job design;
employee development;
team building;
change management;
organisational effectiveness;
manpower and succession planning;
management development;
employee communications;

performance management;
career path management;
counselling; and
incentive and benefit schemes.
A4 Roles and responsibilities

At the end of the day the responsibility for the management of people within an organisation
rests with line management. The role of the human resource management specialist is to
provide line management with the help, support and guidance necessary to enable them to fulfill
their people management responsibilities. 3
In particular, the human resource management specialist is responsible for working with senior
management to develop the organisation's overall human resource strategy. Subsequently, the
specialist is responsible for working with line management to develop policies and practices,
which will enable the strategic goals to be achieved.
A5 Developing an integrated strategy

In order to develop an integrated human resource strategy, it is necessary to consider the full
range of policies and systems throughout the organisation which impact on the attitudes,
behavior and performance of managers and employees.
The business strategy will carry with it implications in terms of individual behavior and attitudes
as well as corporate behaviour and culture. An integrated human resource strategy will identify
what changes need to be made to each of the systems impacting on behaviour in order to bring
about the overall change required by the business strategy It Is also necessary to ensure that
all systems carry congruent messages in order to avoid or minimise resistance to change.
Once the business strategy and implication analysis have been completed, the human resource
plan will be developed to focus on areas which will be most pivotal in bringing about desired
changes in behaviour. For example, if it were decided that, in order to achieve overall business
aims, line managers need to boost employee morale and engender commitment, it may be
more effective strategy to reflect the change in the manager's reward structure than to embark
on a major programme of employee relations training for managers.
A6 Manpower planning
People are the resource within the financial services industry that accounts for the major part of
an organisation's costs. It is also, in the long term, the quality of an organisation's people that
will play a critical role in its success.
Therefore, the need to plan strategically for the acquisition and development of people to
achieve strategic goals and objectives is essential.
Two key components of a human resource strategy are the manpower and succession plans. In
essence, manpower planning helps to determine the numbers and skills of people the
organisation will need in order to achieve its strategic goals whilst succession planning helps to
ensure the continuity and growth in the management of the business by ensuring that
successors for key positions in the future are identified and developed.

A6A Nature of manpower planning
Manpower planning is concerned with ensuring that the supply of people in an organisation is of
an adequate quantity and contains the required quality to enable the organisation to achieve its
objectives. At its simplest level, it concerned with matching the estimated demand for labour
with the available supply. The three major components of a manpower plan are:
supply;
demand;
4
time.
Manpower planning's contribution lies in the area of reducing the problems of balancing supply
and demand by providing time to enable recovery action to be taken.
A6B Output of the manpower plan
The comparison of supply and demand forecasts will indicate changes that will be necessary in
relation to the organisation's manpower requirements. The manpower planning process will
result in the formulation of a range of manpower objectives designed to correct imbalances
within the organisation. Such objectives may include, for example:
improved career progression;

modified age structure;
optimised skill mix;
minimisation of wastage.
To achieve the manpower objectives, it will be necessary to produce a manpower Action Plan.
This could cover areas such as:
recruitment programmes;
training programmes;
redundancy;
short-time working;
re-organisation; and
re-training and developing new skills.
A6C Problems and limitations
As with any planning process, manpower planning faces a range of problems and limitations.
The major problem is often that of obtaining accurate forecast!. Ideally the planning process
should be a five-year rolling plan and inevitably the level of accuracy will decline in any five-
year period. However, ongoing planning should enable minor adjustments to be made to
manpower programmes on an annual basis. Other problems include:
obtaining the information (and updating);

rapid changes in the business environment;
legislation;

changes in the labour markets;

changes in the economy;
Government policies;
difficulty in obtaining commitment.
Despite the problems and limitations, manpower planning is an important and valuable tool. It
must be of use to an organisation to be able to determine the nature of manpower changes,
associated with their objectives, even if the details are not 100% accurate. Given the basic
knowledge appropriate action can be planned to enable an organisation to smooth its path to
change and growth.
Activities 5
Contact your HR department and find out what manpower planning activities are undertaken in
organisation and how this information is used.
A7 Succession planning
Traditionally, succession planning has been concerned with providing an organisation with a
supply of people to replace existing jobholders with new ones able to perform the same job.
In the current volatile environment of the insurance world, this static view of succession
planning is no longer as helpful as it used to be ss markets change so do organisations; as
organisations change, so do the jobs within them. Thus, for succession planning purposes, jobs
may no longer be viewed as static. In this situation, the skills and abilities of a successor are not
necessarily going to be those of the existing jobholder.
In today's environment succession planning is becoming concerned with ensuring that an

organisation has an adequate pool of skills and talent to provide it with continuity in
management, who are then able to respond to changing organisational and market needs. 1l1is
pool should be able to cover existing jobs, and contain the talent necessary to resource new or
expanded business activity.
In periods of rapid change in the business environment and/or portfolio, it may become
necessary to supplement such internal pools with recruitment from external sources.
A7A Succession and management development
The formulation of a succession plan will entail identification of the critical skills and abilities,
which need to be developed to meet the demands of future business strategies.
The programmes to develop these skills and abilities will be an integral and important part of the
company's management development strategy. If management development is to be effective,
it must produce sufficient numbers of people with the skills and talents necessary to meet
succession requirements.
A7B Succession and business strategy
It is essential that succession planning is closely tied to a company's strategic planning process.
The strategic plan provides a picture of the direction in which the organisation is heading. The
plan enables possible future organisational structures to be identified and subsequently the

critical skills and abilities needed to achieve future goals and objectives. This information
enables succession plans to the formulated.
A7C Key steps in succession planning
All succession planning should begin with a review of the organisation's business strategy. This
will provide the targets the succession plan needs to meet. Having reviewed the overall
business strategy the next steps may be summarised as follows:
identify the key jobs necessary to achieve strategic goals;

identify the extent to which these jobs will change (or indeed represent new jobs);
6
identify the performance factors critical to success in these jobs (e.g. skills,
qualifications, experience);
establish current key players;
prepare an inventory of the skills, abilities etc. of current key players;
identify a timescale before current key players will leave the organisation;
establish a means of identifying current skills of potential successors and their potential
to develop new skills.
Reinforce
Before moving on, take some time to check that you understand the distinction between
manpower planning and succession planning.
A7D Identifying potential
Increasingly, organisations are concerned that traditional promotion practices and career paths
do not produce a wide enough succession pool. There is a growing interest in finding better
ways of identifying people with potential to be developed to succeed to key positions.
Approaches to identification of potential include:
psychometric testing;
assessment centres;
panel or board interview .
A8 Integrated human resource management

Manpower and succession planning are clearly major components of a human resource
strategy. However, for these plans to work effectively, it is necessary that people are
appropriately recruited, developed, rewarded and promoted to meet the long-term needs of the
business.
Therefore, it is important that all of the human resource policies and practices are developed to
fit in with the needs of the business strategy.
A9 Developing an integrated human resource strategy

In order to formulate an integrated human resource strategy it is necessary to begin by
examining the overall business strategy. This analysis will indicate:

skills required;
organisational values and culture; future organisational structures;
potential career paths.
From this a range of human resource policies may be developed. These policies should be fully
integrated to ensure that they are all conveying the same messages and supporting the
business goals. In this section we will be considering human resource management policies
including recruitment and selection, training and development, and appraisal and reward as
important aspects of an integrated strategy.
7
A10 Human resources and corporate culture
In chapter 2, we looked at the concept of corporate cultures; we recognised that an
organisation's corporate culture is made up of its norms, beliefs, values and management style.
We also discussed the ways in which different corporate cultures affect the way individual
employees view their work. We also need to understand that threats to corporate culture can
affect staff morale and productivity.
The overall values and culture of an organisation have been found to have a significant impact
on the performance of employees, as well as on how the organisation is perceived by its
customers. Peters and Waterman in their book in Search of Excellence highlighted the fact that
the external image of an organisation mirrors its internal values and culture.
Organisational culture has a significant impact on human resource management. In a number of

organisations the achievement of key strategic goals is dependent upon effective
implementation of a human resource strategy designed to bring about a significant shift in the
organisational culture or climate.
Activity
The well-known management writer Charles Handy conducts research into organisational
corporate culture. Look up his writings on the subject (you can use one of his books or the web)
and identify the four cultures he describes. Then assess which cultures feature in your
organisation.
A stable and strong corporate culture is likely to provide an organisation's employees with a
positive atmosphere at work. In such an atmosphere, shared beliefs (i.e. what underlies the way
that organisational systems and practices work) and values (i.e. what is important about the
organisation and what it stands for) will produce accepted norms for employee behaviour.
However, even the strongest corporate culture can be destabilized by a number of factors, such
as:
organisational crisis;
acquisition of, merger with or acquisition by other organisations;
the adoption of a self-destructive culture.
A10A Organisational crisis
An organisational crisis is the occurrence of a serious and damaging incident or the sudden
discovery of an unexpected state of affairs. Examples in the past include the financial

impropriety scandals that have rocked Guinness, Barings Bank, Mirror Group Newspapers and
Lloyd's of London and today we have the credit crisis, which is impacting on many organisations
including the financial sector.
As crises unfold, employees usually experience a range of emotions including anger and guilt,
and occasionally long-term emotional and physical stress. The organisation's formerly strong
culture may be damaged irretrievably. As a result of the crisis, its goals and strategies may
need to change, and the culture that supported former excellence may not evolve properly or
support the new damage control measures that must be brought into place to aid the
organisations survival.
A10B Merger with other organisations 8
Strong cultures may not mix together well when one organisation merges with, acquires, or is
acquired by another organisation - especially if the two have traditionally been rivals. In recent
years, there were many such couplings in the financial services sector in the UK, particularly
involving the merger of composite insurers and the acquisition of insurance organisations by
banks.
Typically, the managers in the stronger or larger firm will expect certain changes to occur if the
new partner organisation or the newly acquired subsidiary is to be brought into line with its own
corporate culture. ln such cases, there is often a prolonged period of integration that is
frequently turbulent, and staff members suffer anxiety since most do not enjoy the insecurity
that organisational change can bring.
A10C Adoption of a self-destructive culture
Some strong cultures threaten the attainment of organisational objectives because they
legitimize in-fighting, secrecy and empire-building. This is often true in family businesses that do
not properly prepare for the orderly passage of power to successors, or in large organisations
where senior managers vying for more senior positions adopt a 'cloak and dagger' culture.
A10D Organisational change
Whatever causes their development, organisations quite naturally evolve over time. They grow
and shrink. They acquire other organisations, or are acquired by .them. They enter new markets
and leave existing ones. They adopt new technologies and dispose of old ones.
The way that changes are implemented and managed is crucial for employees, and
organisations typically follow one or more of the courses of action noted below as they evolve:
Changing objectives and strategies. Organisations may need to introduce new products
and services to react to external pressures on existing ones.
Introducing new technology. The retrenchment of staff alters the introduction of new
computer technology to increase efficiency and lower operating costs may bring about
significant changes in the organisation.
Changing the organisation's structure. Organisations change by shifting from one

structural design to another in order to compete more effectively with rivals.

Change can also be provoked by disharmony in the internal environment of the organisation.
Indicators of a weakening corporate culture and poor organisational health include:
diminished productivity;
increased employee sabotage of company property;
increased absenteeism;
increased expressions of grievance against colleagues and managers; strikes, work-to rule
and lock-outs.
However, unless the company has adopted a self-destructive culture, such internal imbalances
usually originate from threats to an organisation's culture from the external environment. 9
A10E Human resources In the face of change
Organisations often implement and manage the human resources aspects of cultural change in
the face of the above threats to stability through the three methods outlined in this section.
Job design
The work performed by individuals or groups can be modified to provide more opportunities for
satisfying the needs of employees. For example, jobs can be redesigned to provide more
variety, autonomy, feedback, significance and even social interaction.
New recruits
The organisation's selection, placement and training systems can be altered to bring new blood
into the organisation, and to encourage new behaviors and skills in current employees.
Control systems
The organisation can alter its performance appraisal and reward schemes. Such changes might
encourage new behaviors in return for rewards that employees value.
In all the areas mentioned in this section, an effective human resources function can provide
direction, guidance and support to help senior and line management with the smooth transition
of change and culture and also act as an advice point for the employees who are impacted.
Reinforce
Before moving on, ensure you fully understand the HR and corporate culture Issue by
summarizing in this box the impact you feel human resources can have on corporate culture.
B Recruitment and selection

B1 Recruitment process
Effective recruitment is essential for any organisation's success since new recruits are the raw
material of the organisation's human resources. There are three key stages in the recruitment
process, as shown in figure 6.1.

Figure 6.1: stages in the recruitment process
Job analysis
Reviewing the assessment tools
Deciding which assessment tools to use

10
B1A Job analysis
Job analysis focuses on the content of what employees actually do at work. The procedure
consists of producing a job description that identifies the duties for each prospective or actual
employee and the competences required to do the job in an excellent manner. The job
description will usually state the main purpose of the job, key responsibilities, key activities, the
measurement criteria for performance and the limits of authority in relevant areas.
So job analysis should build up a clear specification of the characteristics, skills, competences,
qualifications, knowledge and experience that the jobholder will need to have in order to
perform the job adequately.
Once job analysis is complete, the recruiter has a list of the key abilities needed for the position.
This should identify those attributes which are essential as well as those which are desirable but
not essential. At this stage, there is enough information available for the position to be
advertised.
B2 Advertising the vacancy

There will be a need to attract suitable candidates to apply for vacant posts unless the employer
already has a suitable candidate in mind from within the company. Even where there is a
suitable internal candidate, firms will very often advertise positions within the company and/or
outside to see whether any better suited candidates wish to apply.
The wording of the advertisement is crucial to the next stage in the process. If there is too little
information in the advertisement or it is vaguely worded, unsuitable candidates may apply. On
the other hand, a requirement within an advertisement (e.g. for a particular qualification) that is
not absolutely necessary for competent performance of the job, may discourage an otherwise
ideal candidate. It is also important to ensure that job advertisement wordings do not
contravene employment discrimination legislation, e.g. regarding race or age.
Advertisements should therefore focus upon key job requirements, location (and the need to
travel if necessary), the qualities being sought by the employer and any essential experience or
qualification. Remuneration (or guide figures) is usually also included, expressed in the most
appropriate way for the job type- hourly rate, starting salary, on-target earnings (OTE). For more
senior jobs that are advertised there may be no indication of the actual remuneration package
on the basis that this is negotiable.

B3 Preparing the shortlist

On the assumption that the advertisement has been worded well and that the most appropriate
media have been selected (e.g. trade press, national newspaper, local newspaper or staff
notice- board), the list of applicants may be a manageable length. However, it is not uncommon
to find very large numbers (say more than 100) applying for particular posts. It is important to
ensure that the shortlist represents the most suitable applicants for the job.
This may be carried out in many ways. One of the most effective is to narrow down the list or
applicants progressively by introducing new selection criteria. The first stage is to exclude those
who do not meet the requirements stated in the advertisement. It is not uncommon for this to
11
have a dramatic effect on the number to be considered. Next the employer will have some
preferred characteristics that are not included in the advertisement. Care needs to be taken to
ensure that the employer is selecting candidates on the basis of criteria that are within the law.
Selection may not be made on the basis of race, ethnic origin, disability, sex or sexual
orientation and age. Emphasis, therefore, needs to be placed on the quality and relevance of
the applicant's experience.
Many companies seek to ensure that they are (and are seen to be) complying with race
relations legislation by operating an ethnic monitoring system. This is usually achieved by
requesting that a separate form is completed by each applicant detailing their ethnic
background. These forms are detached from other written information supplied by the candidate
and kept in a central file or database so that future questions about compliance that may arise
can be answered accurately. It is essential that all selectors have been trained in the use of the
assessment tools, which are to be utilized.
B4 Reviewing the assessment tools available

Once the critical abilities for a position have been decided, the recruiter must find adequate
means of measuring them in prospective candidates. There are a number of assessment
methods. The major methods are set out below.
B4A The interview

The interview is the most popular of all selection devices. There are some doubts about how
effective it is in finding the right candidate for the job, since interviewees may be dishonest or
may behave in an uncharacteristic and unrepresentative way during the short interview period.
Interviews rely on the expertise of the interviewers, who must be able to give all of the
interviewees the same opportunities to demonstrate their suitability for the role without allowing
their personal views to cloud their objectivity. Interviewers must ensure none of their questions
can be interpreted by the interviewee as being discriminatory in nature, e.g. questions relative
to marriage, race, sexual orientation and age. Some interviewees may be very skilled and able
to perform well while others are perhaps less confident and so less able to give a good account
of themselves. A skilled interviewer will be able to see through these situations to select the
candidate who represents the best fit for the organisation.
The job competences will identify 'what demonstrates good performance' and are based around
the behaviour of people who are excellent performers in specific jobs. The characteristics can
include: motives; behaviour; attitudes or knowledge; anything that can be reliably measured.

So it is useful to remember that the main difference between job descriptions and competences
is that a job description describes what activities/tasks a job-holder gets involved in, whereas
competencies describe how individuals should behave In order that the job is done correctly.
Ideally, for any person there should be a job description and a competency profile.
Interviews are relatively inexpensive and can be used for almost any job, however, they must
always be properly planned, structured and professionally conducted.
B4B References
A reference provided by someone known to the candidate for some time (usually a previous 12
employer) is a widely used element of the recruitment process. Even though there are doubts
about their fairness, references are commonly used because they are inexpensive to devise
and administer, readily available and can cover many types of job. Owing to a fear of incurring
liability for making misrepresentations on which a new employer may rely, some employers will
not provide a reference, which offers any opinions on an ex-employee trustworthiness or
honesty. Instead, they will make only factual statements, such as stating the length of time that
the employee was a part of the workforce.
B4C Personality tests
For some jobs, personality can be an important element of good performance but can be
difficult to assess. Some employers use questionnaires to measure a person's attitudes,
opinions, values, beliefs and experiences. Others use psychometric tests, that is, tests that are
designed to measure personality traits on a universal scale, thereby allowing comparisons to be
made between different candidates on a level playing field. The interpretation of the results of
psychometric tests is a specific skill, which needs to be learned by the assessor. Some use
both methods together. Questionnaires can be written or verbal, are often multiple choice, and
are carefully researched and designed to highlight inconsistencies.
However, like interviews, personality tests can be regarded as unreliable despite the fact that
they can pick up inconsistencies. This is because a candidate may be able to answer questions
in a consistently dishonest way.
Tailor-made personality tests are very expensive to develop, although there are some relatively
inexpensive tests available 'off the shelf. These tests are limited to a narrow range of positions.
84D Intelligence tests
Intelligence tests differ from personality tests in that they rely much less on the candidate's
honesty. There is a wide range of questionnaires and psychometric intelligence tests and
considerable debate about what it is precisely that intelligence tests are testing. Many
intelligence tests measure specific abilities such as mechanical, numerical and verbal aptitudes,
while others seek to measure IQ.
Like tailor-made personality tests, tailor made intelligence tests are very expensive to develop,
although there are some relatively inexpensive ready-made tests available. These tests are also
limited to a narrow range of positions.

B4E Simulations
These are attempts to reproduce some elements of the job itself and to assess how well the
candidate can carry them out. The candidates are then assessed in terms of their intergroup
skills and their ability to deal with problems creatively and thoroughly. Simulations are time
consuming and relatively expensive to administer. They are generally used for managerial or
professional positions.
Example
A common simulation exercise used Is that of an 'in-tray. This is where examples of pieces of
work are given to the candidates and they are allowed a certain amount of time to record what
they would do to each piece of work. These are then marked by the assessors. 13
B4F Assessment centres
Assessment centres can be a valuable tool to the recruitment process and utilise the whole
range of recruitment tools. Candidates may spend one or two days being assessed by
interview, simulations and tests. It is assumed that using so many methods of assessment will
allow recruiters to make more accurate choices. Assessment centres are expensive to develop
and administer and are therefore only appropriate for managerial and professional jobs.
Assessment centres can also be used for the selection of internal candidates for posts that
require filling.
B5 Deciding which assessment tools to use

After considering all of the assessment tools available, the recruiter must decide which ones to
use for the vacant positions. As explained above, some tools are more appropriate and effective
than others for certain positions and characteristics.
Once the recruitment tools have been decided upon, arrangements will need to be made for
their use, such as ensuring interviewers and interview rooms are available, that test documents
are ready, and that assessment centre places have been reserved.
Activity
Identify the assessment tools used in your organisation for recruitment and consider whether
they are robust h for the needs of your company.
C Appraisal and reward

Appraisal is a systematic assessment of how effectively each job in the organisation is being
performed. The appraiser (person carrying out the appraisal) will seek to identify the reasons for
a particular level of performance and to identify ways to improve future performance. As we
shall see, some organisations link employees' rewards to employees' appraisals, which is why
the two are sometimes grouped together.
C1 Appraisal process
The appraisal process can be broken down into four distinct phases.

C1A Assessing the Individual's performance
The job description and competences profile are normally used as the starting point in
determining the extent to which the jobholder has met, exceeded or fallen short of the required
standards. It is this fact more than any other that should encourage the development of job
descriptions with as many measurable objectives as possible. This may be relatively easy for a
salesperson whose objectives relate to new business acquisition. The measure is externally
verifiable. Many jobs are not this straightforward, but time spent in defining measurable
performance standards reaps its reward at the appraisal stage.
There are normally two types of appraisal/feedback that should be given in the workplace: 14
feedback related to job performance and feedback related to behaviour:
Job performance involves a person's competency - whether or not they are capable of
performing the specific tasks assigned to them.
Work-related behaviour involves the way in which a person carries out their tasks.
Within this there are two types of feedback that are especially effective in the workplace:
Reinforcement - this identifies job-related behaviors and performance that contribute to

individual, group or organisational goals and encourages the individual to repeat and
develop them.
Redirection- this identifies behaviors and performance that do not contribute to individual,
group or organisational goals, and helps the individual to develop alternative tactics.
It is important that the appraiser is the person to whom the appraisee normally reports and that
the appraisal process is concerned with measuring job performance and not with personality
issues.
Reinforce:
Before moving on, make sure you fully understand the types of feedback that apply in the
workplace and identify whether the feedback normally given in your organisation is conducted in
this manner. If not, consider whether there is any action you could take to improve the appraisal
feedback normally given. Make notes in the box below.
C1B Agreeing the assessment
The next phase is to provide an opportunity for discussion and feedback to the individual about
their performance. This is usually done at an appraisal interview. The date and time should be
mutually agreed at least one week in advance. Many employers issue guidelines to employees
upon the nature of appraisal and what it is designed to achieve. It is normal for the main issues
and criteria affecting performance appraisal to be noted and agreed afterwards. In any areas
where performance has fallen short of agreed standards, the appraisee should be encouraged
to identify issues beyond their control that affected results.

Since a key aim of any appraisal system is to find mutually agreed ways of improving
performance, it is vital that the appraiser and the person being appraised agree not only on
current performance but also on what needs to be done to improve it.
C1C Identifying training and development needs
The training and development needs of the individual need to be identified. This phase should
concentrate not only on the skill requirements for the individual's current job, but also on
personal preparation for a more important job in the future.
15
C1D Setting objectives
Once the first three phases are complete, the appraiser and the person being appraised should
agree on realistic performance objectives to be achieved by the next review period. The
appraiser should indicate to the person being appraised what resources, if any, the organisation
will provide to help them achieve future objectives - such as help with training or other support
from managers.
For each identified area an action plan should be agreed with a timetable for completion. In
some companies it will be the jobholder's responsibility to ensure that these are met. So, for
example, if it is agreed that an individual requires training in the area of time management, it
would be agreed that a suitable training course be found, the overall budget would be set and a
date agreed by which time a course should have been attended. The jobholder would need to
find a suitable course within the budget and the agreed timeframe. This would then become an
item to be reviewed, usually at the next appraisal. In other companies, responsibility for finding
and booking a suitable course would rest with the appraiser or human resources department.
C1E Appraisal criteria
Any appraisal or feedback session needs to meet the following criteria in that it must be:
Specific -looking at the performance achieved, what was good and not as good.
Developmental - the appraisee is aware of the training, support and guidance they will
receive to develop or improve performance.
Motivational - the appraisee is motivated by the appraisal experience.
Reinforce
Write a quick summary of each of the four steps of the appraisal process, setting out the main
points of each:
assessing the Individual's performance:

agreeing the assessment;
identifying training and development needs;
setting objectives.
C2 Reward
Employees at all levels compare their efforts and rewards against those of their colleagues.

Rewards strongly influence employee effort and performance levels, and play an important role
in motivation and job satisfaction.
Broadly speaking, rewards fall into two categories:
Intrinsic rewards are derived from the pleasure which the individual associates with doing
the job itself, such as using personal skills to the full, dealing with problems, achieving
targets, and working with like-minded people. Intrinsic rewards tend to be more motivational
than extrinsic rewards for most employees.
Extrinsic rewards are given to the employee by the organisation and do not emerge from
doing the work itself. They include salary and wages, performance bonuses, overtime,
holiday pay and pension contributions.
16
Some rewards (both extrinsic and intrinsic) are aimed at teams and groups, as opposed to
individuals.
All organisations are interested in the effective distribution of extrinsic rewards. Currently,
businesses use a variety of guidelines for distributing rewards. The main ones are outlined in
the following section.
C2A Performance
When rewards are allocated on the basis of work performance, they motivate the individual to
perform to the best of their ability. The performance bonus is a useful tool for employers. Rather
than rewarding good performance with an increase In salary that will be effective into the future,
the giving of one-off cash bonuses as a reward from time to time encourages continuous good
performance.
Performance rewards are most appropriate where performance is easy to measure, such as in
sales positions and production lines. Performance appraisal systems incorporate ways of
demonstrating that the individual's agreed targets have been met.
As an aid to assessing performance, external examinations and tests under the auspices of an
accredited examination body give a universal guide to standards of performance. These are
only helpful where the skill being assessed is easily quantified at any time - for example,
accuracy or speed of typing. By contrast, having a qualification such as a university degree or a
professional diploma might indicate a level of knowledge, but will not be a test of performance.
C2B Effort
Some organisations reward their staff according to the amount of effort which they put into their
work- regardless of whether .this produces any tangible benefit for the organisation. The
manager's assumption is that a member of staff who works hard will eventually bring some
advantage to the organisation.
Reward for effort is appropriate where a constantly high standard is required of the worker, but
where - although it is possible to measure the amount of effort the worker is expending - it is
not always possible to link this to a definite return. Examples of the type of worker for whom
reward for effort would be appropriate include a training officer and customer relations manager.

C2C Seniority
Rewarding through seniority is becoming an increasingly outmoded method of rewarding staff,

and most employees now expect to be rewarded on the basis of merit rather than length of
service.
C2D Equality
This policy of compensation means that the same grades of employee receive the same pay
and pay rises. Such arrangements are common in partnerships where the managing partners
agree to receive equal salaries.
17
D Training and development

Training and development are necessary because recruitment and selection techniques cannot
always attract individuals who are capable of carrying out all job functions to a high
performance standard. In addition, staff within an organisation need development. For this
reason many modern businesses allocate a substantial proportion of their overall budget to
training and development.
Furthermore, a business is unlikely to meet its strategic aims and goals unless it has an
appropriately skilled management and workforce. This means there must be effective and
robust training and development starting with employee induction going all the way through to
management development.
There are other reasons why staff training is needed. For instance, jobs may change over time
because of organisational growth or new technologies, and workers need to learn how to adapt
their skills to these changes.
It is essential that training is looked upon as an investment; training for training's sake should
never be contemplated. TI1ere must be a need, which is recognised by both the manager and
trainee, and there must be outcomes that clearly link to the businesses aims and objectives.
As businesses need to continually improve performance in order to be successful, the training

and development of staff is a key enabler for business improvement and profit. Therefore, any
training delivered should be aimed at achieving one or all of the following:
Improved efficiency- achieving the same thing at lower cost.

Improved effectiveness- achieving improved results at the same cost.
Improved productivity - achieving Increased results at a lower cost.
Therefore, before training there needs to be a one-to-one meeting between the manager or
supervisor and the trainee so the trainee is clear about:
How the training and development is proposed to improve their performance in their current
or future role.
What is expected of them and how they will be supported once they have completed their
training.
How expected improvements will be measured and what feedback they will get in the
workplace.

After the training there should be a briefing between the trainee and their manager or supervisor
with the purpose of identifying:
What they learnt from the training programme.

How the learning will improve their current or future job performance.
What opportunities the trainee will have for practicing what has been learnt.
What help or support the trainee will need and from whom.
How the trainee and their manager/supervisor will measure how well the trainee puts their
learning into practice.
The trainee's performance should then continue to be measured through the performance
management process, with further training identified to aid continued development. 18
Without these key actions training can easily become a cost rather than an investment that will
help improve business performance.
D1 Identification of training needs

Job analysis (see section BlA) and performance appraisal {see section CIA) can provide a
useful guide to an individual's training needs.
Identifying skill gaps- the size of the gap between job requirements and skills available- also
helps to highlight where training is needed.
Once it has been decided that training for a particular set of skills is feasible, the next stage is
to design an appropriate programme based around what the trainee should be able to do at the
end of the training. The content of the training needs to be developed so that it helps to plug
skill gaps.
D2 Training programmes
There are a number of key areas that training needs to cover. Examples are:
Induction - what the new recruit needs to know about the company they have joined and
the basic skills they need to do their job.
Skills development for the job - these are the main skills they need for their job and any
changes that may occur to their job.
Skills to develop the person - many people have career aspirations and to enable them to
aspire to new job roles, development training will be essential.
Regulatory training - the FSA is establishing very clear competency requirements for
certain financial services roles, which means formal training must be delivered to certain
staff and they must achieve and maintain a certain level of competence for their particular
jobs.
Training can be carried out by external trainers or in-house, depending on what types of
instruction are available. When implementing a course of training, it is important to take into
account the capabilities of each participant and create a secure, stimulating teaching
atmosphere in which trial and error are permissible and the trainee has time to feel comfortable
with the new skills.

There are a number of methods of training:
On the job - this is training actually conducted at the workplace, for instance showing
someone how to do a task and then supervising them until they are proficient.
Off the job- this is training conducted away from the workplace, for instance classroom
training, internal company courses or workshops, and external courses that are carried out
away from the workplace.
Open learning - this is a structured self-training approach utilizing training materials and
books. It has the benefit that the trainee can work on the training whenever they want to,
either inside the workplace or outside, say at home.
Computer Based Training (CBT) - CBT involves the use of PC computers with CD-ROMs
with prepared training programmes. An extension of this Is E-Learning where the trainee 19
can access a library of material maintained on a central company database.
Professional Certificates and Diplomas - an example of this form of training is the CII
examinations. These examinations are a learning experience and cover a number of topics
that are key to developing competence in the profession concerned.
D3 Benefits of training
For a company to be efficient and cost effective it requires its employees to be highly competent
'in the way they conduct their job roles. This can only be achieved by training its people so they
have and can use the skills they need.
Furthermore, when people join a company today, they have an expectation that they will be not
only trained to do their jobs effectively, but also to be able to develop themselves and achieve
career aspirations. If a company does not provide the training and development expected, staff
will leave. Experience and research findings have shown that good training and development is
a key factor in helping to keep a company's staff turnover down.
It costs anything between 5,000 and 10,000 to recruit a new employee today, to train them
and develop them up to full proficiency. If a company quickly loses a person because it did not
properly support and train them, and they leave, it means the company has to start again and
find someone new. Therefore, all the costs and time spent in recruiting and training that
employee are lost.
D4 FSA training and competency requirements

People working in financial services need to be aware of the need to meet the FSA rules on
staff training and competency. These are set out in the FSA Handbook of Rules and Guidance.
The broad rules on training are that if a company's employees engage in or oversee an activity
with, or for, private customers, the company must:
determine the training needs of those people;

organise appropriate training to address the needs;
ensure the training is timely, planned, appropriately structured and evaluated.
The new rules now take the requirements further than previously. Therefore, companies need to
ensure that they keep up to date with any changes the FSA introduces as the penalties the FSA
can apply to companies can be severe.
With regard to competence, a company must not permit an employee to engage in or oversee

an activity unless they have been assessed as competent in the activity. Again, the FSA
Handbook sets out the competency requirements.
There are also rules on record keeping so a company can demonstrate compliance with the
training and competency rules.
E Motivation and morale

One of the most vital areas in managing human resources and leading teams effectively lies in
knowing how to get people to give of their best. Any amount of planning and organising will not
compensate for the effects of disinterest, frustration and boredom at work. Low productivity,
20
high turnover, absenteeism and counterproductive behaviour can often have their roots in the
poor motivation of employees. Good motivation is central to the effective management of
people.
Staff morale is partly controlled by industrial relations the management of the relationship
between managers and workers. It is also affected by job satisfaction and by the motivation of
individual employees.
E1 Motivation
There is no universally accepted definition of motivation. It incorporates all the factors that push
or pull us to behave in certain ways and is recognised by psychologists as having three
components:
Direction - what a person is trying to do.

Effort - how hard a person is trying.
Persistence- how long a person continues trying.
But what really stimulates humans to try and do anything in the first place? Human behaviour
relates to basic needs and motives.
To develop the explanation in the opening paragraph of this section, a need is an experienced
state of deficiency that pushes one to behave in a particular way. Examples of needs are
hunger, thirst and a sense of belonging.
A motive, on the other hand, pulls one's behaviour in a particular direction. For example, a
person who wishes to earn extra holiday money may be motivated to work extra hours. The
thought process behind a motive is 'How can I maximise my gains?'
So if a business is to achieve its business aims in the most effective way, a well-motivated
workforce is essential. This will also help to achieve a commitment to the business by its
people. It also needs to be remembered that managers cannot make people be motivated. The
responsibility for motivation lies with the Individual, however, what the manager can do is to
create a work environment and climate where people want to be motivated.
An effective approach to motivation is goal setting. It is based on the premise that intentions
shape actions. If work goals such as target levels of performance are specific and difficult, and if
they are accompanied by feedback from managers on how well one is doing, work performance
is usually enhanced.

So, in considering motivation it is important for a manager to:
Identify factors impacting on motivation which the manager can and cannot control or
influence. Having made this distinction the manager should focus on the factors within their
control.
Understand the people being managed; their needs and requirements.
Clarify, through individual discussion, both the needs and expectations of the manager and
subordinates.
Create a working environment which enables individuals to fulfil their needs.
If a manager does not consider these points properly, they could end up with a team that is not 21
motivated, and this will have an effect on the team's performance.
Of course poor motivation is not the only factor that could cause the kinds of symptoms you
have identified. Other factors could be contributing, from poor systems to inadequate conditions
of employment. However, if people are properly motivated, their manager should expect a lower
rate of turnover, higher productivity, better quality work, and so on.
The adoption of an effective people focused approach will mean reductions in recruitment and
training costs and efficiency gains through the retention of well skilled and experienced people.
This approach will also enable customer service levels to be increased and, ultimately,
favourably impact the bottom line. To achieve such success managers need to ensure they
create and maintain a highly motivational climate.
Managers and team leaders hold the responsibility for enabling motivation, therefore, to achieve
a motivational climate and be successful people motivators, they need to:
facilitate motivation;
be a role model and inspiration for the team; trust the team and delegate responsibly;
give praise, encourage growth and recognise contributions;
build a rapport and strong relationships;
develop the team through coaching and training;
communicate and provide regular feedback on team progress and business plans;
promote an environment that is conducive with staff motivation;
provide feedback to management on the issues that are getting in the way of successful
motivation.
Question
The results of a poorly motivated team can manifest itself In many ways. Identify five effects
that a de-motivated team can have on team performance.
E2 Industrial relations
Staff morale is high when industrial relations are good, and the human resources manager is an
important catalyst in the process of cultivating both.
Human resources managers deal with the organised labour force through three main
mechanisms based on discussion, which are described in more detail below:
joint consultation;

collective bargaining; and

conflict management.
In addition, staff can be encouraged to become more involved and take a greater interest in the
affairs of the business by being given share options or shares as part of their remuneration.
Various other profit-sharing and bonus schemes which do not involve share ownership are also
used by modern businesses.
E2A Joint consultation
Joint consultation is an important part of building rapport between managers and workers.
There is new legislation being put in place by the Government on this aspect. Involving all staff
22
in ideas and discussing proposed changes in procedure in advance with the people affected
helps morale by making-staff feel that they are participating in management decisions, and that
they have some control over their own work environment. This kind of empowerment
contributes towards a sense of worth, and demonstrates managers' respect for other employed
contributions to the business as a whole.
Joint consultation typically takes the form of meetings between representatives of the managers
and representatives of the non-managers. If communal benefits are stressed as the objectives
of such meetings, consultations will tend to be constructive.
E2B Collective management
Collective bargaining involves management and unions in the negotiation of wages and
conditions. The typical activities include research, assisting in policy formation and negotiation
with representative employee groups.
E2C Conflict management
Many organisations operate procedures that resolve disputes between management and non-
management staff. In most cases the formalisation and complexity of the disputes procedure is
directly linked to the size of the firm. Where it is formalised, the usual principle adopted is a
requirement for the employees to initiate discussions with their immediate superior (or vice
versa). Only if this process fails are matters referred to a higher level. Exceptions to this general
procedure might include allegations of sexual harassment. For some arrangements the trade
union representative may automatically become involved
A breakdown in relations can result in a strike, industrial stoppage or slow-down by workers,

which can be very expensive both for organisations and their workers. Managing conflict is
therefore an important tool in the successful management of modern businesses;
E3 Job satisfaction
Job satisfaction is made up of attitudes, which employees have to their work setting, rewards,
supervision and job de ands. When employees are satisfied with the work itself, with pay, with
their fellow workers, with supervision and with promotions, there is evidence that both their
mental and their physical health increase.

Research shows that employees who are satisfied with their jobs have more resistance to
stress and live longer. Organisations with satisfied workers also report fewer absences, lower
staff turnover and increased productivity.
However, the relationship between job satisfaction and individual performance is indirect.
Employees' performances are certainly influenced by their degree of job satisfaction, but they
are also affected by their sense of receiving a fair reward for the work they are doing. If they do
not feel they are being fairly rewarded, there is evidence that their performance fails.
F Employment and workplace legislation

23
Legislation for the workplace concentrates into the following key areas:
Data protection.
Health & safety.
Employment law.
Equality & diversity.
Human rights.
Financial Services and Markets Act (FSMA) 2000.
We will look at each of these key areas.
F1 Data protection
We looked at the Data Protection Act 1998 (DPA) in chapter 4, section H2. As stated, it is the
main piece of legislation that governs protection of personal data in the UK.
F1A Implications for the Insurance Industry
The privacy of data should be of great concern to managers in the insurance industry - both
brokers and Insurance companies. Many insurers keep significant amounts of personal data
and this data should be protected from all forms of abuse. The Act has the following
implications for die insurance industry:
There are vast amounts of personal data retained either on computer systems or in paper
files and both these fall within data protection rules.
All insurers have to operate strict conditions on the processing of sensitive data -
information about racial or ethnic origin, political opinions, religious or other beliefs, trade
union membership, health, sexual life, and criminal convictions and offences:
Insurers must comply with the eight principles for handling the data.
All insurance companies are required to have a nominated data controller.
Trading via the internet increases the risk of a breach of security with hackers searching for
sensitive information, e.g. medical records etc.
Some insurance companies use 'junk mail' to market products. The Act specifically allows
individuals to prevent their personal details being used for direct 1narketing purposes. If the
insurance companies disclose data without proper authorization, then it may lead to a
criminal prosecution.
The Act equally applies to UK held data used by outsourced operations, including those that
are overseas.

F2 Health and safety

The heading Health and Safety covers three pieces of legislation and a set of standards. These
are:
Offices, Shops and Railway Premises Act 1963;

Health and Safety at Work etc. Act 1974;
Health and Safety (Display Screen Equipment) Regulations 1992; and
The Health & Safety Executive Stress Management Standards.
F2A Offices, Shops and Railway Premises Act 1963 24

This Act extended to offices, shops and railway premises the same sort of protection that had
long existed for factory employees. It laid down requirements in the following areas:
cleanliness, overcrowding, temperatures, ventilation, lighting;

sanitary conveniences, washing facilities, drinking water;
accommodation, seating arrangements, eating facilities;
floors, passages and stairs;
fencing of exposed machinery, cleaning of machinery;
training and supervision for work with dangerous machinery;
prohibition of heavy work;
first aid, fire protection.
F2B Health and Safety at Work etc. Act 1974
This Act is aimed at:
maintaining or improving standards of health, safety and welfare of persons at work;

protecting persons other than persons at work against risks to health or safety arising out of
or in connection with the activities of persons at work;
controlling the emission into the atmosphere of noxious or offensive substances from
premises of any class prescribed for the purposes of this paragraph;
controlling the keeping and use of explosives or highly flammable or otherwise dangerous
substances, and generally preventing the unlawful acquisition, possession and use of such
substances; and
setting up a Health and Safety Commission and Executive to be responsible to the
Secretary of State for Employment and other Ministers for administering the legislation.
It puts responsibilities on both employers and employees.
With regard to employers, every employer has the responsibility to ensure the health and safety
and welfare at work of all employees so far as is reasonably practicable. This responsibility
includes in particular:
the provision and maintenance of plant and systems of work that are, so far as is
reasonably practicable, safe and without risks to health;
arrangements for ensuring so far as is reasonably practicable, safety and absence of risks
to health in connection with the use, handling, storage and transport of articles and
substances; the provision of such instruction, training and supervision as is necessary to
ensure, so far as is reasonably practicable, the health and safety at work of employees;

so far as is reasonably practicable as regards any place of work under the employer's
control the maintenance of it in a condition that is safe and without risks to health and the
provision and maintenance of means of access to and egress from it that are safe and
without such risks;
the provision and maintenance of a working environment for employees that is, so far as is
reasonably practicable, safe, without risks to health, and adequate as regards facilities and
arrangements for their welfare at work.
The appointment of a senior company officer who is responsible for health and safety in the
organisation and the compliance with the Health & Safety regulations.
For employees it places a duty while at work:

to take reasonable care of the health and safety of themselves and of other persons who 25
may be affected by their acts or omissions at work; and
as regards any duty or requirement Imposed on the employer or any other person or under
any of the relevant statutory provisions, to co-operate with them so far as is necessary to
enable that duty or requirement to be performed, or complied with.
In addition to this general outline It is necessary to be acquainted with the Codes of Practice
relating to health and safety and time off for the training of Safety Representatives. Guidance
notes are also available from HMSO detailing the provisions of the Health and Safety at Work
etc. Act in relation to Safety Representatives and Safety Committees.
F2C Health and Safety (Display Screen Equipment) Regulations 1992
This legislation applies to all workers who regularly se VDUs for a significant part of their normal
work.
There are two key problems when working with DSE, namely visual fatigue and postural fatigue.
There is also the problem or repetitive strain injury (RSl).
The actions employers must take to reduce the risks associated with DSE are:
ensuring the equipment used meets certain minimum standards (e.g. the screen should
have adjustable controls for brightness and contrast). All equipment used must now meet
the requirements of the Act;
planning work so there are breaks or changes in activity;
training employees in the healthy and safe use of their work station equipment. including
correct height and posture;
keeping a record of what has been done.
F2D Health & Safety Executive Stress Management Standards
The Health & Safety Executive (HSE) has now become concerned at the high level of work-
related stress being reported by workers in the UK. Consequently, the HSE has developed a set
of Stress Management Standards (SMS) as guidance to employers with the aim of reducing the
number of days employees go off sick, or who cannot perform well at work because of stress.
The aim of this emphasis is that the HSE wants employers to work with employees and their
representatives to implement the SMS together with a process of continuous improvement, as
this would be of benefit to both employees and business.
The Management Standards define the characteristics, or culture, of an organisation where

stress is being managed effectively. They cover six key areas of work design that, if not
properly managed, are associated with poor health and well-being, lower productivity and
increased sickness absence. In other words, the six Management Standards cover the primary
sources of stress at work. These are:
Demands - such as workload, work patterns and the work environment.

Control - such as how much say the person has in the way they do their work.
Support - such as the encouragement, sponsorship and resources provided by the
organisation, line management and colleagues.
Relationships - such as promoting positive working to avoid conflict and dealing with
unacceptable behaviour.
Role - such as whether people understand their role within the organisation and whether the 26
organisation ensures that they do not have conflicting roles.
Change - such as how organisational change (large or small} is managed and
communicated.
The HSE considers that employers have a duty to ensure that risks arising from work activity
are properly controlled. Therefore, the Management Standards approach helps employers work
with their employers and representatives to undertake risk assessment for stress.
At the present time the SMS are guidance, not regulations or an approved Code of Practice, but
they do give employers a workplace standard and a practical framework to undertake the
statutory risk assessment process.
F3 Employment law
There is a heavy concentration on the area of employment law. Employment law governs the
rights and obligations of employers and employees and has grown substantially in the UK since
the 1960s. In particular, laws governing the conduct of industrial relations have had a significant
impact on the way in which workers are managed. Successive Conservative governments
brought about a weakening of trade unions' power. In addition, enlightenment about social
integration and fairness brought new legislation against discrimination by employers. Many of
the laws enacted over the last 30 years of the twentieth century greatly influenced the way
people were treated at work. We shall look at the most important statutes and the areas they
cover.
The following legislation comes within employment law:
Employment Protection Act 1975;

Employment Rights Act 1996;
Employment Acts 1980, 1982, 1984, 1989, 1990;
Employment Act 2002;
Maternity and paternity regulations;
Flexible working;
Minimum wages regulations;
Dispute Resolution Regulations 2004;
Employment Act 2008;
Information and Consultation Directive;
Fixed Term Employees (Prevention of Less Favourable Treatment) (Amendment)
Regulations 2008;
Working hours regulations.

F3A Employment Protection Act 1975
This Act and its successor, the Employment Protection (Consolidation) Act 1978, cover a whole
range of issues affecting the contract of employment between an individual and an employing
organisation. They deal with such issues as:
the statutory requirements for terms of employment;

periods of notice of termination of contracts of employment; the employee's entitlement to
an itemized statement of pay; special treatment of pregnant women;
suspension from work on medical grounds; time off for trade union activities;
27
unfair dismissal and redundancy.
It is also important to remember that the UK is a member of the European Union. This means
that the regulations and directives made by the European Commission are binding on Member
States. The EU legislation has had a major impact on employee protection, consumer
protection and competition policy.
We will now look at the key requirements laid down with regard to contracts of employment.
Once a person agrees a job offer, they enter into a contract that gives both the employee and
employer rights and duties. Some of the rights and duties begin from the time of accepting a job
offer, while others begin when the person actually starts work. In certain cases it will be
necessary for the employee to work a certain amount of time before full rights can be enjoyed. It
is not necessary for the full contract of employment to be in writing, however, if it is it helps to
avoid possible problems in the future. It is necessary though for an employee to receive a
written statement of the main terms of the contract within two months of starting work.
Contracts can include other details beyond the statutory ones. For example there may be a
requirement to wear a uniform or to drive company vehicles. All these written items become a
part of what is called the express terms of a contract. However, there are other issues that may
not be in writing, but have been held by courts to be implied in a contract. These implied terms
include:
that a person will attend for work;

that employees will follow reasonable instructions from their employer;
that the employee acts in good faith towards the employer (e.g. the employee is not taking a
job to carry out industrial espionage);
that the employee takes reasonable care in the performance of their duties.
There are other rights that come within a contract of employment, and the following are some of
the statutory rights that cannot be signed away by the employer or employee. Therefore, an
employee is entitled to:
equal pay with members of the opposite sex providing it is like work or of equal value;
maternity and paternity rights & benefits;
parental leave;
an itemized pay statement;
not to have any unlawful deductions from an employee's pay;
be paid when an employee is laid off;
redundancy pay (subject to service conditions);

part-time/contract workers to be treated in the same manner as full-time employees;

statutory sick pay;
paid time off for certain duties;
belong or not belong to a trade union;
a safe system of work;
not to be unfairly dismissed;
not to be discriminated against on grounds of race, sex, marriage or disability;
employee access to their personal data held by the employer;
be able to make disclosures about illegal activities on the part of the employer.
The Act also set up the Arbitration, Conciliation and Advisory Service (ACAS). ACAS is a
statutory, non-departmental public body whose mission is to improve the performance and 28
effectiveness of organisations by providing an independent and impartial service to prevent and
resolve disputes and to build harmonious relationships at work. It is frequently used to resolve
wage disputes between the management of an organisation and its trade union members and
workers.
F3B Employment Rights Act 1996
This Act enhanced the Employment Protection Act 1975 and the Employment Protection
(Consolidation) Act 1978. Some sections of this Act are given over to maternity provisions. In
general terms, all female employees, regardless of their length of service or hours of work, have
the right to maternity leave. The section of the Act that deals with maternity also covers
regulations affecting notification of maternity leave and the right to return to work. However,
these rights were improved under the Maternity and Paternal Leave Regulations 2001/2002.
The Act also covers employees' rights to have the particulars of their employment in writing, the
right to an itemised pay statement, the right not to suffer unauthorised pay deductions from
wages, and other provisions concerning termination of employment and the right not to be
unfairly dismissed. Examples of unfair dismissals are:
Striking.
For pregnancy.
For membership of a trade union.
Where the employee has brought proceedings to enforce a statutory right.
For health and safety reasons.
Following the sale of the employer's business to a new employer (this is covered in TUPE
regulations).
For taking statutory parental or domestic leave.
The Act states the grounds for fair dismissal although there are a number of conditions relative
to these:
Capability or qualifications to perform the work (this includes skill, health or other physical or
mental quality).
Conduct of the employee.
Redundancy.
While companies who dismiss employees always think they have dismissed someone fairly, it is
the decision of the tribunals and courts to decide whether a particular case is unfair or not.

F3C Employment Acts
The Employment Acts 1980, 1982, 1984, 1988, 1989 and 1990 represent a cumulative
strengthening of the law relating to industrial relations and deregulation in the workplace.
In particular, they curb the power of trade unions and make sympathy strikes and secondary
picketing more difficult.
F3D Employment Act 2002
The Department of Trade and Industry (DTI) introduced a new Employment Bill in November
2001, which became the Employment Act 2002. It was a wide ranging package covering:
29
work and parents;
dispute resolution in the workplace; improvements to employment tribunal procedures; the
introduction of an equal pay questionnaire;
provisions to implement the Fixed Term Working Directive;
a new right to time off work for union learning representatives;
work focused interviews for partners of people receiving working-age benefits; data sharing
provisions.
The Act came into force in stages.
F3E Maternity and paternity regulations
The change in government in 1997 led to new 'family-friendly' employment policies being
implemented, many of which became law between 1999 and 2002 and are still being extended.
Statutory maternity rights have been established for many years, however; further
improvements were introduced in 2003. Through the Maternity and Parental Leave Regulations
2001/2002, all female employees are now entitled to a minimum of 52 weeks. This is made up
of 26 weeks ordinary maternity leave, and 26 weeks of additional maternity leave. Also, the
payment period for Statutory Maternity Pay (SMP) and maternity allowance is now 39 weeks.
SMP is paid by employers and then reimbursed by the Treasury.
Notice of taking maternity leave is now 28 days. Also the notice a woman must give if she is
changing her date of return from maternity leave is eight weeks.
Through the Maternity and Parental Leave Regulations 2001/2002 paternal rights were put in
place. In this fathers gained a statutory right to paid paternal leave for up to two weeks, to be
taken within the first 56 days of the baby's birth. The payments are similar to maternity pay, and
there are similar rights for non-discrimination against a father taking this leave.
In addition working adoptive parents have the right to 26 weeks paid and a further 26 weeks
unpaid leave.
Further changes came into force from 2011 for parents of children due on or after the 3 April
2011 where there is a new right to additional paternity leave (APL) for fathers up to a maximum
entitlement of 26 weeks to care for the child if the mother returns to work before using her full
entitlement to maternity leave. This effectively gives mothers the right to transfer a proportion of
their paid leave to their partner.

F3F Flexible working
Mothers and fathers of young children under 6, or disabled children under 18, also now have
the right to request a flexible working arrangement. Employees have a statutory duty to
consider such requests seriously and according to a set procedure. They will only be able to
refuse requests where they have a clear business reason.
F3G Minimum wages regulations
Legislation lays down a clearly defined level of hourly pay to employees and directors of a
company and came into force as the National Minimum Wages Regulations in 1999. It is
important to remember that this is an area where no regional or sectorial wage variations are
30
accepted by the authorities.
The Low Pay Commission establishes the actual level of the minimum wage and they usually
review this every year. The hourly rate applies to all workers whether part or full-time,
temporary, or employed through an agency etc. There are no options to opt out for the
employee or employer and overtime cannot be used towards working out compliance with the
regulations. However, the wage must be the minimum paid for all the hours during which a
worker is required to be at the place of work and available for work. The requirement to pay the
minimum wage is not dependent on the performance of the employee. A company must keep
adequate records on pay to prove that the rate is being paid. HM Revenue & Customs (HMRC)
is empowered with enforcement rights. Non-compliance is a criminal offence and penalties are
incurred accordingly.
F3H Dispute Resolution Regulations 2004
From 1 October 2004 new statutory procedures applied when an employer sought to dismiss or
discipline an employee, and when an employee wanted to raise a grievance in the workplace.
The aim of the procedures was to improve dispute resolution and reduce the number of cases
resulting in tribunal. These regulations have now been repealed through the new Employment
Act 2008, which is outlined below.
F3I Employment Act 2008
Key parts of this piece of employment legislation came into force in April2009 and which
included the repeal of the statutory dismissal and grievance procedures outlined in section F3H.
These statutory procedures have now been replaced with a requirement that employers follow
the ACAS Code of Practice on discipline and grievance.
Under this new regime, employment tribunals may take into account a failure to follow the code
when assessing compensation. There are other important changes introduced under this
legislation relating to employment tribunals' powers to determine cases and the extension of
ACAS's powers to conciliate in disputes.
F3J Information and Consultation Directive
This Directive requires employees to be informed and consulted on a range of business

matters. Employee representatives should receive appropriate information and provide the
employer with feedback on issues such as the company's economic situation, employment
prospects and substantial changes in work organisation or contractual relations, including
redundancies and transfers. Companies with less than 50 employees are not affected.
However, regardless of the number of employees, 10% of the workforce must request an
Information and Consultation procedure before an employer needs to act.
F3K Fixed Term Employees (Prevention of Less Favourable Treatment)

(Amendment) Regulations 2008
Previously, employees under fixed-term contracts who were employed through an agency had a
different entitlement to statutory sick pay in comparison to other workers. However, as from
31
October 2008, agency workers on contracts of less than three months will be entitled to receive
statutory sick pay during periods of sickness absence.
F3L Working hours regulations
The Working Time Regulations 1998 were introduced in October 1998 to comply with the
European Commission's Working Hours Directive. The Regulations create rights and
obligations relating to work and rest.
The principal provisions are:
a limit on the average weekly working time to 48 hours, although individuals can choose to
work longer;
a limit on night worker's average normal daily working time to eight hours;
a requirement to offer health assessments to night workers;
minimum daily and weekly rest periods;
rest breaks at work if working day is longer than six hours;
paid annual leave;
a worker is entitled to a rest period of eleven consecutive hours between each working day;
a worker is entitled to an uninterrupted rest period of not less than 24 hours in each seven
day period. This may be averaged over a two week period, i.e. a worker is entitled to two
day's rest over a fortnight.
The Regulations give a higher level of rights for adolescent workers, i.e. those who are over the
school leaving age, but under 18. The rights cover:
health assessments for night work;

minimum daily and weekly rest periods;
rest breaks at work.
The Regulations provide for a new mechanism for employers to agree working time
arrangements with workers who do not have any terms or conditions set by collective
agreement. This is known as a working agreement. They also protect workers from being
discriminated against for asserting their rights. This means no one can be forced to work more
than the Regulations permit, and the employer cannot take action against the employee for not
doing so.
The 1998 provisions were then enhanced with the Working Time Regulations 1999. These
concentrate on the coverage of the regulations, the types of agreements, which can be made,

and the average of the 48 hour week. The principal differences are:
The only groups of employees who can claim exemption are those whose working time is
not measured and who determine when and where they work, like the self-employed.
Three types of workforce agreements are defined as, Collective, Relevant and Workforce:
- Collective agreements are defined as those between an independent trades union and
an employer;
- Relevant are any legally binding agreement in writing between a worker, or a group of
workers and their employer;
- Workforce agreements are a mechanism new to the Regulations. 1hese allow
employers to reach agreements with the whole workforce or a group of workers within 32
it. They can have effect for no more than five years. To be valid the agreement must be
in writing and circulated to all people to whom it refers. Only staff representatives who
have been elected by secret ballot can negotiate them with the employers.
Where individuals choose to work more than the limit of 18 hours per week, the employer must
draw up an agreement in writing. This agreement must be capable of being unilaterally ended
by the worker. It can include a three months' termination period, but if no notice period is
included, the period is seven days. However, the ability to work more than 18 hours per week is
an opt-out granted to the UK and some other European countries. There was a move to end
this opt out but European legislation talks broke down in April 2009 with no agreement.
The 1998 Regulations were amended further in 2001 through the Working Time (Amendment)
Regulations 2001 in that the previous qualifying period for four weeks' leave after 13 weeks'
employment no longer applies, so employees now have the right to receive paid annual leave
from the first day of their employment. In 2002 further amendments were made so as to protect
workers aged 15-18. This restricts the working time of 'young workers' to a maximum of eight
hours a day, 40 hours per week. There are also some further restrictions within these
regulations as well.
In 2007 the Working Time (Amendment) Regulations 2007 were introduced. These regulations
introduced an increase in the minimum annual holiday entitlement (including bank holidays)
from 4 weeks to 5.6 weeks. This increase was introduced in two phases, namely in October
2007 and April 2009. This took the total annual leave entitlement for a full-time worker (working
a five-day working week) to 28 days.
F3M Agency Workers Regulations 2010
These came into force on 1 October 2011. The regulations require temporary agency workers in
the UK to be given equal treatment comparable to permanent employees after 12 weeks on the
job. This is to comply with the EU Temporary Agency Workers Directive 2008.
F3N Pensions Bill
A Bill was introduced to Parliament on January 2011, which will require employers to
automatically enrol employees into a pension scheme from 2012.It also brings forward the
increase in State pension age to 66 by 2020 and brings women's State pension age in line with
men's to 65 by 2018.

F4 Equality and diversity

This is the term used to cover discrimination at work. Over the years there have been numerous
pieces of legislation to cover this aspect; however, from October 2010 these acts and
regulations were incorporated into the Equality Act 2010, which also widens the scope of
discrimination. The Act does not apply to Northern Ireland.
As this is such an important piece of legislation it is important to fully understand the extent of
the Equality Act 2010, therefore, it is useful to have an appreciation of the purposes of the
previous legislation. In this context there were five main acts and several sets of regulations that
are concerned with discrimination:
33
Equal Pay Act 1970;
Sex Discrimination Acts 1975 & 1986;
Sex Discrimination Act 1975 (Amendment) Regulations 2008
Employment Equality (Sexual Orientation) Regulations 2003
Race Relations Act 1976;
Disability Discrimination Act 1995;
Employment Equality (Age) Regulations 2006.
The principle behind this legislation is that it is unlawful to discriminate on the grounds of sex,
disability, marital status, sexual orientation, age, race, skin colour, ethnic or national origin.
F4A Equal Pay Act 1970
The Equal Pay Act 1970 made it unlawful for employers to discriminate between men and
women in their pay and conditions where they are doing the same or similar work; work rated as
equivalent; or work of equal value. The Act applied to both men and women but did not give
anyone the right to claim equal pay with a person of the same sex - any comparison must be
with a person of the opposite sex. It covers both pay and other terms and conditions such as
piecework, output and bonus payments, holidays and sick leave.
European law extended the concept of equal pay to include redundancy payments, travel
concessions, employers' pension contributions and occupational pension benefits. This means
that even though a man and a woman are receiving the same basic rate of pay there may still
be a breach of the principle of equal pay because other benefits (such as a company car,
private health care etc.) are not provided on an equal basis. The Equal Pay Act applied to pay
or benefits provided by the contract of employment. The Sex Discrimination Acts (referred to
below) cover non-contractual arrangements including benefits such as access to a workplace
nursery or travel concessions.
F4B Sex Discrimination Acts 1975 and 1986
The Sex Discrimination Acts 1975 and 1986 made it unlawful to give less favourable treatment
to employees on the grounds of sex or marital status. It is an offence for a person to
discriminate against another on grounds of gender or marital status when determining who will
be offered a job or in regard to the terms and conditions of the job. It is also illegal to deny
access to training and promotion on the grounds of gender.
There are exceptions where the gender or marital status of the person required is a genuine
occupational qualification, for example for reasons of physiology.

The Sex Discrimination Act 1975 established the Equal Opportunities Commission.
In 2008 the Sex Discrimination Act 1975 (Amendment) Regulations 2008 was introduced. The
two key changes introduced by these regulations were the removal of the distinction between
the rights of employees on ordinary and additional maternity leave. Under this change, the
same employment benefits must be afforded during additional maternity leave as is awarded in
ordinary maternity leave. Women also benefited from a change to the rules for calculating
bonuses for employees on maternity leave. During maternity leave employees are entitled to
receive any bonuses that fall outside the definition of 'remuneration:
F4C Employment Equality (Sexual Orientation) Regulations 2003 34
These regulations made it unlawful to discriminate on the grounds of sexual orientation,

including direct or indirect discrimination, victimization and harassment.
F4D Race Relations Act 1976
This Act made job discrimination on racial grounds unlawful. It also established the Commission
for Racial Equality, which has a broader duty to work towards the elimination of all
discrimination on the grounds of race.
F4E Disability Discrimination Act 1995
This Act made it unlawful to discriminate in certain specified circumstances on the grounds of
disability. The employment provisions of the Act made all UK employers of20 or more
employees liable for discriminating against disabled job applicants and employees in respect of
selection arrangements. These included recruitment, the terms on which employment is offered,
terms and conditions of employment, opportunities for promotion, transfer or training,
employment benefits and dismissal or any other detrimental treatment.
F4F Employment Equality (Age) Regulations 2006
Discrimination on the basis of age became unlawful in the.UK in October 2006 with the
introduction of these regulations. Like the other discrimination legislation, its purpose was to
ensure that staff are treated fairly based on their merits.
Employees are individually responsible but employers may additionally be responsible for the
actions of their employees, e.g. failing to take reasonable steps to avoid harassment.
It applied to all workers (employed and self-employed) including those in vocational training and
covers all ages. Only exceptions that are based on genuine occupational requirements are
allowed but in practice, these will be difficult to prove. It will be necessary to demonstrate a 'test
of objective justification' to show they are pursuing a legitimate aim.
Discrimination includes:
direct discrimination such as stating a minimum or maximum age;
indirect discrimination refers to criteria, policies or benefits which may discriminate, e.g.
setting criteria for minimum periods of experience for a job application that younger people

cannot meet. Whether intentional or not, this again is unlawful;

harassment or victimization. This obviously includes violent conduct but may also include
teasing, name calling or other behaviour which is regarded as upsetting.
This most directly affects the following areas:
Recruitment and selection. Age discrimination means that no one should be

disadvantaged because of their age. This means that using phrases such as 'applicants
should be age 30-40' or 'seeking a mature person' is discriminatory in a recruitment
advertisement. Likewise, specifying that applicants should have 'a minimum of x years
experience' should be avoided as this might disadvantage younger applicants. In what
might sound like a minefield, emphasis needs to be placed on the quality and relevance of
35
the applicant's experience.
Promotion. Age or service should not be seen as a barrier - anything where people are
described as 'too old to be considered' or 'too young' may be considered discriminatory.
Redundancy. This must be based on job-related criteria. There are examples where
employers have been tempted to make those closest to retirement redundant. This
approach is considered discriminatory.
Retirement. Compulsory retirement below age 65 is unlawful. There is no need to set a
compulsory retirement age but enforced retirement below age 65 needs to be justified
(again, this would be difficult in practice). Employees also have a right to request to work
beyond age 65 or all other retirement age set by the company act the employer has a duty
to consider such requests.
F4G Equality and diversity in recruitment
Over the years there have been many complaints to tribunals about unfair discrimination in
recruitment processes. This can happen at every stage in the recruitment process, for instance:
Job and person description - setting the requirements that are needed for a job too high.
Examples are conditions of age, mobility, length of service or experience (these could
disadvantage women or disabled people). Job descriptions should not imply that only
people from one sex are more likely to be able to do the job.
Application forms - questions that suggest an organisation could discriminate on the
grounds of race, sex or marriage. These cause people to believe they may not be treated
fairly. Examples are number and age of children, parents' occupations, are they planning to
get married or have children.
Job advertising these must be worded so that there is no implication that any form of
discrimination could occur.
Interviewing - questions should not be asked about marriage, marital status or children and
age. It is particularly important not to ask questions about domestic arrangements.
Questions for disabled applicants should focus on their ability to do the job, not on their
disability.
Final selection - it is important to avoid getting into situations where discrimination can
occur. This can be overcome by ensuring there is a systematic matching of the information
obtained about the candidate with the job specification, and the keeping of notes on the
reasons for accepting or rejecting candidates.
It is essential that companies have in place clear policies and processes on equality and
diversity and that these are strictly enforced and followed by all employees. If this is not done, a
company can quickly find itself being called to a tribunal and having to defend itself. Even
unsuccessful recruitment candidates can take a company to a tribunal if they consider they

were discriminated against in the recruitment and selection process. If a company loses a case
it can be expensive and the resultant publicity could impact on the public image of that
company.
All these elements still apply under the new legislation, but there are now further requirements
to meet and these are outlined below in the general changes the Equality Act will bring about.
F4H Equality Act 2010
This Act mostly came into effect on the 1 October 2010, but the implementation of some parts
will not come into effect until 2011, 2012 and 2013.
36
The purpose of the Act is to tidy up and widen the laws already in place to prevent inequality
and discrimination.
To achieve this both the Labour and Coalition Governments considered it necessary to
streamline the law, so as to provide help to people to understand their rights, and to help
businesses to comply with the law. The reasons for this are that:
while the discrimination laws have helped to make progress on equality, they have
developed over more than 40 years, and have become complex and difficult for people to
understand and navigate;
there are currently a number of major pieces of discrimination legislation, around 100
statutory instruments setting out rules and regulations and a high volume of guidance pages
and statutory codes of practice.
Consequently, all this legislation is replaced with a single Act, which forms the basis of practical
guidance for employers, service providers and public bodies.
In a 2009 Government paper entitled 'A Fairer Future' it was summarized that the new Act
would strengthen equality law by:
1. Introducing a new public sector duty to consider reducing socioeconomic inequalities;

2. Putting a new Equality Duty on public bodies;
3. Using public procurement to improve equality;
4. Banning age discrimination outside the workplace;
5. Introducing gender pay and equality reports;
6. Extending the scope to use positive action;
7. Strengthening the powers of employment tribunals:
8. Protecting carers from discrimination;
9. Protecting breastfeeding mothers;
10. Banning discrimination in private members' clubs; and
11. Strengthening protection from discrimination for disabled people.
The main parts that are likely to impact on employment law for the financial services industry
are 5, 6, 7 and 11.
To understand the impact of this Act in employment terms you can access a later reference
paper on the Government website www.equalities.gov.uk and access the pdf document
entitled 'The Equality Act 2010- Easy Read:
An element within the new Act is that the types of discrimination have been redefined. The

Government Equalities Office ACAS in their publication The Equality Act - What's new for
employers? sets out the key changes. These are summarised below in sections F41 F4L,
however, it would be useful to access this guide on the Government Equalities Office website
and review the full document.
F4I What's new in the Equality Act 2010?
For an employer, the obligations remain largely the same. The Act harmonises and replaces
previous legislation (such as the Race Relations Act 1976 and the Disability Discrimination Act
1995) and ensures consistency in what an employer will need to do to make the workplace a
fair environment and to comply with the law.
37
The Equality Act covers the same groups that were protected by existing equality legislation-
age, disability, gender reassignment, race, religion or belief, sex, sexual orientation, marriage
and civil partnership and pregnancy and maternity. These are now called 'protected
characteristics.
The Act extends some protections to characteristics that were not previously covered, and also
strengthens particular aspects of equality law. As a result, employers may need to review and
change some of their policies and practices.
F4J Types of discrimination: definitions
Direct discrimination - occurs when someone is treated less favourably than another person
because of a protected characteristic they have or are thought to have (see perceptive
discrimination below), or because they associate with someone who has a protected
characteristic (see associative discrimination below). The full guide provides an example of
direct discrimination.
Associative discrimination - already applies to race, religion or belief and sexual orientation. It
is now extended to cover age, disability, gender reassignment and sex. This is direct
discrimination against someone because they associate with another person who possesses a
protected characteristic. The full guide provides an example of associative discrimination.
Perceptive discrimination - already applies to age, race, religion or belief and sexual
orientation. It is now extended to cover disability, gender reassignment and sex. This is direct
discrimination against an individual because others think they possess a particular protected
characteristic. It applies even if the person does not actually possess that characteristic. The full
guide provides an example of associative discrimination.
Indirect discrimination - already applies to age, race, religion or belief, sex, sexual orientation
and marriage and civil partnership. It is now extended to cover disability and gender
reassignment.
Indirect discrimination can occur when there is a condition, rule, policy or even practice in a
company that applies to everyone but particularly disadvantages people who share a protected
characteristic. Indirect discrimination can be justified if an employer can show that they acted
reasonably in managing their business, i.e. that it is 'a proportionate means of achieving a
legitimate aim: A legitimate aim might be any lawful decision made in running the business or
organisation, but if there is a discriminatory effect, the sole aim of reducing costs is likely to be
unlawful.

Being proportionate means being fair and reasonable, including showing that the employer
looked at 'less discriminatory' alternatives to any decision made. The full guide provides an
example of indirect discrimination.
Harassment - is 'unwanted conduct related to a relevant protected characteristic, which has the
purpose or effect of violating an individual's dignity or creating an intimidating, hostile,
degrading, humiliating or offensive environment for that individual:
Harassment applies to all protected characteristics except for pregnancy and maternity and
marriage and civil partnership. Employees are now able to complain of behaviour that they find
offensive even if it is not directed at them, and the complainant need not possess the relevant
38
characteristic themselves.
Employees are also protected from harassment because of perception and association. The full
guide provides some examples of harassment.
Third party harassment - already applies to sex. It is now extended to cover age, disability,
gender reassignment, race, religion or belief and sexual orientation.
The Equality Act makes an employer potentially liable for harassment of employees by people
(third parties) who are not employees of the company, such as customers or clients. An
employer will only be liable when harassment has occurred on at least two previous occasions,
the employer is aware that it has taken place, and has not taken reasonable steps to prevent it
from happening again. The full guide provides an example of third party harassment. However,
the UK Government has now announced that it will consult to remove the "unworkable"
requirement under this Act in order for employers to take reasonable steps to prevent
harassment of their staff by third parties.
Victimisation - occurs when an employee is treated badly because they have made or
supported a complaint or raised a grievance under the Equality Act; or because they are
suspected of doing so. An employee is not protected from victimisation if they have maliciously
made or supported an untrue complaint.
There is no longer a need to compare treatment of a complainant with that of a person who has
not made or supported a complaint under the Act. The full guide provides an example of
victimisation.
F4K The protected characteristics: key points
Age (no change)

The Act protects people of all ages. However, different treatment because of age is not unlawful
direct or indirect discrimination if an employer can justify it. Age is the only protected
'characteristic that allows employers to justify direct discrimination.
While the Act continued to allow employers to have a default retirement age of 65, this was
repealed with the Employment Equality (Repeal of Retirement Age Provisions) Regulations
2011, which came into force on 6 April 20 II. It introduced transition arrangements for the
removal of the Default Retirement Age (ORA). The Regulations also repeal sections of
equalities legislation and the Employment Rights Act 1996 relating to retirement. This means
that, from 1 October 2011, compulsory retirements will be age discrimination and unfair
dismissal unless the employer can justify the dismissal as a proportionate means of achieving a

legitimate aim.
Disability (new definition and changes)

The Act has made it easier for a person to show that they are disabled and protected from
disability discrimination. Under the Act, a person is disabled if they have a physical or mental
impairment which has a substantial and long-term adverse effect on their ability to carry out
normal day-to-day activities, which would include things like using a telephone, reading a book
or using public transport.
As before, the Act puts a duty on an employer to make reasonable adjustments for staff to help
them overcome disadvantage resulting from an impairment (e.g. by providing assistive
technologies to help visually impaired staff use computers effectively).
39
The Act includes a new protection from discrimination arising from disability. This states that it is
discrimination to treat a disabled person unfavourably because of something connected with
their disability (e.g. a tendency to make spelling mistakes arising from dyslexia). This type of
discrimination is unlawful where the employer or other person acting for the employer knows, or
could reasonably be expected to know, that the person has a disability. This type of
discrimination is only justifiable if an employer can show that it is a proportionate means of
achieving a legitimate aim.
Additionally, indirect discrimination now covers disabled people. This means that a job applicant
or employee could claim that a particular rule or requirement an employer has in place
disadvantages people with the same disability. Unless the employer can justify this, it would be
unlawful.
The Act also includes a new provision, which makes it unlawful, except in certain
circumstances, for employers to ask about a candidate's health before offering them work.
Gender reassignment (new definition)

The Act provides protection for transsexual people. A transsexual person is someone who
proposes to, starts or has completed a process to change his or her gender. The Act no longer
requires a person to be under medical supervision to be protected - so a woman who decides to
live permanently as a man but does not undergo any medical procedures would be covered.
Transgender people such as cross dressers, who are not transsexual because they do not
intend to live permanently in the gender opposite to their birth sex, are not protected by the Act.
It is discrimination to treat transsexual people less favourably for being absent from work
because they propose to undergo, are undergoing or have undergone gender reassignment
than they would be treated if they were absent because they were ill or injured. Medical
procedures for gender reassignment such as hormone treatment, should not be treated as a
'lifestyle' choice.
Marriage and civil partnership (no change)

The Act protects employees who are married or in a civil partnership against discrimination.
Single people are not protected.
Pregnancy and maternity (no change)

A woman is protected against discrimination on the grounds of pregnancy and maternity during
the period of her pregnancy and any statutory maternity leave to which she is entitled. During
this period, pregnancy and maternity discrimination cannot be treated as sex discrimination.
The full guide provides an example. An employer must not take into account an employee
period of absence due to pregnancy-related illness when making a decision about her

employment.
Race (no change)

For the purposes of the Act 'race' includes colour, nationality and ethnic or national origins. A
racial group can be made up of two or more different racial groups (e.g. Black Britons).
Religion or belief (no change)

In the Equality Act, religion includes any religion. It also includes a lack of religion, in other
words employees or jobseekers are protected if they do not follow a certain religion or have no
religion at all. Additionally, a religion must have a clear structure and belief system. Belief
means any religious or philosophical belief or a lack of such belief. To be protected, a belief
must satisfy various criteria, including that it is a weighty and substantial aspect of human life
40
and behaviour. Denominations or sects within a religion can be considered a protected religion
or religious belief. Humanism is a protected philosophical belief but political beliefs would not be
protected. Discrimination because of religion or belief can occur even where both the
discriminator and recipient are of the same religion or belief.
Sex (no change)

Both men and women are protected under the Act.
Sexual orientation (no change)

The Act protects bisexual, gay, heterosexual and lesbian people.
F4L Other key changes
Positive action
As with previous equality legislation, the Equality Act allows an employer to take positive action
if they think that employees or job applicants who share a particular protected characteristic
suffer a disadvantage connected to that characteristic, or if their participation in an activity is
disproportionately low. The positive action requirement in recruitment and promotion came into
force on 6 April 2011. The full guide provides an example of positive action.
Pre-employment health-related checks

The Equality Act limits the circumstances when an employer can ask health- related questions
before they have offered the individual a job. Up to this point, an employer can only ask health-
related questions to help them to:
decide whether they need to make any reasonable adjustments for the person to the
selection process
decide whether an applicant can carry out a function that is essential ('intrinsic') to the job
monitor diversity among people making applications for jobs take positive action to assist
disabled people
assure themself that a candidate has the disability where the job genuinely requires the
jobholder to have a disability
A jobseeker cannot take an employer to an Employment Tribunal if they think the employer is
acting unlawfully by asking questions that are prohibited, though they can complain to the
Equality and Human Rights Commission.
Once a person has passed the interview and the employer has offered them a job (whether his
is an unconditional or conditional job offer) the employer is permitted to ask appropriate health-
related questions.

Extension of employment tribunal powers

Under previous legislation, an employment tribunal could make a recommendation that an
employer must eliminate or reduce the effect on the claimant of any discrimination. The Act
extends this power so that it will now be possible for a tribunal to make recommendations that
an organisation takes steps to eliminate or reduce the effect of discrimination on other
employees, not only on the claimant. For example, the tribunal might specify that an employer
needs to train all staff about the organisation's bullying and harassment policy. This power does
not apply to equal pay cases. The full guide provides an example of how Tribunal
recommendations can affect an employer.
41
Equal pay-direct discrimination
The Equality Act retains the framework that was previously in place. This means that in most
circumstances a challenge to pay inequality and other contractual terms and conditions still has
to be made by comparison with a real person of the opposite sex in the same employment.
However, a change in the Equality Act allows a claim of direct pay discrimination to be made,
even if no real person comparator can be found. This means that a claimant who can show
evidence that they would have received better remuneration from their employer if they were of
a different sex may have a claim, even if there is no-one of the opposite sex doing equal work in
the organisation. This would be a claim under sex discrimination.
Pay secrecy
The Act makes it unlawful for an employer to prevent or restrict employees from having a
discussion to establish if differences in pay exist that are related to protected characteristics. It
also makes terms of the contract of employment that require pay secrecy unenforceable
because of these discussions. The full guide provides an example. An employer can require
their employees to keep pay rates confidential from some people outside the workplace, for
example a competitor organisation.
F5 Human Rights Act 1998

This Act incorporates the European Convention on Human Rights into domestic UK law and
came into force in October 2000. In effect, slices of UK common-law stretching back to the
Magna Carta have been replaced by a Statute.
Public bodies are required to act in compliance with the Convention unless prevented from
doing so by statute, thus individuals are able to rely on a range of positive rights in their
dealings with public authorities such as government departments, local authorities, the police,
immigration, prisons, NHS and trust hospitals, the courts and tribunals. The Act does not make
Convention rights directly enforceable in proceedings against a private litigant, however private
individuals and companies have to take the Convention into account because the courts are
obliged to interpret the law so as to conform to It wherever possible.
The courts are able to Issue injunctions to prevent violation of rights, award damages and
quash unlawful decisions. If judges decide that an existing law is irreconcilable with the Human
Rights Act, the dispute may be referred to the European Court of Human Rights or to
Parliament who may consider changing the law.
The Act includes rights such as freedom from arbitrary arrest and detention and freedom of
religion. Whilst there is no right to work as such In the Convention, several Articles could be
relevant in the context of employment:

Article 6 - Fair Trial. The right to have one's civil rights adjudicated upon by an independent
tribunal (although the guarantees of this Article do not extend to public sector employment
disputes).
Article 8 - Privacy. Issues could arise if there is a question that an employee's privacy is
being infringed (telephone calls/correspondence).
Article 11 - Freedom of Association and Assembly. This Article ensures the right to peaceful
assembly and freedom of association with others including the right to form and join (or not
join) trade unions.
Article 14- Freedom from Discrimination. This Article states that the rights and freedoms set
out in the Convention shall be secured without discrimination on any grounds such as sex,
race, language, religion etc. If an applicant is able to base an employment claim on any one 42
of the substantive Convention articles, there may be scope for a discrimination claim under
Article 14.
F6 Financial Services and Markets Act (FSMA) 2000

In October 1997, the UK Chancellor of the Exchequer announced a new framework of financial
services regulation. The announcement by the Government was that it intended to reform both
the operation of the Bank of England and the regulation of the financial services industry. The
reforms entailed the creation of the new Financial Services Authority (FSA) and the passing of
the Financial Services and Markets Act 2000 (FSMA). The process entailed the merging of nine
separate regulators and-five Acts of Parliament were repealed.
The Treasury assumed responsibility for insurance regulation in January 1998. The FSA was
formed as an independent non-governmental body, given powers by the Financial Services and
Markets Act 2000. It officially assumed its full role of single regulator for the UK financial
services industry in December 2001. It is now the single statutory regulator responsible for
regulating deposit taking, insurance and investment business. It has also taken on certain new
responsibilities, for example tackling market abuse, promoting public understanding of the
financial system and reducing financial crime.
However, this all likely to change again in the near future as the new Coalition Government that
came into power in May 2010 proposes to reform the structure set up by the previous
Government. Full changes to the structure are at this point in time still under discussion but a
consultation paper has been published and the changes are due to take place in 2013. An
outline of the proposed revised structure can be found in the Aug/Sept 2010 edition of the CII
Journal. The article is entitled 'A new approach to financial regulation.
You will remember that in chapter l we referred to the FSA theme of 'Treating Customers Fairly'
(TCF). This theme is so important that the FSA considers it to be a central part of insurance
business philosophy.
To achieve these outcomes the FSA is applying a thematic approach (known as ARROW) in
choosing the important issues and investigating these across firms. It is also using a risk-based
tool for small firm supervision and then communicating the findings back to the industry.
The Treating Customers Fairly theme is now seen as so important to the insurance industry that
you will remember that the Chartered Insurance Institute has also issued a set of Fact Sheets
as guidance to companies, brokers and employees working in general insurance. CII members
can access the detail of these Fact Sheets through the en website- www.cii.co.uk.

There are a number of references to the FSA in this course book, which are important for
managers to understand. However, there is a large amount of useful information on the FSA's
website www.fsa.gov.uk.
F7 Bribery Act 2010

This is an Act that all industry managers will need to be aware of. It came into force on 1 July
2011.
The purpose of the Bribery Act is to reform the criminal law to provide a new, modern and
comprehensive scheme of bribery offences that will enable courts and prosecutors to respond
more effectively to bribery either at home or abroad.
43
It aims to:
provide a more effective legal framework to combat bribery in the public or private sectors;
replace the fragmented and complex offences at common law and in the Prevention of
Corruption Acts 1889-1916;
create two general offences covering the offering. promising or giving of an advantage, and
requesting, agreeing to receive or accepting of an advantage;
create a discrete offence of bribery of a foreign public official;
create a new offence of failure by a commercial organisation to prevent a bribe being paid
for or on its behalf (it will be a defence if the organisation has adequate procedures in place
to prevent bribery);
require the Secretary of State to publish guidance about procedures that relevant
commercial organisations can put in place to prevent bribery on their behalf; and
help tackle the threat that bribery poses to economic progress and development around the
world.
(Source Ministry of Justice.)
The FSA will be expecting the financial services industry to actively meet its obligations under
the Act and PDF papers can be found on the FSA website. In addition, there is also a PDF
paper on the Government website: www.justice.gov.uklguidance/docslbribery-act-2010-
guidance.pdf

Bab 7: Main Accounting Principles
and practices
Introduction
One of the functions of a business, and an activity which all organisations need to address, is
finance and accounting. Just as in our individual lives where we need to be aware of the money
we earn or have at our disposal for spending. investing or saving, so too do businesses need to
keep track of the money which they raise from the sale of goods and services. In addition, they
need to know how much they invest in equipment or spend on wage and salaries and raw
materials or working materials. We will also see later in this chapter that organisations are
governed by legislation with regard to the recording and publishing of information to those who
have an interest in such information.
Just as it is sensible for individuals to devise a system of knowing how much money they have
at any one time, even if this involves only regular enquiries of our bank account, so
organisations need to have and maintain a systematic approach to the accounting, or recording,
of financial transactions. The actual record-making process of accounting is known as book-
keeping; accounting in a wider context is a discipline involving the analysis and interpretation of
information that affects the performance and financial position of the business;
Failure to record and keep track of information can not only result in non-compliance with
legislation, but also disaster for and perhaps extinction of the business. While accountants are
the 'experts' in this field, managers need to be aware at all times of the monetary position of
The organisation, and so require sufficient knowledge to initiate, participate in and control the
decision-making process.
A Purpose and function of financial accounting

Financial accounting describes a general business discipline which consists of a series of
techniques and procedures that are used to identify, measure, record and communicate
information, including financial information, about an organisation to a range of people who may
be interested in it. As we established in chapter 1, these interested people are referred to as
stakeholders and financial accounting is about ensuring that this Information is reported
externally to the stakeholder by means of statutory accounts. Throughout the remainder of the
chapter these will be referred to as the accounts. As we established in chapter 4, included in
these accounts will be:
narrative reports from the chief executive and directors on the performance of the company
in the previous period including information on how they have discharged their social
responsibilities;
the company's plans for the future and the risks that the business is exposed to;
the financial accounts for the period including the balance sheet, income statement and
cash flow position; and
other legal requirements, such as details of the directors' remuneration.
All this detailed information is published in statutory financial year-end accounts so that
Bab 7: Main Accounting Principles and practices
stakeholders can be fully aware of the success or otherwise of the company they have some
interest in, and its financial position at a point in time. Companies whose shares are quoted on
a stock exchange will also publish less detailed information during the year in the interim
accounts.
Be aware
Note that in this chapter we refer to the 'income statement' which is also called the 'profit and
loss account: The term 'income statement' comes from International Financial Reporting
Standards (IFRS) and 'profit and loss account' comes from UK Generally Accepted Accounting
Principles (UK GAAP).
In general usage the terms 'income statement' and 'profit and loss account' are
2
interchangeable. See section A 1 of this chapter and also chapter 8 for more information on the
usage of IFRS and UK GAAP
A1 Legislative background
The practices associated with financial accounting provide managers and accountants with
information about their business and its operations. In addition, it is also a discipline which
organisations must undertake in order to comply with the law. As we established in chapter 4,
the primary legislation in the UK is the Companies Act 2006.
Tile Companies Act 2006 includes regulations on accounting such as: Requirement to keep
adequate accounting records.
Directors' duty to prepare accounts for a company.

Directors' duty to prepare accounts for a group of companies and the consistency of
financial reporting within a group.
Requirement to prepare accounts that show a true and fair view.
Company legislation also requires companies, other than certain small companies, to have their
financial year-end accounts audited by an independent auditor (see chapter 4, section D).
As we have established in chapter 4, section C2, accounts have to be published in a format that
complies with regulations and accounting standards requirements. They include the company's
financial statements, which comprise the following:
The income statement which shows the results of the company as a consequence of
transactions during the accounting period. It sets out the income, expenses, tax and the
profit or loss.
The balance sheet which is a statement of the financial position of the business at a point in
time ('as at' a particular date) i.e. the account period or year-end date. lt is a 'snap shot' of
the company's position at a particular point in time, listing all the company's assets and
liabilities - what is owned and what is owed. What is owed by the company includes the
shareholders' equity which is the total of the assets less the total of the liabilities. See
section D 1 for a more explanation of shareholders' equity.
Cash flow statements are presented as an integral part of a companys financial statements
to recognise that accounting profits is not the only indicator of a company's performance.
Cash flow statements show the sources and uses of cash and are a useful indicator of a
company's liquidity.
These items will be discussed in detail later in this chapter (see sections F, G and H).

True and fair view

The financial statements are intended to show a 'true and fair view' of the economic activities of
the organisation and are available not just to the stakeholders, but to anyone who wishes to
review them. They are produced within a highly regulated legal framework to enable fair
comparisons to be made on the financial position of different organisations, whether they are in
the same industry or not. Examples of the accounts of an insurance broker and an insurance
company are provided in the appendix to this chapter.
Be aware
You should note that in preparing their consolidated accounts, companies listed on the London
Stock Exchange have to follow International Financial Reporting Standards (IFRS). Other
companies in the UK not listed on the London Stock Exchange can also adopt these
3
international standards, or can continue to use the UK generally accepted accounting principles
(referred to as UK GI\AP), although there is a reasonable expectation that most companies will
be required to use IFRS, or a version of IFRS, in the next few years.
The intention of whichever standards are applied is to ensure consistency in preparing the
accounts. They lay down the recommended procedures and practices to be adopted by the
professional accountants when faced with a particular accounting problem or circumstance.
(See chapter 8 for further discussion of the main accounting standards and the requirement that
accounts must be 'true and fair)
B Financial and management accounting

There are two aspects of accounting which serve separate but inter-related purposes in the
operation and control of a business. We have already discussed financial accounting in section
A and have seen that it is concerned with providing historic information to external stakeholders
and interested parties. The second aspect is management accounting which is concerned with
the internal planning and control of an organisation to enable its managers to make sound
decisions. It aims to show managers how the organisation is performing in comparison with
anticipated outcomes; and, if there is any deviation, what corrective action should be taken.
Critical to the concept of management accounting for many businesses is the principle of
costing: this is concerned with establishing the necessary accounting information for profit and
contributions to overhead costs of the various components of the business. To achieve this, the
company needs to have a good costing system which is capable of collecting, storing and
processing data and reporting the information in the required format.
B1 Differentiating between financial and management accounting

There are further distinctions between the two and which are examined in more detail below
B1A Structure and sources
Financial accounting involves the day-to-day recording of the company's transactions and
presenting this information in financial statements for external consumption for those outsiders
who have an interest in the company. It is highly structured around the accounting equation
(see section D) and, as we have already noted, has to comply with legal and regulatory
requirements. "The information has to be prepared using a framework which enables
stakeholders to compare the company's performance from one year to the next and also
against other companies in the sector.

By comparison, management accounting can be formulated in different ways to suit many

purposes. As well as using the source day-to-day transactional data captured for financial
accounting information, management accounting will also incorporate a variety of other different
information sources to enable managers to fulfil their responsibilities.
B1B Format
Information on the financial position is primarily provided in the balance sheet, that of
performance in the income statement. Unlike financial accounting systems, management
accounting systems are not just concerned with money. They include non-monetary quantitative
information such as labour hours, the amount of raw material used in a process and the
electricity consumed by a factory.
4
Whereas financial accounting looks at and records the financial impact of events on the
organisation as a whole, management accounting is naturally segmented and concentrates on
processes, individual departments and other areas of responsibility, in terms each manager can
understand.
B1C Time periods
Management accounting information is largely focused on the future. It is concerned with

forecasts and projections. Inevitably, these are sometimes imprecise, but managers are usually
willing to sacrifice precision for speed.
Financial accounts are based on historical information, i.e. transactions that happened in the
previous accounting period and are not intended as a guide for the future.
B1D Regulation
In preparing and presenting their financial statements for external users, all companies have to
use a conceptual framework as laid down in accounting standards. Use of this framework
ensures the information on the company's financial performance, and its financial position, is
comparable with previous rears and with other companies. The framework also helps to portray
the results of 'stewardship management', enabling users to assess the quality of the managers
who take responsibility for safeguarding the assets of the company on behalf of its owners, the
shareholders.
Management accounting has no external regulatory constraints. Management accountants are

comfortable about providing estimates and forecasts, and presenting information in different
ways for different purposes.
Financial statements also include valuations and provisions but the calculation of these is
subject to accounting standards.
81E Legal requirements to publish accounts
Organisations are not obliged by law to produce management accounts, whereas they are
legally required under the Companies Act legislation to produce financial accounts which have
to be filed at Companies House and hence are available to the public.
B1F Access to management accounting information
Whereas limited companies disclose to the world at large the information that they are obliged
to disclose by law- most commonly their financial statements, by contrast, management

accounting is a more private affair and an organisation's management accounting information is

not usually made available publicly.
81G Audit requirements
The role of the auditor was discussed in chapter 4, section D. While companies over a certain
size have to have their financial statements audited to confirm they show 'a true and fair view',
management accounts do not have to be audited by external auditors, although auditors may
want to examine some aspects of the management accounting system to check the
organisation's internal controls.
If the organisation has an internal audit department, it will have delegated responsibility from
senior managers to ensure there are adequate systems of control. Part of its audit review work 5
will be to ensure that the management accounting system and the reports produced are
relevant, reliable, accurate and complete for management purposes.
C Users of financial information and their information

requirements
C1 Users of financial information
We have previously mentioned that people who are interested in an organisation's financial
affairs are part of a group known as stakeholders. These stakeholders will have differing
reasons for having an interest, i.e. a stake in the company. This is illustrated in figure 7.1.
Figure 7.1
Creditors and
lenders
Tax authorities Competitors
FSA Financial analysts
Employee Brokers
Directors and
General public
managers
Organisations financial
Owners Customers
information
Think
What do you think the various stakeholders identified will want to know about an organisation's
financial affairs?

Owners
The owners of the business may be individuals, partners or shareholders, depending upon the
type of company. They will need to know how the business is performing financially in order to
make decisions about continuing, or increasing, their capital investment. This applies especially
to shareholders in public limited companies (pies), in which investment decisions are often
taken on a purely financial basis.
Directors and managers

Directors and managers have overall responsibility for managing the business. They will need
to know whether or not the organisation has been making the best use of its resources. In
addition, they will need to know whether the organisation has enough capital and liquidity to
enable it to carry out its plans, whether some parts of the business are more successful than
6
others, and whether the company has behaved as a responsible part of the community.
Employees
Employees are usually concerned to know how secure their jobs are. They can use financial
information to gauge how well the organisation has been performing, and to take an informed
view on whether it is likely to be able to pay their wages. Employees can also be shareholders
in the company which means they may have conflicting stakeholder objectives.
The public
The public includes people who may be potential investors or shareholders in the organisation,
pressure groups that may want to monitor aspects of the organisation's activities, and people
who might be considering applying to work for the organisation.
Tax authorities
Tax authorities will want to know that the organisation is paying the appropriate level of tax.
Financial analysts
Some in this category are independent advisers who will want to know whether they should
advise shareholders and potential shareholders to buy or sell shares in the organisation. They
use financial information to track the organisation's performance. Others may be journalists and
financial commentators who provide general advice to the public at large. In the case of
insurance companies there are also ratings agencies that prepare important league tables
relating to financial performance and security assessment These are discussed further in
chapter 11, section A.
Creditors and lenders

Creditors are other businesses or individuals who might extend credit to an organisation, such
as its bank, its suppliers or its landlord.
They will need to make a judgment about whether they should extend credit to an organisation
and, if so, what limit they should set.
Competitors
An organisation's competitors can use financial information about it to help them readily
understand its strengths and weaknesses.
Brokers
From an insurance point of view, brokers will want to know whether companies they deal with
are financially strong.

Customers
Similarly, potential and existing customers of insurance companies want to know that they are
insured with a reputable organisation which is able to pay its claims.
Financial Services Authority (FSA)

The FSA is responsible for regulating and supervising insurance companies in the UK to
promote market confidence in the financial system and to secure the appropriate degree of
protection for consumers.
C2 Type of information required

As we have seen, the groups of people mentioned in section C1 need both quantitative and
7
qualitative financial information about an organisation in order to make a judgment or decisions
about their relationship with the organisation. The information may be clearly available in the
published accounts, sometimes however, the information has to be interpreted and analysed
from the accounts (including the directors' and auditors' reports) in order to arrive at an informed
judgment. Information may also be obtained from other sources, such as financial analysts,
rating agencies and the media, e.g. newspapers and other public documents. As stakeholders
become more socially aware, companies are now placing particular emphasis when reporting to
them on how the company is meeting its social obligations.
The users of the information are likely to want to know a range of things about the
organisation's state - some general, so e fundamental and some specific. These are explained
briefly in the following paragraph.
Organisation's activities
People may want to know what the organisation has been doing for the last year. Financial
statements often contain narrative about the organisation's activities, outlining areas of
particular success or failure and covering new or discontinued projects, as well the directors'
assessment of risk and objectives for the current and future management of the company. In
addition many companies now provide information on how they undertake their social
responsibilities to the wider community, e.g. how they are addressing environment issues or
helping to reduce the impacts of climate change.
Accountancy terms
Profitability PROFITABILITY is companys ability to generate revenues in excess of
the costs incurred in producing those revenues.
Cash position Cash liquidity is an important measurement of a successful business.
(liquidity) Good liquidity usually indicates that a business has good internal cash
controls and solid accounting processes. Liquidity is also an important
calculation for outside investors and banks; solid business operations
will increase accounts receivable (A/R) and cash while keeping short-
term liabilities in check.
Income and An income and expenditure account is a record showing the amounts of
expenditure money coming in and going out of an organization during a particular
period of time. In British companies, it is usually called the profit and
loss account, while in US companies; it is called the income statement.
This account is credited with all earnings (both realized and unrealized)
and debited with all expenses (both paid and unpaid).
Solvency The ability of a company to meet its long-term financial obligations.
Solvency is essential to staying in business, but a company also needs
liquidity to thrive. Liquidity is a company's ability to meet its short-term

obligations. A company that is insolvent must enter bankruptcy; a

company that lacks liquidity can also be forced to enter bankruptcy even
if it is solvent.
D Basic financial concepts and the accounting equation

Before we look more closely at the financial statements themselves, we need to set out basic
definitions for some accounting concepts. To avoid confusion we will use the accounting
concepts based on IFRS.
8
D1 Basic definitions
Income
Income is simply all of the amounts of money earned by the organisation from any source,
including sales, rentals, interest payments and investments.
Income generated from sales (excluding VAT) is sometimes called revenue or turnover.
Expenditure
Expenditure is all the amounts of money incurred to pay for goods or services.
Profit
In accounting terms, profit is any excess of income over expenditure incurred in running the
business that earns that income.
Shareholders equity
Shareholder's equity is the stake shareholders have in the company. It is calculated as the total
value of all the assets in the business less the total value of all the liabilities.
Capital and regulatory capital

The capital of a trading company is the sum of the equity and long-term debt used to finance
the business.
For an insurance company it is regulatory capital that is important. This is the sum of the equity
and long-term debt that is classified as regulatory capital. Long-term debt can only be classified
as regulatory capital if it meets stringent rules set by the FSA. Equity counts as Tier 1capital.
Depending on the structure of the debt, particularly the repayment terms, long-term classified
debt may be categorised as either Tier 1 or Tier 2 capital. The FSA imposes limits on the
amount of Tier 1 and Tier 2 debt that may be classified as regulatory capital. If debt is classified
as regulatory capital then this improves the solvency margin of the company as this debt does
not count as a liability for regulatory purposes. An advantage of having regulatory debt capital in
addition to equity is that the cost of regulatory debt capital is normally lower than the cost of
equity. Hence for a given level of regulatory capital and profitability shareholders should expect
a higher earnings per share if the company has Tier 1 or Tier 2 debt compared to only holding
equity.
Assets
An asset is any physical property or right that has a money value and is owned by an
organisation. Assets are either tangible or intangible.
A tangible asset is one that is physical, i.e. 'real: such as cash, land, buildings,
machinery or investments. Some tangible assets - especially machinery and equipment

- lose their value as time goes by and they are used in the conduct of the organisation's
business. In accounting terms, their loss in value is called depreciation.
An intangible asset is one that is not physical, such as a trademark, a copyright, or
goodwill. Purchased goodwill is the difference between the amount paid for acquiring a
business and the value of the net assets of that business when acquired.
Liability
In accounting language, a liability is an amount owed by an organisation.
Be aware
For the purposes of clarification, In Insurance terminology, 'liability' can refer to an Insurer's
acknowledged commitment to pay an amount of money arising out of a claim under a policy, or 9
I to a class of business or sub-section of a policy.
Cash
In accounting terms, cash is money that is available to the business and includes money
deposited at the bank or cash retained on the premises, e.g. petty cash.
Creditor
A creditor is any individual or organisation to whom a debt is owed, e.g. a supplier. This means
that when a company purchases goods or services on credit, i.e. buys something but does not
pay for it immediately; it then incurs a debt to the organisation providing those goods or
services. In other words our company has incurred, a liability, that it will have to pay off over an
agreed period, e.g. within two months. Until it is paid off it remains a liability on the company's
balance sheet. Once the money is paid then the relevant accounting entries will be made to
reflect the elimination of the liability and the reduction in cash available.
Debtor
A debtor is any organisation or person who owes a debt to our company. This means that when
our company makes a sale to an organisation who does not pay for the goods or service
immediately, that organisation incurs a debt to our company. In other words they owe us money
and they have incurred a debt to our company which they will have to pay off over an agreed
period. This debt is considered as part of our current assets and is shown as such in the
balance sheet. Once the money is paid then the relevant accounting entries will be made to
reflect the elimination of the debt and the increase in cash available.
Depreciation
Organisations may purchase non-current assets, such as buildings and machinery, for long
term use in the business with the purpose of generating income for future years and these
assets usually decline in value over time. Accounting concepts require that some adjustment is
made to the value of these assets over their useful lives to reflect that, eventually, these assets
will deteriorate or become obsolete. This is known as depreciation.
This is a reasonable procedure to adopt, as the asset's cost should not be attributed to the first
year of its use, as it will contribute to the organisation's activities over a period of time. Also, if
the whole cost of assets was included as expenditure in the year of purchase, reported profits
would fluctuate wildly from year to year. Accountants therefore deliberately 'write down' the cost
of an asset over a period of time, using a recognised method, leaving a notional value of the
asset in the organisation's balance sheet at any point in time. Depreciation is, in reality, a book-
keeping entry with the company setting up a 'depreciation provision account: No cash actually
leaves the organisation as depreciation is incurred, i.e. it does not affect cash flow.
The simplest way to think of depreciation in accounting terms is as the cost of an asset

apportioned over the financial period during which the business will benefit from the use of that
asset. It is important that a clear distinction is made between how the accounts treat the
devaluing of the asset and what happens in real cash terms. It is also important to recognise
that the amount recorded as non-current assets in the balance sheets is not necessarily the
amount that would be realised if they were sold.
Example
To illustrate depreciation, let us use an example for an individual.
Max buys a computer to help him write a novel. He plans to complete the book within twelve
months, and his publisher has agreed to pay him 2.400 at the end of the project. The computer
costs 1,200 and Is expected to have three years of useful life from the time he buys it. In cash
10
terms, Max has spent 1,200 and now has an asset worth 1,200.
As the computer has a useful life of three years it would be inappropriate to say that his
enterprise has incurred an expense of 1,200 on day 1. By using the concept of depreciation,
Max can notionally spread the cost of the computer evenly over the period of its useful life of
three years. This is known as straight-line depreciation.
There Is a formula that can be used for straight line depreciation:
Cost of asset- scrap or residual value

The life of the asset
As planned, Max completes the novel within twelve months and earns 2,400 from his
publisher. In this first year he has also Incurred depreciation on the computer of 400, being
one-third of its cost and so has a net profit of 2,000 before allowing for other expenses he
might have Incurred. In each of the next two years Max will also have to Incur a depreciation
cost of 400 and clearly the profit he will earn will depend on the Income he can earn from
writing further novels.
There are several other ways of calculating how to spread the cost of assets through
depreciation, but they fall outside the scope of this course. The choice of method depends on
the circumstances. Some businesses may decide to apply depreciation to equipment relatively
quickly, i.e. to write it off In less than Its potential working life, especially If the item Is subject to
rapid obsolescence through technological advances. Depreciation Is normally allowed for tax
purposes but HMRC require that the calculation for tax purposes follows their rules which is
likely to differ from the depreciation used for accounting purposes.
Reinforce
Before moving on see if you can remember what the effect is on the solvency margin of an
insurance company if debt is classed as regulatory capital and the reason for it and why it Is
advantageous for an insurance company to have regulatory debt capital in addition to equity.
Make some notes below:

D2 The accounting equation

Accounting is based on the accounting equation.
To enable a company to operate effectively it needs resources, for example, cash, office
furniture and equipment, computers, stock, vehicles etc. These are assets and have to be
acquired by the company. The whole basis of accounting is the idea that everything owned by a
business must be funded from somewhere.
Initially, it is usual for the owner of the organisation to provide the necessary funds to start up
the business. Other people or organisations such as creditors, quasi-governmental small
business start-up schemes or banks may provide additional funds later in the life of the 11
business to help it to carry out its trade.
The relationship between the things owned by a business (its assets) and the funds which were
used to buy them is expressed by the accounting equation:
Assets = Equity + Liabilities
It is an accounting convention that the equation must always balance. Like any mathematical
equation, it can be rearranged:
Equity = Assets- Liabilities
But what does it mean? For simplicity's sake, we will take the example of a small business,
Grow Ltd, to illustrate what is meant by the accounting equation.
Example:
Grow ltd
Let us imagine that John and his brother Jack start a gardening company, Grow Ltd. They have
each saved 1,000 in cash and they invest this in the company as equity. This means that, at
the start, they each have a half share in a company worth 2,000.
As a limited company, Grow ltd has its own Identity which is separate from the Identities of John
and Jack. They cannot be pursued as individuals for the debts of Grow Ltd. The maximum they
can lose in the event that the company cannot continue to trade is the amount they have
invested in it - i.e. 1,000 each. If the company went into liquidation, John and Jack would lose
some or all of their investment, depending on the extent of the company's debts.
The 2,000 cash now belongs to the company, and must be used for the company's objectives.
It appears as cash in the company's bank account, and is therefore an asset.
Grow Ltd uses 500 of the cash to buy some gardening tools, and 500 in cash is taken from
the cash held at the bank to pay for them. The tools become the company's assets (worth
500).
The company then buys another asset, a lawnmower, for 750 on six months' credit. The
lawnmower is being financed by the seller (who becomes a creditor), so there is no need to
subtract 750 from the cash amount at the bank. After six months, Grow Ltd will have to pay
cash for the lawn mower, but until that time the 750 unpaid debt to the seller remains a current

liability.
After two weeks, the company completes its first job for a customer. It subcontracts the work to
a freelance gardener and pays him 50. The company charges 100 for the job. The customer
pays the company in cash at the end of the job. That 100 is income for the company, and is
added to the cash in the bank (Increasing the assets). The company's equity has now increased
by 50.
The accounting equation

Let us now group these items under their Individual headings at different times during the above
process. Working through the scenario and noting the position after each transaction will give
you an understanding of the processes that underpin financial accounting.
12
Equity = Assets Liabilities
1. At the time when the business Is first started:

2,000 = 2,000 cash 0
2. After the tools are bought:

2,000 = 500 tools +
1,500cash 0
3. When the lawnmower is bought on credit:

2,000 = 500 tools + 750 lawnmower +
1,SOOcash 750 creditor
4. After the company's first job

2,000+
50 profit = 500 tools + 750 lawnmower +
1,550 cash 750 creditor
So the final equation following these transactions continues to balance, i.e.
Equity (2,050) = Assets (2,800) liabilities (750)
The accounting equation underpins the entire accounting recording system. It is a logical way of
looking at financial transactions and of explaining how income and expenditure relate to the
value of a company.
As we shall see, the accounting equation forms the basis of the more formal financial
statements that are compiled by companies to meet statutory reporting requirements. In
particular, it forms the basis of the accounting entries that make up the income statement and
balance sheet.
E Receipts and payments

In order to produce financial information, a business needs to establish some kind of system for
recording its financial transactions, both income and expenditure, or its receipts and payments.
Initially, this is termed 'book-keeping: although advances in information technology have meant
that electronic book-keeping systems have largely replaced paper-based books. Accounting
packages which include book-keeping functions can be bought off the shelf.

Not all transactions between businesses are for immediate cash. Many (like the purchase of the
lawnmower in the accounting equation example above) are 'on credit', which means they do not
have to be paid for straight away. An organisation needs a system for recording these
transactions, and usually creates a number of different documents in order to do so.
The nature of the system will depend on the type of business and the size of the organisation in
question, but all accounting systems require the same basic information.
In order to record amounts that are owed to the business by other parties, invoices (also called
debit notes or fee notes) are raised. These are documents that show when a transaction has
taken place and record details such as:
13
the amount of the debt incurred;
the individual or organisation who owes the money;
the organisation to whom the debt is owed;
the date when the debt was incurred; the date when payment is due;
the way the debt amount was calculated and what service or goods were supplied;
ancillary financial information such as any VAT associated with the charge and the
organisation's VAT registration number.
To keep records of amounts of expenditure by the organisation, receipts or invoices from

suppliers will be retained. Money received and actual payments made are recorded in a cash
book; a balance will be calculated frequently to monitor liquidity.
Double-entry principle
All financial transactions are recorded in the books of account using the double-entry principle.
This principle shows the two-fold effect on the accounting equation by reflecting that the
business both receives and gives value in each transaction.
Example
If an Insurer sells Insurance and receives cash from a customer, it will record that it has earned
a certain amount of income which is balanced by the increase in cash. So the double-entry
system enables the organisation to keep track of its business and provides the information for
the financial statements.
Using IFRS requirements we will now consider the financial statements and their component
parts that a listed company is required by law to produce.
F The balance sheet

The balance sheet is a statement of the net wealth of a business at a particular time. Items of
wealth owned by a business are assets. A business will also owe items of wealth, i.e. its
liabilities. The difference between a business's total assets and its total liabilities is called its
shareholders' equity and belongs to the owners of the business. Note the definitions of each
item, as this will aid the construction of a balance sheet.
F1 Classifying assets
Assets are normally classified into non-current assets and current assets.

F1A Non-current assets
These are items of wealth that are owned by the business which the company intends to keep
for more than one year. Major categories of non-current assets include:
Goodwill and other intangible assets

Goodwill is the difference between the amount paid for acquiring a business and the value of
the net assets of that business when acquired. Other intangible assets include patents, brands
and licences.
Property
This includes freehold and leasehold property and land used by the business for trading.
14
Investments
Investments include property if held for investment rather than used by the business for trading,
equities, government bonds and corporate bonds.
F1B Current assets
These are items of wealth that the business owns and intends to use within the next twelve
months. Below are three major types of current assets:
Cash and cash equivalents

This is cash in hand and cash held in the business's bank accounts including deposits held for
up to three months from the balance sheet date.
Stock
In most cases, there are three different types of stock owned by businesses. The first is raw
materials, next is work in progress, and finally there are finished goods. The business would
normally expect to convert its stocks into cash by selling finished products to its customers
within a year.
Debtors
Debtors are customers who owe the business money. They are created when goods or services
are sold on credit. Debtors are considered to be an item of wealth on the balance sheet, since a
customer owes the money to the business and is expected to pay.
F2 Classifying liabilities
Just as assets have a twelve-month rule, so do liabilities. If the business has to pay the money
out in less than twelve months then it is a current liability, and if over twelve months then it is a
non-current liability.
F2A Current liabilities
Bank overdraft
This is a current liability as it may have to be paid within twelve months. Banks generally have
the right to call in an overdraft at 24 hours' notice.
Trade creditors
Most businesses also have trade creditors on their balance sheet as a current liability. These

arise when a business has bought goods or services from a supplier but have yet to pay the
supplier's invoice.
F2B Non-current liabilities
This is any amount owed that must be paid back but not within twelve months. Common
examples of non-current liabilities include bank loans, mortgages and bond issues.
F3 Other long-term sources of finance

In addition to bank loans, mortgages and bond issues businesses may raise long-term finance 15
from issuing shares and by retaining profits as reserves:
Share capital
Limited liability businesses can sell shares in order to raise long-term-finance. The amount
raised is always owed to the business's shareholders (the owners). In this way share capital can
also be seen as an item of wealth that the business effectively owes to the shareholders.
Reserves
Businesses often raise the necessary finance required to expand their operations by using the
profits they have created from the previous trading period. Reserves are the accumulated
profits of the business that have been reinvested into the business. At first glance it is difficult to
see why reserves are an example of money that is owed. This relates to the issue of business
ownership and legal identity. Any profit that a business makes (after tax liabilities have been
discharged) belongs to the owner(s) of that business. Limited companies are owned by their
shareholders, so the profits of the business are owned by the shareholders and not by the
business itself. Consequently, any profits that have been ploughed back into the business
(rather than being paid out to the shareholders as a dividend) are owed by the business to the
shareholders.
Share capital and reserves differ from a liability in that, in the normal course of trading, there is
no requirement to repay these amounts.
F4 Other balance sheet terminology

Working capital
Working capital is the money used to finance day-to-day trading activities. Working capital is
used to pay for wages and raw materials and for overheads such as utility bills. On the balance
sheet the value of working capital is calculated by subtracting current liabilities from current
assets. Working capital is known as net current assets.
Assets employed
Assets employed are calculated by adding non-current assets to working capital {net current
assets).
Be aware
You may come across the term 'minority interest' and, although it is outside the scope of the
syllabus, it Is explained here for the sake of completeness. It is a liability you may see on a
consolidated balance sheet to recognise the fact that some companies in a group may not be
owned 100% by the holding company.

To take an example- company A has net assets of 100,000 and, in addition, owns 80% of
company B which has net assets of 70,000. In total, company A has net assets of 156,000
(being 100,000 and 80% of 70,000).
The accounting convention Is that the consolidated balance sheet will reflect 100% of each of
the Individual assets and liabilities of companies A and B (the argument being that company A
has control over the assets of company B even though It does not own the company 100%) and
a deduction called 'minority interest' of 14,000 (In this example) to recognise that there are
external shareholders which own 20% of company B. This means that in the consolidated
balance sheet the Individual assets and liabilities will come to 170,000 and the deduction of
the 14,000 minority Interest gets the overall consolidated net assets back to the 156,000
16
noted above.
F5 Balance sheet example

We will now consider the simplified financial statements of a non-insurance company using
IFRS. A requirement of IFRS is that current and non-current assets are normally shown
separately, as are current and non-current liabilities. However, there is an exception to this rule
as we shall see when we look at the balance sheet of an insurance company in the appendix at
the end of this chapter. There is also a prescribed list of items which must be shown separately
if they are significant, however unlike UK GAAP, there is no prescribed format for the layout.
As stated at the beginning of this chapter, the balance sheet is a 'snapshot' of the assets and
liabilities of a business on one day of the year. The example shown follows the guidance which
accompanies, but is not part of, the standard.
Balance sheet example
ASSETS
Current Assets
Cash $ 20,000
Accounts receivable $ 15,000
Inventory $ 150,000
Total Current Assets $ 185,000
Non-Current Assets
Plant and equipment $ 50,000
Business premises $ 650,000
Vehicles $ 70,000
Total Non-Current Assets $ 770,000
TOTAL ASSETS $ 955,000
Current Liabilities
Accounts payable $ 25,000
Bank overdraft $ 10,000
Credit card debt $ 5,000
Tax liability $ 30,000
Total Current Liabilities $ 70,000

Non-Current Liabilities
Long term business loan 1 $ 450,000
Long term business loan 2 $ 50,000
Total Non-Current Liabilities $ 500,000
TOTAL LIABILITIES $ 570,000
NET ASSETS $ 385,000
OWNERS EQUITY $ 385,000
Source: http://www.smallbusiness.wa.gov.au/example-balance-sheet
17
Note that the simplified examples shown in this chapter exclude some of the IFRS requirements
such as comparative figures and notes to the financial statements.
F6 Balancing the balance sheet

On this balance sheet format the total assets are shown to equal total equity and liabilities. An
alternative format may be used showing net assets (total assets less liabilities) balancing with
the shareholders' equity.
Reinforce
Before moving on, take some time to ensure that you understand the purpose of the balance
sheet and that you understand all the items appearing in the example together with the reason
for their position and treatment.
G The income statement

This is the second major financial statement in a business's annual report. The income
statement shows the amount of profit (or loss) made by the business in the last financial year.
Profit is the difference between total income and total expenses.
Be aware
Note that the profit calculation is subject to estimations and care must be taken to distinguish
the difference between profit and cash when assessing company accounts.
IFRS allows flexibility in the presentation of the income statement although a typical company is
likely to show gross profit and profit for the year. Some companies will also show operating
profit. Operating profit is not required by IFRS but, if shown, the meaning of operating profit will
need to be set out in the financial statements. The reason that companies sometimes show
operating profit is that this is the measure of profit typically used internally to assess the
financial performance of the business units.
G1 Gross profit
Gross profit is calculated by subtracting cost of sales from turnover. Costs should be matched
against the revenues generated within the same accounting period and so, as a consequence,
the value of unsold stock is not included as a cost on the income statement. An example of the
matching principle in action is as follows:

Example:
Suppose that Company X bought 200 units of stock for 2 each and sold 150 units for 4 each
during its financial year. The profit made that year would be as follows:
Turnover 600 (150 X 4)

Cost of sales 300 (150 X 2)
Gross profit 300.
The increase in the business's stock holdings (of 50 units) during the year is recorded on the
balance sheet and when paid this will be reflected in the cash flow statement. On the balance
sheet the stock which is a current asset will rise, by 100 (50 units x 2). On the cash flow
statement (see section H), the increase in the business's stock holdings will reduce the
18
business's cash flow by an Identical amount, i.e. 100.
Revenue
This is the total value of all sales invoiced during the year. Revenue is not always the same as
the business's annual cash inflow from sales. This is because revenue includes both cash and
credit sales. Revenue is also referred to as turnover and is normally the value of sales
excluding VAT.
Cost of sales
This is the cost of the stock bought in during the year that has been subsequently sold. Cost of
sales does not include money spent on stock that has yet to be sold.
G2 Profit for the year

To achieve the profit for the year the following are the main items that will be added or
subtracted.
Finance income
This is the income earned on any investments held during the year.
Finance costs
This is the cost of loans made to the company such as bank loans, mortgages and corporate
bonds.
Overheads
These are the other expenses incurred by a company such as the cost of management,
administration staff and office accommodation.
Taxation
All businesses have to pay corporation tax on their profits.
G3 Movement In equity
Reserves will increase by the profit for the year and decrease by dividends paid to
shareholders. Changes in reserves are changes to equity and IFRS requires these to be shown
in either a statement of changes in equity (SOCE) or a statement of recognised income and
expense (SORIE). IFRS also requires certain other items to be reflected as a movement in
equity such as some foreign currency movements and actuarial adjustments to defined benefit
pension schemes.

G4 Simplified example of an Income statement
Income Statement for Company XYZ, Inc.

for the year ended December 31, 2013
Total Revenue $100,000
Cost of Goods Sold ($ 20,000)

Gross Profit $ 80,000
19
Operating Expenses
Salaries $10,000
Rent $10,000
Utilities $ 5,000
Depreciation $ 5,000
Total Operating Expenses ($ 30,000)
Operating Profit (EBIT) $ 50,000
Interest Expense ($ 10,000)

Earnings before tax (EBT) $ 40,000
Taxes ($ 10,000)
Net Income $ 30,000
Number of Shares Outstanding 30,000
Earnings Per Share (EPS) $1.00
Source: http://www.investinganswers.com/financial-dictionary/financial-statement-analysis/
income-statement-1104
H Cash flow statements

This is the last of the three major financial statements in a company's annual report. The cash
flow statement records the movements of cash in and of cash out that took place during the last
financial year. It also shows the company's net cash flow for the year.
H1 Uses of a cash flow statement

Profit and cash flow are two different concepts. Profit is not calculated by subtracting cash
inflows from cash outflows. Instead, it is based on a calculation of the difference between total
income and total expenses. Clearly, income is not always going to be the same as total cash
inflow. For example, a business with income of 2m may have received only a small fraction of
this 2m in cash if the majority of its customers have bought goods on extended credit.
Remember that revenue is equal to the total value of all invoices issued during the year. This
may be totally different from cash inflows as not all customers will pay in cash and not all
invoices are paid on time.
Cash outflows need not be the same as costs. For example if a business buys machinery for

1m the cost of buying the machine is spread over the asset's useful life. This means that rather
than charging all of the 1m to this year's income statement, only the depreciation due this year
should be allocated as a cost.
Investors, suppliers and other interested parties scrutinise the differences between a business's
cash flow position and its current profitability. Lack of cash is more likely to cause a company to
cease trading rather than a lack of profit. Therefore, it could be argued that when assessing a
business's short-term survival prospects, the cash flow statement is more relevant than the
income statement.
H2 Format of the cash flow statement

20
A cash flow statement analyse the cash flows into those arising from:
operating activities;
investing activities; and
financing activities.
H2A Cash flows from operating activities
Businesses generate cash flows from their trading activities. This section of the cash flow
statement deals with how much cash the business managed to generate or consume as a direct
consequence of its trading activities including tax paid, interest received and paid and dividends
received. The financial statements will show a reconciliation of the cash generated from
operations to net profit before tax.
H2B Cash flows from Investment activities
This section shows cash inflows and outflows created by investing activities. Inflows will include
proceeds of sales of investments including associates and subsidiaries purchased and outflows
will include investments made.
H2C Cash flows from financing activities
This section deals with changes to loan and share capital and payment of dividends to
shareholders. If the business has managed to raise cash by negotiating new loans or by issuing
more shares, a cash inflow is shown. On the other hand, if it has paid back some of its loan
capital during the year, an outflow of cash is shown. Cash outflows can also occur when a
business decides to redeem or buy back some of its share capital.
H3 Increase/decrease in cash and cash equivalents

The cash flows from operations, investing and financing are totalled to show the increase or
decrease in cash and cash equivalents.
H4 Simplified example of a cash flow statement

Following is a cash flow statement prepared using indirect method:
Company A, Inc.
Cash Flow Statement
For the Year Ended Dec 31, 2010
Cash Flows from Operating Activities:

Operating Income (EBIT) $489,000
Depreciation Expense 112,400
Loss on Sale of Equipment 7,300
Gain on Sale of Land 51,000
21
Increase in Accounts Receivable 84,664
Decrease in Prepaid Expenses 8,000
Decrease in Accounts Payable 97,370
Decrease in Accrued Expenses 113,860
Net Cash Flow from Operating Activities $269,806
Cash Flows from Investing Activities:

Sale of Equipment $89,000
Sale of Land 247,000
Purchase of Equipment 100,000
Net Cash Flow from Investing Activities 136,000
Cash Flows from Financing Activities:

Payment of Dividends $90,000
Payment of Bond Payable 200,000
Net Cash Flow from Financing Activities 290,000
Net Change in Cash $115,806
Beginning Cash Balance 319,730
Sending Cash Balance $435,536
Source: http://accountingexplained.com/financial/statements/cash-flow-statement
Depreciation and any other non-cash items deducted from revenues are added back to net
profit to arrive at a figure of cash inflows. Note that tax paid (i.e. the cash outflow) may differ
from the tax expense relating to the profit for the year.
H5 Long-term business cash flows

You should note that IFRS requires the cash flows of an insurance company writing long-term
business to include the cash flows of the long-term business even though these are generally
held for the benefit of the policyholders and so are not generally available to be used by the
insurance company. In contrast UK GAAP requires the statement of cash flows to only include
those cash flows relating to shareholders.
In conclusion, it is important to have a cash flow statement, an income statement and a balance
sheet in a set of published accounts because each document measures a different aspect of
the business's financial health.

The cash flow statement focuses on the business's ability to generate cash.
The income statement indicates the business's trading conditions.
The balance sheet demonstrates the financial strength of the business (i.e. the excess of
assets over liabilities).
See the appendix to this chapter for examples of the accounts of both an insurance broker and
an insurance company.
Statutory notes to the accounts

When reading a set of accounts it is important not only to review the primary statements but
also to look at the notes to the accounts. Certain disclosures are required to be given in the
notes to the accounts to clarify for the reader full details about the company or group. It is only 22
by reading these notes that the user of the accounts will fully understand the true financial
position of the company.
One of the most important notes is the accounting policy note which requires that the
accounting policies adopted by the company in determining the amounts to be included in
respect of items shown In the balance sheet and in determining the profit or loss of the
company are disclosed.
As a result, sufficient information must be included in the financial statements to enable users to
understand the accounting policies adopted and how they have been implemented. For
example, there are detailed disclosure requirements for revenue items (cash flow) and for the
income statement.
For an insurance company's income statements, notes will usually be found on:
segment reporting which shows the results analysed by operating segment based on how
the business is managed;
continuing and discontinued operations;
effect on profit of a change in accounting policy;
investment return;
operating expenses and other charges;
employee information;
earnings per share;
directors' remuneration;
tax; and
dividend.

Bab 8: Accounting standards and
insurance company accounts
Introduction
You will have noted from the comments made in chapter 7, section A1 that quoted companies
are required to prepare their consolidated accounts following International Financial Reporting
Standards (IFRS) and that although other UK companies, including the subsidiaries of quoted
companies, are currently allowed to use UK Generally Accepted Accounting Principles (UK
GAAP) the Accounting Standards Board (ASB) in the UK has put forward a plan that could see
the demise of UK GAAP over the next few years, other than for very small businesses.
The aim of this chapter is to provide you with an understanding of topics such as:
The bodies responsible for setting IFRS and UK GAAP.

How IFRS has been adopted in the EU and how other countries such as the USA plan to, or
currently do, allow the use of IFRS.
The IFRS framework.
The requirement that accounts should show a 'true and fair' view.
The IFRS financial statements and requirements to be introduced for small businesses.
The purpose is not to list and explain the extensive number of accounting standards that are
currently in force, although we will mention how some of the standards impact insurance
companies.
We shall start by outlining the role of the International Accounting Standards Board (IASB).
A Role of the International Accounting Standards Board

(IASB)
The International Accounting Standards Board (IASB) is the independent standard-setting body
of the IFRS Foundation.
The IASB's mission is to develop a single set of high quality, understandable and international
financial reporting standards for general purpose financial statements. The IASB publishes its
standards in a series of pronouncements called International Financial Reporting Standards
(IFRS). It has also adopted the body of standards issued by its predecessor body, the Board of
the International Accounting Standards Committee (IASC). Those pronouncements continue to
be designated 'International Accounting Standards (IASC).
It is supported by an external advisory council: the IFRS Advisory Council, and an

interpretations committee: the IFRS Interpretations Committee to offer guidance where
divergence in practice occurs.
Bab 8: Accounting standards and insurance company accounts
Figure 8.1: Structures of International Financial Reporting Standards (IFRS) Foundation
The IASB co-operates with national accounting standard-setters to achieve convergence in

accounting standards around the world; in the UK this is the Accounting Standards Board (ASB)
and in the USA this is the Financial Accounting Standards Board (FASB). See section C for
more detail on the ASB.
Be aware
For Information, the IASB has decided to change the way it refers to the financial statements.
For instance 'balance sheet' has become 'statement of financial position, income statement'
has become 'statement of comprehensive income' and 'cash flow statement' has become
'statement of cash flows. Entities are not required to use the new titles In their financial
statements.
B International Financial Reporting Standards (IFRS)

B1 Who uses IFRS?
As mentioned, from 2005 companies listed on the London Stock Exchange, in common with all
companies listed on EU stock exchanges, were required to prepare their consolidated accounts
following International Financial Reporting Standards (IFRS). UK companies not listed on the
London Stock Exchange are free to use IFRS but there has been a reluctance to move away
from UK Generally Accepted Accounting Principles (UK GAAP). Some of the reasons for this
reluctance are set out in section C4.

All major economies have established time lines to converge with or adopt IFRSs in the near
future. The international convergence efforts of the organisation are also supported by the
Group of 20 Leaders (G20) who, during their September 2009 meeting, called on international
accounting bodies to redouble their efforts to achieve convergence with IFRS within the context
of their independent standard-setting process.
In August 2008 the US Securities and Exchange Commission (SEC), America's financial
markets watchdog, proposed a roadmap for companies listed in the USA to switch to IFRS from
US GAAP. The commission has already cleared the way for overseas firms to use IFRS (the
international version, not the EU version) when doing business or listing securities in the USA.
The target date for substantial convergence with IFRSs is 2011 and a decision about possible
adoption for US companies is also expected in 2011.
3
In 2007, HM Treasury's budget report announced that public sector bodies would adopt IFRS.
This was 'to bring benefits in consistency and comparability between financial reports in the
global economy and to follow private sector best practice: NHS, probation and central
government bodies have already adopted IFRS in their 2009/10 accounts. Local authorities
adopted IFRS to a slightly later timetable and will be the last major part of the public sector to
adopt IFRS fully in preparing the 2010/11 accounts. (Source Audit Commission)
B2 EU endorsement of IFRS
IFRS only apply in the EU after they have been formally endorsed. The EU has set up the
Accounting Regulatory Committee (ARC) which is composed of representatives of Member
States and whose role is to endorse IFRS for use by EU quoted companies. The ARC will take
account of a recommendation from the European Financial Reporting Advisory Group (EFRAG)
in deciding whether to endorse a standard. EFRAG is composed of representatives from
European national standard setters, the major accounting firms and industry groups. The
European Parliament also has to approve the endorsement.
Therefore, IFRS as applied in the EU may differ from that used elsewhere. The ARC has
endorsed the majority of standards without making changes. It deleted some wording, in
relation to the fair value option and hedge accounting, in IAS 39 (Financial Instruments
Recognition and Measurement). The issue relating to the fair value option has been resolved
and the accounting services of the Commission are working together with IASB to resolve the
remaining hedge accounting carve-out.
B3 IFRS framework
The underlying assumptions used in IFRS are:
Accrual basis - the effect of transactions and other events are recognised when they
occur, not as cash is received or paid.
Going concern - the financial statements are prepared on the basis that an entity will
continue in operation for the foreseeable future. If management has significant concerns
about the entity's ability to continue as a going concern, the uncertainties must be
disclosed. If management concludes that the entity is not a going concern, the financial
statements should not be prepared on a going concern basis, in which case International
Accounting Standard 1 requires a series of disclosures.

The IFRS framework describes the qualitative characteristics of financial statements as being:
understand ability;
relevance;
reliability; and
comparability.
The framework also sets out the statement of financial position (balance sheet) as comprising:
assets - resources controlled by the entity as a result of past events and from which
future economic benefits are expected to flow to the entity;
liabilities - a present obligation of the entity arising from past events, the settlement of 4
which is expected to result in an outflow from the entity of resources embodying
economic benefits;
equity - the residual interest in the assets of the entity after deducting all its liabilities;
and the statement of comprehensive income (income statement) as comprising:
income is increases in economic benefits during the accounting period in the form of
inflows or enhancements of assets or reductions in liabilities;
expenses are decreases in such economic benefits.
An item is recognised in the financial statements when it-is probable that a future-economic
benefit will flow to or from an entity and when the item has a cost or value that can be measured
with reliability.
Note: The text in section B3 is based upon Deloitte's IAS Plus. Copyright Deloitte Touch
Tohmatsu, used with permission.
B4 Requirement that accounts must be 'true and fair'

For many years company law in the UK has required all companies to prepare financial
statements each year which give a 'true and fair' view and the Companies Act 2006
incorporates a requirement - which applies to all financial statements, whether or not they are
prepared in accordance with IFRS - that the directors must not approve them unless they are
satisfied that they give a 'true and fair' view.
There is no equivalent requirement in the USA and most European countries do not have this
requirement either. In most other countries accounts are taken to present a company's results
fairly if they comply with the accounting standards.
'True and fair' is not defined in the legislation but has been generally interpreted as giving a
faithful representation of the financial performance of the company for the period, its financial
position and, where relevant, its cash flows at the end of the period.
If directors conclude that compliance with an accounting standard would be misleading and
conflict with the requirement to give a 'true and fair' view the entity is required to depart from the
accounting standard, with detailed disclosure of the nature, reasons, and impact of the
departure. This is only expected to happen in very rare occasions.
If an accounting standard gave a choice of treatment, the directors should consider carefully

which choice would give a true and fair view. (Review of practical implementation issues
relating to international financial reporting standards report 2008 United Nations 2008.
Reproduced with permission)
B5 New IFRS
The IASB introduced a moratorium on new standards and interpretations up to the end of 2008
as a result of user pressure following the EU requirement for quoted companies to adopt IFRS
in 2005. Companies argued that they needed to have time to make the appropriate changes to
their accounting systems and procedures which clearly can be expensive as well as being a
distraction for senior management. Constantly changing standards are also not liked by
investors as they complain that the 'goal posts' are constantly moving and the changes make
the interpretation of accounts more complex.
5
Companies argued that they needed to have time to make the appropriate changes to their
accounting systems and procedures. The IASB acceded to this request and the next wave of
changes became effective on 1 January 2009. These included:
Reclassification of financial instruments. Financial instruments may be reclassified in certain

circumstances from 'held for trading' to 'loans and receivables: 'available for sale' or 'held to
maturity. A reclassification has the potential of reducing the volatility of the balance sheet
value of the financial instrument.
How subsidiaries should account for schemes when their employees receive equity
instruments of their parent company.
The IASB together with the Financial Accounting Standards Board (FASB), its US equivalent,
created the Financial Crisis Advisory Group (FCAG) to consider financial reporting issues
arising from the global financial crisis.
The group reported In July 2009 and the chief areas addressed were:
effective financial reporting;

limitations of financial reporting;
convergence of accounting standards;
standard setter independence and accountability.
They reported that the crisis has exposed weaknesses in accounting standards and their
application. These weaknesses reduced the credibility of financial reporting, which in part
contributed to the general loss of confidence in the financial system. The weaknesses primarily
involved: the difficulty of applying fair value ('mark to market') accounting in illiquid markets; the
delayed recognition of losses associated with loans (particularly in banks); issues surrounding
the broad range of off-balance sheet financing structures, especially in the USA; and the
extraordinary complexity of accounting standards for financial instruments, including multiple
approaches to recognising asset impairment.
B6 IFRS 4
There is currently no comprehensive IFRS insurance accounting standard. IFRS 4 is the
standard that relates to insurance contracts but this mainly deals with the definition of an
insurance contract and guidance on presentation and disclosure requirements. IFRS 4
requirements include:
insurers need to make extensive disclosures about their insurance risk management policy,

interest and credit risk information and terms and conditions of insurance contracts with the
impact on future cash flows;
insurance liabilities must be kept in the insurer's balance sheet until they are discharged,
cancelled or expire:
insurance liabilities must be included in the balance sheet without offsetting them against
related reinsurance assets;
a test for the adequacy of recognised insurance liabilities;
an impairment test for reinsurance assets;
provisions for possible claims under contracts that are not in existence at the reporting date,
such as catastrophe, and equalisation provisions, are not permitted (by way of contrast UK
GAAP requires equalisation reserves to be shown as a liability).
6
Currently an insurance company can follow recognised GAAP, such as UK GAAP or US GAAP,
when setting its accounting policies for insurance contracts.
The IASB are currently working on Phase II of their insurance accounting project. They
published an exposure draft in July 2010 and this was open to comments up to November
2010. In January 2011, the FASB decided to continue the project jointly with IASB after
considering the comment letters on their Discussion Paper Preliminary Views on Insurance
Contracts. It is expected that an accounting standard will be available by the end of 2011.
The expectation was that Phase II would be ready in time to be used to value insurance
company balance sheets for Solvency II, which is now due to be implemented in January 2014.
The current expectation is that the Solvency II balance sheet will differ markedly from current
and future IFRS, creating significant technical, logistical and market communications challenges
for European insurers. PwC have prepared a useful commentary which can be found at:
http://www.pwc.com/gx/en/insurance/solvency-iiicountdown/1010-coming-up-with-
the-numbers.html. (Source PwC)
The insurance industry focuses on managing assets and liabilities on an economic basis,
something which its accounting practices often do not reflect. The application of IFRS can result
in a significant accounting mismatch between assets and liabilities when there is little or no
economic mismatch. Conversely, a significant economic mismatch, for example between the
duration of assets and liabilities, might exist that is not apparent from the financial statements
due to the accounting policies selected by an insurance company. In addition, when an
international insurance group reports a particular insurance contract line item (e.g. deferred
acquisition costs) in its balance sheet, different recognition and measurement bases may have
been used to determine the amount reported because IFRS 4 permits the consolidation of
amounts determined under different previous GAAPs. (Source: Ernst & Young - IFRS Insurance
Reporting- Beyond Transition, copyright Ernst & Young.)
The expectation is that Phase II of the insurance accounting project will result in improved
consistency in the recognition and measurement of insurance assets and liabilities within the
industry.
B7 Claims development tables (CDTs)

IFRS also requires claims development tables (CDTs) to be shown for general insurers. CDTs
convey valuable information about how accurate management's prior estimates of outstanding
claims were and the extent to which insurance liabilities are subject to variation. Users of
financial statements generally appear to agree that CDTs have the potential to provide some
really useful information. However, there is some variation in how these tables are shown
including:

how to account for acquisitions and disposals;

how to factor in the effects of foreign exchange fluctuations;
how to include incurred but not reported (IBNR) claims in the tables;
how to account for the effects of discounted liabilities?
(Source: Ernst &Young -JFRS Insurance Reporting- Beyond Transition, copyright Ernst 8c
Young.)
B8 IFRS financial statements

7
IFRS financial statements consist of:
a balance sheet;
income statement;
a cash flow statement; and
notes, including a summary of the significant accounting policies.
In addition, either a statement of changes in equity (SOCE) or a statement of recognised

income and expense (SORIE) is required. If a company includes a SORIE it is also required to
show in the notes a reconciliation of opening and closing share capital and reserves.
IFRS also requires comparative information for the previous accounting year to be shown.
Example financial statements are shown in chapter 7 appendix.
B9 IFRS untuk entitas kecil dan menengah
Pada bulan Juli 2009 IASB menerbitkan IFRS yang lama ditunggu-tunggu untuk digunakan oleh
entitas kecil dan menengah, yang akan menawarkan alternatif untuk IFRS penuh. Ruang
lingkup standar ini berpotensi lebar - memang ditujukan untuk semua entitas yang tidak
memiliki 'akuntabilitas publik' dan menerbitkan laporan keuangan untuk tujuan umum bagi
pengguna eksternal.
Menyadari
Kebanyakan, jika tidak boleh disebut semua, asuransi yang memilih untuk menggunakan IFRS
cenderung harus menggunakan IFRS penuh karena mereka dianggap bertanggung jawab
kepada publik.
Pada bulan Oktober 2010, ASB menerbitkan sebuah draf eksposur mengenai masa depan
pelaporan keuangan di Inggris dan Republik Irlandia, yang menetapkan proposal untuk
kerangka pelaporan tiga tingkat (three-tier) dan yang akan berlaku untuk periode akuntansi
yang dimulai pada atau setelah 1 Juli 2013 , sebagai berikut:
Tier 1 - entitas publik akuntabel akan menerapkan IFRS seperti yang diadopsi oleh Uni
Eropa.
Tier 2 - semua entitas Inggris lainnya, selain mereka yang dapat menerapkan Standar
Pelaporan Keuangan untuk Entitas yang Lebih Kecil (FRSSE), bisa menerapkan
FRSME yang didasarkan pada IFRS untuk Entitas Kecil dan Menengah.
Tier 3 - entitas yang lebih kecil, tanpa akuntabilitas publik, bisa memilih untuk terus
menerapkan FRSSE.

Jika mengadopsi ini akan menyebabkan matinya UK GAAP selama beberapa tahun ke depan,
selain untuk usaha sangat kecil.
C UK Generally Accepted Accounting Principles (UK GAAP)

Until 2004 all UK companies were required to prepare their accounts in accordance with UK
GAAP. As noted in section B, from 2005 quoted companies were required to prepare their
consolidated accounts following IFRS.
UK GAAP is determined by the Accounting Standards Board (ASB) and it has sought to mirror
developments in international accounting, and the most recent UK Financial Reporting
8
Standards (FRSs) and Urgent Issues Task Force (UITF) interpretations have been largely
(although not exclusively) taken directly from IFRS. UK GAAP comprises:
Statements of Standard Accounting Practice, issued from the 1970s and prepared by the
original Accounting Standards Committee which was replaced by the independent ASB in
1990;
FRSs prepared by the ASB; and
UITF Abstracts, prepared by the UITF and issued by the ASB.
The main role of the UITF is to assist the ASB in areas where an accounting standard or
Companies Act provision exists, but where unsatisfactory or conflicting interpretations have
developed or seem likely to develop. Its consensus pronouncements are issued as UITF
Abstracts, which the ASB expects to be regarded as accepted practice and the basis for what
determines a true and fair view.
C1 Financial Reporting Council (FRC), Accounting Standards Board

(ASB) and the Financial Reporting Review Panel (FRRP)
The FRC is the UK's independent regulator responsible for promoting confidence in corporate
reporting and governance. The FRC's main strategic outcome is to be an effective, accountable
and independent regulator, operating in the public interest and actively helping to shape the UK,
and to influence EU and global approaches to corporate reporting and governance.
It has three supporting outcomes:
The FRC meets the principles of good regulation.

The FRC is recognised in the UK and globally as independent, credible, authoritative and
influential.
The FRC has adequate resources and management processes and operates efficiently.
(Source FRC.)
The FRC believes that there are strong connections between the issues of corporate
governance, auditing, actuarial practice, corporate reporting and the professionalism of
accountants and actuaries.
In 2011/12, the FRC will focus their work on four major outcomes:
stronger and better-informed engagement between institutional investors and company

boards;

corporate reporting and auditing that deliver greater value to investors and better serve the
public interest;
a strong UK voice in the EU and international debate on the future regulation of corporate
governance, reporting and auditing; and
a more effective UK regulatory framework that adds value for investors and other
stakeholders at low incremental cost. (Source FRC Annual Plan.)
The ASB and FRRP are two of several operating bodies of the FRC as shown in the following
figure.
Figure 8.2
9
The ASB issues accounting standards for the UK and Ireland but, with the move to IFRS, it is
increasingly focused on influencing the setting of standards by the IASB on behalf of its
stakeholders.
The FRRP reviews the financial statements of publicly quoted and large private companies for
compliance with company law and with applicable accounting standards. Reviews are carried
out on a sample basis, according to certain risk criteria, so not all financial statements are
examined each year. As explained below, the FRRP also reacts to direct complaints and press
comments. The FRRP can ask directors to explain apparent departures from requirements. If
the FRRP is not satisfied by the directors' explanations, it aims to persuade the directors to
adopt a more appropriate accounting treatment. The directors may then voluntarily withdraw
their financial statements and issue a replacement set that corrects the matters in error.
Depending on the circumstances, the FRRP may accept another form of remedial action - for
example, correction of the comparative figures in the next set of annual financial statements.
Failing voluntary correction, the FRRP can apply to the court for an order to secure the
necessary revision of the financial statements although to date it has never had to do this.

C2 Statements of Recommended Practice (SORPs)

SORPs are recommendations on accounting practices for specialised industries, such as
insurance, and they supplement accounting standards. SORPs are not issued by the ASB but
by industry bodies. A SORP is required to carry a statement by the ASB confirming that the
SORP does not appear to contain any fundamental points of principle that are unacceptable in
the context of current accounting practice.
The Association of British Insurers (ABI) produces the SORP for insurance business.
Be aware
The recommendations In this SORP only apply directly to UK GAAP and have no direct 10
application to entitles using IFRS. These entities are, however, encouraged to have regard to Its
provisions insofar as this Is compatible with the requirements of IFRS.
Insurance companies preparing accounts following UK GAAP are required to state that they
have complied with the SORP.
C3 Financial Reporting Standard for Smaller Entities (FRSSE)

Prompted by concerns to reduce burdens on businesses there are simplified UK GAAP
accounting rules for small businesses called the FRSSE.
The FRSSE brings together the relevant accounting requirements and disclosures from UK
GAAP, simplified and modified as appropriate for smaller entities. The basic measurement
requirements in the FRSSE are the same as those in other accounting standards (although with
some slight simplifications), but many of the disclosure and presentation requirements of other
standards have not been included in the FRSSE.
The latest version of the FRSSE was published by the ASB in June 2008 to reflect changes in
company law arising from the Companies Act 2006. No changes were made to the
requirements that are based upon Generally Accepted Accounting Practice.
The FRSSE is a standard that may be applied by most companies with an annual turnover of up
to 6.Sm. Entities adopting the FRSSE are exempt from applying all other accounting standards
and UITF Abstracts. This considerably reduces the volume of accounting standards those
entities need to comply with, or refer to. However, it remains open to them to choose not to
adopt the FRSSE and to comply with the other UK accounting standards and UITF Abstracts
instead or, if they are companies, international accounting standards.
The full text is available from: www.frc.org.uk/asb/technicaUfrsse.cfm
C4 UK GAAP and IFRS

Although UK quoted companies are required to produce their accounts in accordance with
IFRS, other companies have been slow to change from UK GAAP to IFRS. Indeed it is common
for quoted companies that prepare IFRS accounts to publish the accounts for their subsidiaries
using UK GAAP. Accounts for these subsidiaries will have to be prepared using IFRS for
consolidation purposes but they are free to publish accounts using UK GAAP if they so choose.
Reasons for the reluctance to convert from UK GAAP to IFRS are likely to include:

potential adverse tax consequences given that the starting point for tax on trading profits is
the accounting profit in the published accounts whether this be UK GAAP or IFRS;
potential adverse effect on distributable profits;
potential adverse impact on regulatory solvency again the starting point would be the
published accounts;
potential adverse implication on debt covenants particularly if the adoption of IFRS were to
change the gearing ratios (see chapter 10for more on ratios);
concern over the implications of conversion from UK GAAP to IFRS in terms of
management time, skills available, training requirements, changes required to systems and
cost.
11
As the ASB has made changes to UK GAAP to conform to IFRS the differences between the
two standards have clearly reduced. Nevertheless differences do exist and include:
For some businesses IFRS could produce more volatility in the headline reported result.
For example, it was common for quoted UK insurance companies to include a smoothed
investment return (referred to as the long-term investment return) in their headline result
and so investment value fluctuations did not impact this figure.
In UK GAAP the cash flow statement does not include any amounts relating to the long-
term business except cash transactions between the long-term business and shareholders.
In IFRS the cash flow includes all cash movements on the long-term business.
UK GAAP requires the equalisation provision to be shown as a liability and movements in
the provision to be shown in the profit and loss account. IFRS does not allow the
equalisation provision to be included in the accounts.
UK GAAP is very prescriptive over the layout and description of line items in the financial
statements. IFRS is much less prescriptive.
Businesses sometimes have to prepare accounts on more than one basis. For instance a UK
insurance business that is part of a group may prepare and file accounts at Companies House
using UK GAAP. Other accounts it may have to prepare include:
IFRS accounts if it has a parent company reporting IFRS results.

US GAAP accounts if it has a parent reporting US GAAP results.
Annual statutory returns for the FSA. The starting point would be its UK GAAP accounts
filed with Companies House with adjustments made as specified by the FSA.
In addition, adjustments to the UK GAAP accounts will need to be made for tax computation
purposes in accordance with the rules governed by tax legislation.
D FSA UK Listing Rules

All companies are subject to company law, but publicly listed companies have to abide by
additional regulations called the 'listing Rules: which are administered by the FSA and
effectively have the force of law.
The Listing Rules dictate such matters as the contents of the prospectus for a company seeking
a listing for the first time (this is referred to as an Initial Public Offering or an IPO), and on-going
obligations such as the disclosure of price sensitive information, and communications on new
share offers, rights issues, and potential or actual takeover bids for the company.

The Listing Rules require quoted companies to produce half-yearly financial reports as well as
annual reports. The rules implement the EU Transparency Directive but also set slightly more
stringent requirements.
12

Bab 9: Claim reserving
Introduction
In chapter 7 we looked at the main accounting principles and practices and in chapter 8 we
looked at the main accounting standards that affect insurance. Now we are going to move on to
claims reserving (the process by which the company determines how much to set aside for
claims), which is a practical topic that goes to the heart of understanding an insurance
company's, and a reinsurance company's profitability and is critical in understanding its financial
strength.
As we shall see, determining the amount that should be set aside for claims is normally the item
in the accounts that is the most uncertain, and the profitability is generally highly sensitive to the
amount that is chosen.
We shall also see that if the amount that is set aside for claims at the end of one year is found
to be too little in later years the impact on a companies' financial position can be materially
adversely affected.
In addition, as part of the planning process it is important to make a range of decisions such as:
which lines of business are profitable and should be grown;

which lines of business are not earning the required return on capital and so remedial action
is required;
what are the appropriate premium rates to charge to earn the target return on capital;
whether the company should seek more capital and, if so, what the expected return on
capital would be;
whether the company is holding the appropriate amount of capital for the risks that it is
writing:
what the appropriate reinsurance programme is for the risks the company plans to accept
and whether the net retentions are in line with the company's risk appetite (see chapter 11,
section B).
None of the above can be adequately determined unless the company has set aside the
appropriate amount for claims.
A The importance of accurate reserving

A key requirement of an insurance company, and a reinsurance company, is to ensure that it
makes appropriate provision for the eventual cost of claims arising on policies it has written -
the claims reserving process. Certain claims, such as industrial disease claims, can take years
to manifest, to be notified to the company and to be settled.
Inevitably there is considerable uncertainty as to the eventual outcome of these claims.
The uncertainty over setting an appropriate level of claims reserve is influenced by a number of
factors including:
legislative change in the future having a retrospective impact on existing claims;

future claims payment patterns differing from historical experience;
new types of claim, such as stress and disease claims, emerging from risks written many
years ago;
cases of latent exposures such as asbestos being reported (for example, cases of
mesothelioma can have a latent period of up to 40 years);
the outcome of litigation on existing claims; failure to recover reinsurance; and
unanticipated changes in claims inflation.
Comments made by insurance companies include:
The Group has exposures to risks...that may develop and that could have a material impact 2
upon the Group's financial position
...the eventual cost of settlement of outstanding claims and unexpired risks can vary
substantially from the initial estimates...
Source: RSA report and accounts 2010, copyright RSA reproduced with permission.
Clearly any estimate, such as a claims reserve, that could have a material adverse impact on
the balance sheet is going to be subject to considerable scrutiny from management, directors,
analysts, rating agencies, regulators and investors. There is a fiduciary duty on directors to
ensure that, at any one time, appropriate estimates are made for all assets and liabilities and
given that the insurance claims liability is likely to be material in relation to an insurance
company's capital the estimate is crucial to the assessment of its financial strength. An accurate
view on the required level of claims provisions is also needed to measure financial performance
clearly changes in the estimate of the amount to set aside has a direct impact on the
underwriting profitability.
B Incurred but not reported (IBNR) and its role in insurance

company accounts
As we have seen in chapter 8, section B3, a fundamental accounting concept is that accounts
are produced following the accruals concept which means that transactions are recognised
when they occur. IFRS recognises this in its framework and other accounting standards have
similar recognition requirements. As a result, when considering which claims should be
accounted for in an accounting period there is a requirement to estimate all claims arising from
incidents in the year whether the claims have been reported or not.
If we examine if this makes sense from how profit is calculated it is necessary to start with how
income is recognised. We saw in part 2 of the appendix to chapter 7 how earned premium is
calculated, and that the portion of written premium earned up to the balance sheet date is
included in income for the rear. Any premium attributable to periods after the balance sheet
date is deferred and recognised in the income statement in a subsequent accounting period.
Hence, to work out the profitability of a portfolio of business it is necessary to recognise claims
with an incident date up to the balance sheet date whether reported or not. This is done with an
IBNR (claims incurred but not reported) calculation.
The IBNR calculation is based on an extrapolation of the pattern reported in prior years and up
to the balance sheet date. The prior year are used to estimate the number of claims expected to
be reported after the balance sheet date with incident dates prior to the balance sheet date. The

total value of IBNR is calculated from multiplying the number of such claims by the average cost
of claims. Note that if claim numbers are stable the IBNR increases by claims inflation each
year.
To calculate the total value of claims it is also necessary to estimate whether the claims
reported are adequately stated. The case estimates of liability claims are likely to understate the
total cost to the company for a variety of reasons: one reason being that some injury claims will
develop into high cost claims and it is rarely possible to identify which ones will develop in this
way but an estimate can be made on a portfolio basis. IBNER (incurred but not enough
reported) is a term that is sometimes used when referring to these claims. In the next section
the method of calculating IBNR and IBNER claims is set out.
3
Note that the unearned premium reserve is also examined to test to see that the amount set
aside is at least adequate to cover the expected cost of claims. If it is deemed not to be
adequate then an unexpired risk provision is set up as a liability in the accounts. An extract from
RSA's accounts illustrates a typical accounting policy for unexpired risks:
'At each balance sheet date an assessment is made of whether the provisions for unearned
premiums are adequate. A separate provision is made, based on Information available at the
end or the reporting period, for any estimated future underwriting losses relating to unexpired
risks. The provision is calculated after taking into account future investment income that is
expected to be earned from the assets backing the provisions for unearned premiums (net of
deferred acquisition costs). The unexpired risk provision is assessed in aggregate for business
classes which, in the opinion of the directors. are managed together
C Reserving methods
In section A we discussed the importance of accurate reserving and we have seen that the
eventual cost of claims can vary significantly from the original estimates and have a material
adverse effect on an insurance company's financial position. We have also seen what factors
give rise to this uncertainty.
Insurance and reinsurance companies need to maintain sufficient claims reserves to meet their
outstanding liabilities at any one time. Hence the process for estimating the eventual cost of
claims is vital for indicating whether an insurer is financially solvent and to form an opinion on its
financial performance.
In this section we will look further at the various reserving methods available to insurance
companies.
C1 Categorising claims and collecting the claims statistics

The starting point in determining the appropriate amount to set aside for claims is to establish
the information required to make the assessment. Information on claims is generally gathered
by incident year (also called accident rear) and the reason is as follows: premiums are earned
up to the last day of the accounting period and for profitability purposes this needs to be
matched to incidents that give rise to a claim up to the same day.
The Information required is generally collected by class of business (e.g. motor, property,
liability etc.) and within each class the claims statistics are grouped into categories depending
on how claims develop for each class. In deciding which categories to use regard will be paid

to:
length of tail (being the time from the incident date through to advice and payment);
expected claims pattern;
expectation of a surplus or deficit in the run-off of claims;
average claim values.
For example, motor claims for damage to vehicles have very different characteristics to motor
bodily injury claims. Clearly the former can generally be settled quite quickly and the latter take
longer to assess and are more likely to be the subject of protracted litigation. Hence motor
claims are usually split into these two categories as a minimum. As a rule of thumb liability
claims are separated from property damage claims and large claims are extracted from the 4
statistics and assessed separately. For each claim development category for each class of
business the following statistics are usually collected by incident year:
number of claims reported;

number of nil claims (in case the policy for recording nil claims changes which could have a
distorting effect on total reported claims);
total value of paid claims;
total value of the outstanding case estimate of claims at the period end (from which the
case incurred development can be modelled as the case incurred value is the sum of the
claims paid in the year plus the value of the case estimates outstanding at the end of the
year, less the value of the case estimates brought forward from the prior rear).
The above will be collected by each year of development. Hence for incident year 2XX3 in
2XX8 the statistics required will be as at the end of 2XX3 (the first development year), as at the
end of 2XX4 (the second development year) etc.... up to the end of 2XX8 which will be the sixth
development year. Projections are typically performed from the claims development triangles
with the information shown as follows:
Figure 9.1: claim development for a category of claim as at 2xx8

Incident year Development year
1 2 3 4 5 6
2xx3 xxx xxx xxx xxx xxx xxx
2xx4 xxx xxx xxx xxx xxx
2xx5 xxx xxx xxx xxx
2xx6 xxx xxx xxx
2xx7 xxx xxx
2xx8 xxx
C2 Range of methodologies
It is common to use a range of methodologies for projecting the total cost of claims.
The purpose is to learn about the claims development for each category of claim and form an
opinion on the likely range of possible estimates. Some methodologies might underestimate the
total cost of claims, e.g. if terms and conditions have weakened in the previous few years a
simple extrapolation is likely to underestimate the total cost. These projections are still likely to
be of value as they may be used to set a minimum value to the range of estimates.
Obviously methodologies that do not take into account an improving trend may be used to set

an upper estimate. The analyst working on the claims projections will look for unusual trends
and seek explanations from the underwriter or account manager to improve their understanding
of the claims development patterns.
Methodologies for extrapolating the claims statistics to arrive at an estimate of the total cost of
claims include:
Projection of paid claims. The simplest method is to just extrapolate the paid claims and
not use any other information available such as the incurred cost of claims. As payments
would have b en subject to inflation this method assumes that the typical claims inflation
experienced in the past will be experienced in the future.
5
A variation of this method is to adjust these payments for inflation- obviously the inflation
rate to use is that applicable to the type of claims being made. An inflation adjusted method
is particularly useful when inflation experienced to date is expected to differ markedly from
that expected in the future.
Projection of incurred claims. As this uses more information, the expectation is that this
method will produce a more accurate estimate of total claims than a projection of paid
claims. However, issues will arise with this method when there has been a significant
change to the claims handling procedures - for instance due to changing instructions in
values to use for claims settlements. Hence it is important that the analyst working on the
claims projections meets with the claims handlers to understand what changes have been
made to claims handling procedures.
Again a variation on this method is to adjust the incurred claims by inflation.
Loss ratio method. This method is rarely used on its own but can be used for the most
recent incident years where the value of paid and/or incurred claims is low in relation to the
total value of claims expected. In these circumstances a small change in the experience to
date will extrapolate to a large change in the total estimate. The loss ratio method will
normally start with a year that is reasonably developed, for instance the year that has had
three years of development. Assumptions will be made for the main drivers in the change to
loss ratio from this date such as premium rate changes and claims inflation. From this an
estimate of the loss ratio in the more recent years can be derived.
Bornhuetter Ferguson. This is a straightforward combination of the loss ratio method with
either a paid loss or incurred loss development. As an example, if it is combined with the
paid method and payments in the first two years of development are expected to be 5% and
15% of the total respectively, then, for the first year of development, 5% of the projection
would be based on the paid development method and 95% on the loss ratio projection. For
the second year the proportions used change to 15% and 85%. Clearly as the experience to
date becomes more developed more reliance is placed on it.
Other methods used include average cost of claims and exposure based methods. The
exposure based method would be used for very long-tail liabilities with high degrees of
uncertainty such as asbestos, pollution and health hazard exposures.
C3 Deciding on the amount to set aside for claims

Ultimately it is the board that has to decide on what is a fair presentation of the accounting
statements and hence form an opinion on the significant accounting estimates such as the
amount to set aside for claims. The board will normally decide on a claims reserving policy

which may include a decision to set aside an amount for claims such that no adverse run-off is
anticipated.
Within the senior executive team the responsibility is usually delegated to the chief financial
officer and the team preparing the estimate is likely to be headed by an actuary or someone
with actuarial skills. There will be regular review of claim development; usually monthly for the
most volatile claims and quarterly for the rest of the portfolio. In forming an opinion on the
amount to set aside for claims normal meetings are likely to be held between the claims
reserving specialist, the account manager, underwriters, pricing specialists and the person
responsible for claims handling. Recommendations will he made to the executive team and the
executive team will make recommendations to the board.
6
The normal policy is to set aside amounts for claims allowing for future inflation. Hence the
amount set aside should be the amount anticipated to be required when the claim is paid and
not the amount that would be required to settle the claim at the balance sheet date. Some
companies discount long-tail classes and if they do so their policy for discounting claims will be
set out in their accounts. Discounted claims are claims where the amount set aside is reduced
by the investment income expected to be earned in the future on the investments supporting the
claims.
It is common for a company to employ external actuaries to review the amount set aside for
claims on a regular basis to increase the confidence of investors and external analysts that the
provision is fairly stated.
Claims run-off
The accuracy of the amount set aside for claims is likely to be judged by the claims run-off. The
run off in the year is the incurred cost during the year on the amount set aside for claims at the
start of the year. Hence it will be the opening provision less the closing provision for the same
claims adjusted by claims payments made.
Investors and external analysts will form an opinion on the adequacy of the amount set aside for
claims in the latest set of accounts based on the run-off for the most recent years. It is not
unusual for external analysts, such as rating agencies, to judge that the amount set aside is
inadequate if the run-off in the previous few years is adverse. This may not be the case but it is
frequently their starting point.
It is worth making the point that if there is favourable run-off in the year it is not necessarily valid
to say that the current years result has been distorted by this amount. If the policy is to set
prudent reserves and there is a history of favourable run-off it is not unreasonable to expect that
the amount set aside for claims in the latest accounts will also produce favourable run-off in the
future.

Bab 10: Financial ratios
Introduction
Anyone following a group of companies in the same industrial sector will note that one company
often does badly whereas the other companies do well. Comparing different companies is
useful to many interested parties, for example, directors, managers and shareholders. Most
interested parties will want to:
analyse the performance of a company in the past;

draw conclusions from this past performance about what action should be taken now or in
the future.
In isolation a figure from the balance sheet or the income statement does not convey much
useful information.
Example
If somebody told you that company XYZ made a profit of 50,000 last year, it is impossible to
tell if this is a good or a bad result, unless you know more about the business in question. If we
are talking about a small greengrocer's or newsagent's shop, a 50,000 profit for a year is an
excellent result; but If we are talking about a business the size or Tesco or Marks and Spencer
then a profit of 50.000 is a terrible result!
To make figures meaningful, we need to talk in terms of accounting ratios, and much of the
analysis of company accounts takes the form of working out and interpreting ratios. In this
chapter we will first look at general ratios which apply to all businesses, followed by those with
particular relevance to the insurance industry.
A Frequently used ratios

The standard ratios fall into five categories:
profitability ratios;
productivity ratios;
liquidity ratios;
activity (or turnover) ratios;
gearing ratios.
A1 Profitability ratios
Profitability is one of the most important measures of a company's success and its viability.
However, individual figures shown in the income statement for gross profit and net profit mean
very little by themselves. When the profit figures are expressed as a percentage of sales
(revenue) they are more useful. This percentage can then be compared with those of previous
years, or with the percentage of other similar companies.
The main profitability ratios are:
gross profit percentage;

net profit percentage;
return on capital employed.
A1A Gross profit percentage ratio
Gross profit x 100%

Sales (revenue)
Changes in the gross profit percentage ratio can be caused by a number of factors, e.g.: 2
A decrease may indicate greater competition in the market causing lower selling prices and
a lower gross profit; or an increase in the cost of purchases.
An increase in the gross profit percentage may indicate that the company is in a position to
exploit the market and charge higher prices for its products, or that it is able to source its
purchases at a lower cost.
A change can also be due to a change in the mix of products sold. An increasing volume of
a product with a high gross margin will increase the overall ratio.
A1B Net profit percentage ratio
Net profit x 100

Sales (revenue/turnover)
The relationship between the gross profit and the net profit percentage gives an indication of
how well a company is managing its business expenses. If the net profit percentage has
decreased over time while the gross profit percentage has remained the same, this might
indicate a lack of internal control over expenses.
The reason for the multiplication by 100 is to express the figure as a percentage rather than as
a fraction.
This gives the profit margin on sales, often 5%-10% and shows how effective the management
is - a higher margin is often a sign of skilled management. If the margin is low then the company
may be deliberately increasing the overheads to cope with a planned future expansion of the
business.
A1C Return on capital employed (ROCE) ratio
Return on capital employed (ROCE) = profit before interest charges and tax x 100%
share capital + reserves + borrowings
The ROCE ratio enables an investor to see if the insurer is making money for them and make
comparisons between companies. The ratio is basically concerned with the relationship of profit
to the total capital employed and is seen as giving an indication of how efficiently and effectively
management have deployed the resources available to it, irrespective of how those resources
have been financed. As a rough guide the shareholders want at least two times the return they

would get from putting their money in a typical bank deposit account. Clearly the higher the risk
in a company the higher the return required which is why a start-up company would be
expected to produce a higher return.
The reasons that the ROCE ratio is an important measure are as follows:
A low return could easily be wiped out in a recession.

When acquiring other businesses or moving into new markets, there should be a high
ROCE to make it worthwhile for the capital providers.
A persistent low ROCE in a business division may signal that it is time to dispose of it.
A variation on ROCE is return on equity (ROE). This looks at the return after tax attributable to 3
shareholders as a ratio of equity (see section B3A).
A2 Productivity ratios
Of the five areas of ratio analysis, this is the least practical. However, it is very easy to muddle
productivity with profitability. Both profitability and productivity compare inputs and outputs, but
they do so in different ways:
Profitability compares the money value of the outputs with the money value (the cost) of the
inputs; the difference between the two is the profit, which can be expressed either as an
amount of money or as a ratio.
Productivity also compares inputs and outputs, but it does not use money as a measuring
rod; it compares inputs and outputs directly.
An airline, for example, can work out its fuel efficiency by working out how much fuel (input) it
needs for a certain flight (output). A coal mine can measure its productivity of labour by dividing
the output of coal by the number of man-hours worked; this productivity ratio will take the form
of 'so many kilos of coal per man hour.
There are several applications for such figures. One is to work out how much it costs the
business to produce its output. Another is to make comparisons, which are often a useful basis
for management decisions. An airline, for example, can compare the fuel efficiency of different
types of aeroplane, and take this into account when deciding which one to buy.
When considering the performance of a company as a whole, we can either compare the
productivity of that company in a given year with the productivity of the same company in
previous years, or we can compare its productivity with that of another business in the same
sector. If the productivity of one company is lower than that of others, management may find it
useful to think about whether there are good reasons for that difference or whether it is due to
inefficiency.
Useful efficiency ratios

Most companies, including insurers, offer their customers credit in order to increase their sales.
However, giving credit to customers incurs an opportunity cost as the cash is tied up in
financing receivables/debtors, and there is also the risk of the debts not being paid. Therefore,
companies will normally seek to collect their debts as soon as possible.
The receivables/debtors collection period (in days or months) provides an indication of how
successful (or efficient) the debt collection has been:

Trade receivables/debtors x 365 days

Sales
The payables/creditors payments period links the value of payables/creditors with the amount
of goods and services that a company is purchasing on credit.
Payables/creditors x 365 days

Purchase
Payable/creditors can provide a source of free finance to the company and so it is in the
company's interest to try and defer payments as long as possible. However, this strategy
ignores the value of any cash settlements or discounts that may be offered by suppliers. In
4
addition excessive delays in payment may result in the reduction in the general terms of trade
that suppliers are prepared to offer and can ultimately result in reputational damage for the
company.
The inventory/stock turnover period indicates the average number of days that inventory/stock
is held for.
Inventory/stock x 365 days

Cost of sales
A change in the inventory/stock turnover period can be a useful indicator of how well a company
is doing. A lengthening in the inventory/stock turnover period may indicate a slowing down of
trading or an unnecessary build-up of stock/inventory.
A3 Liquidity ratios
The future of a company that makes losses year after year is obviously bleak. Interestingly,
however, most bankruptcies are not caused by a lack of profitability, but by the inability to pay
creditors on time by a lack of liquidity.
The reason for this is that shareholders rarely find it in their interest to close down their
company even after several years of losses, whereas the first creditor who is not paid on time
can take the company to court and start bankruptcy proceedings. In this context, the word
'creditor' refers to anybody to whom the company owes money. This may be a supplier of raw
materials; a gas, water or electricity supplier; or an individual or an organisation that has lent
money to the company. It is necessary for the survival of the business that it pays its creditors
on time, and it will only be able to do this if it has sufficient liquidity.
Liquid assets are all those assets that either are money (cash) or can be turned into money at
short notice (like short-term deposits with banks or other financial institutions, or short-term
securities). A jeweller may hold stocks of gold or other precious metals; such stocks are liquid
since they can be sold at any time, although their value will fluctuate in line with the market
prices of the metals concerned. The stock of a car manufacturer or dealer, on the other hand,
consists of unsold cars. Such stocks are much less liquid since you cannot sell them whenever
you wish.
The two most useful ratios are:

the current ratio, defined as:

current assets
current liabilities
the quick ratio, defined as:
current assets excluding stock

current liabilities
A current ratio of more than 2 is seen as prudent in order to maintain creditworthiness, but in
recent years a figure of 1.5 has become quite normal. However, it will depend on the nature of
the business and how much stock is readily saleable. An example of a business that can trade
with a low current ratio is a supermarket. They buy goods on credit and sell mainly for cash and
5
so can usually survive on a current ratio of less than I(i.e. current assets less than current
liabilities).
The quick ratio (which is more liquid or cash driven) will often be below 1, which means if a
company had paid up all its creditors and collected from all its debtors at once, the company
would require an overdraft facility. The question is then are the bankers happy to offer an.
overdraft? If not then the company is possibly starting to get into trouble.
A4 Activity (or turnover) ratios

A company's assets do not generate any cash by themselves. They do enable the company to
produce goods or services, and it is from the sale of those goods or services that the company
generates its revenue and profit. Therefore, the profit the company makes will depend, among
other things, on the activity (e.g. measured by the volume of sales) generated by the company's
assets, shareholders' equity or some other balance sheet item.
Activity ratios compare some aspect of the company's activities (usually sales or purchases)
with a relevant balance sheet Item. When comparing sales over a longer period of time, it may
be advisable also to take inflation into account.
Some frequently used ratios are as follows.
Stock:
The stock turnover ratio = cost of sales

average stock
This ratio is used to investigate a company's stockholding policy. If a company has annual cost
of sales of 120 and holds an average stock of 20, the stock is turned over six times per year, or
once every two months. Changes in this ratio affect a business's liquidity. If the stock is turned
over more slowly, less cash is generated and relatively more cash is tied up in stock.
Debtors and creditors:
The debtor turnover ratio = sales

debtors
When expressed in this form, this ratio indicates how often the amount of debtors is turned
over each year; sales of 180 per year and average debtors of 30 would produce a debtor

turnover of six times per year. This is the same as saying that debtors are turned over once
every two months, i.e. that debtors stay on the company's books for two months and they take,
on average, two months to pay.
The creditor turnover ratio = purchases

creditors
This ratio is based on the same principle as the stock and debtor turnover ratios, but since
creditors are created when the business buys something, it should be based on purchases and
not on sales. If our purchases amount to 120 per year and our average amount of creditors is
ten, our creditor turnover is twelve times per year or once a month. This means that we receive
one month's credit from our suppliers.
6
Just like changes in the stock turnover ratio, changes in the debtor or creditor turnover ratios
affect the liquidity of the business. Since creditors are a current liability, an increase in the credit
period increases the liquidity of the business. If we take longer to pay our suppliers, the effect is
the same as if we borrowed more money to pay them; the business has more liquidity than it
would have had otherwise.
A5 Gearing ratios
This is probably one of the best measures of a company's future and the gearing ratio is easy to
understand. It expresses borrowings as a percentage of shareholders' equity. The higher this
ratio, the more the business in question relies on debt finance.
Gearing:
long-term borrowings x 100

shareholders' equity
Expect a good figure to be between 80%-110% depending on the business.
Think
Why is it useful to know gearing ratios? Why does it matter whether a company is highly geared
or not?
The problem with debt is that interest must be paid on the debt, and the debt itself must be
repaid on the due date, no matter how well or badly the company is doing. If a company without
debt has a bad year, it need not pay any dividends to its shareholders, while a debt-financed
company must continue to pay interest on its debt. If it is unable to pay such interest, then it can
be the end of the company. So, the higher the level of debt, the greater the risk.
This leads to the question of why companies borrow at all. If borrowing increases the risk, why
not sell more shares instead of borrowing? One of the reasons is that the borrowing option may
be more profitable to the shareholders. If a company can borrow money, build a new plant and
sell more goods with a decent margin, then it will make more profit for the shareholders - even
after paying for the interest on the debt.
This is great in a healthy economy, but if a recession occurs and the sales reduce, the factory
has to cut production, but the interest on the debt still h s to be paid. Now the company has real
problems and the overexpansion in the good times is looking foolish. Many well-known
companies have collapsed, by overstretching themselves and borrowing too much money in the
good times, without having the reserves to pay the interest in the lean times.

B Ratios in the insurance industry

We have already seen in the appendix to chapter 7 that insurance brokers' accounts are very
similar to the accounts of non-insurance businesses, whereas the accounts of insurance
companies are different. That means that the accounts of insurance brokers can be analysed by
using the usual accounting ratios we have discussed so far. For insurance companies trading in
general business some of the above ratios are still relevant plus there are some additional
ratios. It is outside the scope of the course to consider life business. Irrespective of the
stakeholders' Interest in general, they will all be concerned in ensuring there is:
security, Including solvency;

liquidity; 7
capital adequacy; and
profitability.
B1 Security
The security of a company is largely bound up with its balance sheet, and the cushion provided
by its net assets should enable it to withstand shocks arising from any cause and to take
advantage of new business opportunities.
B1A Solvency
For practical purposes this is taken, for general business, as being measured by its premium
income.
The ratio will then be:
net assets
earned premium net of reinsurance
It will be appreciated that, in general terms, the higher the figure the stronger the company.
However, there is another side to this interpretation: a company with a high level of capital to
support its turnover is usually seen as being 'overcapitalised' and will have a low return on the
ROE (return on equity).
B1B Cover for claims outstanding
Outstanding claims are the major liability of a general insurance company. Changes in bases of
valuation can affect both surplus and profit yet valuation is always a problem and there is a
particular concern at the risks inherent in undervaluation. There is considerable significance in
the ratio:
outstanding claims
net assets
The lower the ratio the more secure the position -but, paradoxically, a company which is under-
reserved will show a better result and this will create problems for the future, maybe even
leading to failure.

B2 Liquidity
As premiums are received before claims are paid insurance companies generally have a
positive cash flow, particularly those that are growing, and therefore do not suffer from liquidity
problems in the same way as manufacturing companies. No company likes to have too much of
its funds tied up in liquid assets that often do not earn it a great amount. Many companies have
excellent credit ratings and can borrow money quickly and cheaply if they need to pay creditors.
However, there is always a danger of sudden unexpected requirements for cash and for an
insurer not to be able to meet these would be a disaster.
A generalised formula used is:

8
total liabilities
cash + investments
There may be various limitations on the investments to be included in the calculations and
some firms may only include quoted investments, whilst others include a proportion of non-
quoted investments too. Irrespective of the calculation used, the lower the result, the greater the
liquidity. Finns must also be consistent year on year in calculating their ratios and in all cases
common definitions of assets and liabilities must be used.
The reason that a different ratio is used when assessing an insurer's liquidity is that an insurer's
liquidity can easily come from freely marketable investments as these are mainly held to fund
claims. Few trading or service companies hold substantial investments that need to potentially
be available to finance long term (i.e. non-current) liabilities such as claims.
B3 Profitability
As we have seen in chapter 9, there can be considerable uncertainty over the appropriate
amount to set aside for claims. Consequently, there is potentially a considerable uncertainty
over the accuracy of each year's profit and so for insurance companies it is often appropriate to
look at profitability ratios for a number of years at a time.
B3A Return on equity (ROE)
This is a primary measure as it enables an investor to see if the insurer is making money for
them and make comparisons between companies. The ratio is basically concerned with the
relationship of profit to the shareholders' capital and is seen as giving an indication of the
efficiency with which that capital is employed. The formula is:
profit after tax x 100

shareholders' equity (capital)
The higher the figure emerging the better the return, but as a rough guide the investor should
be making 2.5 times the amount that they would earn in a bank deposit account over a five-rear
period (the hard and soft market cycle will distort the figures).

B3B Gearing
The gearing ratio shows the proportion of long-term investment that is financed by sources
other than the owners (the shareholders). This source of finance can be from equity capital or
long-term borrowings carrying a fixed interest (unsecured loans, debentures, preference
shares). A company with a high percentage (over 120%) of fixed interest finance is said to be
highly geared, and low would be below 60%.
long-term borrowings x 100

shareholders' equity
A highly eared ratio suggests that a company cannot finance its own .activities. Generally it is
9
not considered to be a good thing for a company to have to borrow a high percentage of its
sources of finance for long-term investment, as it will have to meet a substantial annual interest
bill, which will be to the detriment of profits available for shareholders. However, a high gearing
ratio is acceptable in some circumstances, for example this may be preferred to:
losing control by having too many issued shares; and

with fewer shares there are fewer shareholders to participate in the profit, so a small
increase in pre-interest profit could lead to a large increase in dividends.
B3C The combined ratio
The combined ratio measures the underwriting performance by combining the loss ratio with the
expense ratio and the commission ratio. In other words, is there sufficient premium to cover the
cost of claims and expenses? The expenses will include the costs of reinsurance, claims
handling, underwriting and administration.
The combined ratio is a universal measure among the following interest groups:
Underwriters, accountants and analysts: to gauge how effectively the lines of business
are performing.
Competitors: to gauge how effectively the competition is underwriting.
Senior executives: to gauge how effectively the underwriting divisions are performing.
A combined ratio does not take account of investment income and tracks the underwriting
performance rather than profitability- so it does not provide the whole picture. A combined ratio
below 100% generally indicates a good underwriting performance and above 110% generally
indicates poor underwriting or catastrophe losses. In the past, insurance companies boosted
poor underwriting results with investment income. Recently, the fundamentals within the
investment markets have forced all insurance companies to rethink their underwriting strategies
and focus on driving the combined ratio below 100%.
To understand the combined ratio it is worth understanding the three ratios that drive it:
the claims ratio:
= claims paid net of reinsurance x 100


the expenses ratio:
= administrative expenses x 100

the commissions ratio:
= acquisition costs x 100

10
Together these three ratios form the combined ratio:
the combined (or operating) ratio:
= claims + expenses + acquisition costs

earned premium net of reinsurance X 100
Note that there are variations on how a combined ratio is calculated- see the following points.
The commission ratio

Although some insurers write business direct, many rely on brokers and intermediaries to
supply quality business (acquire it on to the books). To encourage and support these suppliers
of business, the insurance company must pay a commission or acquisition cost. This
commission is open to market forces and will vary contractually across the broker community,
depending on the strength of the relationship and the profitability of the business. It is important
that the insurer does not overpay on the commission, as it will erode profits for the
shareholders, but as a counter argument, the most profitable business will often have the
highest commission. Expect the ratio to be between 10% - 20%.
Be aware
Points to note:
'Premiums' in the ratios mentioned above can be taken to mean either written premiums or
earned premiums, but students should use earned premiums net or reinsurance in their
calculations. However, reasons can be found for and against either approach. While the use of
earned premiums Is more consistent with the general presentation or insurance company
accounts. it can be argued that commissions and expenses arise at the time when premiums
are written, no matter when they are earned.
However, ratios are normally used to make comparisons, either to compare the performance of
two or more companies in one particular year or to compare the performance of one company
over a number of years. The main factor is to be consistent; that is, to use the same approach
(no matter which one) throughout.
These ratios can be worked out to compare the underlying performance, to discover any trends
for the better or the worse, and to spot problem areas that require more attention from
management. The lower these ratios are the better; If you have lower claims or expenses in
relation to premiums, you make a bigger profit.
Using the accounts shown in the appendix to chapter 7, we get the following ratios:

Claim ratio 1,342

1,640 X 100 = 81 8%
Expenses ratio 150

1,640 X 100 = 9.1%
Commission ratio 170

1,640 X 100 = 10.3%
Combined ratio 1,662

1,640 X 100 = 101.3%
11
The fact that the combined ratio exceeds 100% means that the company is making a small
underwriting loss. However, the underwriting result is only part of the story. To get the total
profit or loss, we have to add investment income and any other income the company might
earn. In this case the investment income is greater than the underwriting loss, so the company
makes profits overall.
C Assessing an insurance company's results

Having now seen the ratios available, when analysing an insurance company's accounts you
should use around six ratios - a good mix being the:
claims ratio;
expenses ratio;
commissions ratio;
combined ratio;
return on equity (ROE);
solvency margin.
To summarise:
Ratios can be used in the following ways
To analyse the performance of a business.
To compare the performance of a company over time, by working out a set of relevant
ratios for a number of years. Seeing how the various ratios have changed over time helps
management to pinpoint problem areas.
To compare the performances of a number of businesses. Comparisons with similar
businesses give managers and shareholders an idea of what performance can reasonably
be expected. By comparing a number of businesses investors can decide which company is
most suitable as an investment.
Limitation of ratios
Comparative information is essential for any meaningful ratio analysis.
Accounting ratios are based on income statements and balance sheets, which are subject
to limitations of historical cost accounting. Inflation, differing bases for valuing assets, or
specific price changes can distort the inter-company comparisons and comparisons made
over time.
Ratio analysis helps to build a picture of a company. This though depends on the quality of
the financial information available. If the accounts are poorly constructed, e.g. poor
estimates of depreciation, bad debts etc. then conclusions drawn from the accounting ratios

will be flawed.
Past company performance is not necessarily the best indicator of future performance.
Indeed, by the time the accounts are published and available for analysis they may be
already out of date.
Activity
A useful activity to help reinforce some of the topics covered In this chapter Is to perform a ratio
analysis on a company of your choice (possibly the company you work for?) and compare the
results to prior years and competitors. Try and draw conclusions from the results- and seek
views from colleagues.
12

Bab 11: Financial strength of
insurance companies
Introduction
We have established that the claims reserving process and the assessment of the amount to
set aside for claims have a direct bearing on the financial strength of an insurance company
and we have also looked at how financial ratios are used to assess the financial information
about an insurance company. In this final chapter we shall consider the role of rating agencies
and regulators in order to complete the picture of how the financial strength of an insurance
company is assessed.
A Rating agencies
Large insurance companies (or reinsurance companies) frequently pay rating agencies to
provide an opinion of their financial strength which is a measure of their ability to pay claims
under their insurance policies and contracts.
Be aware
Note that this does not refer to the Insurance company's ability to meet Its non-policy (i.e.
debt) obligations, although debt that a company issues on the capital markets Is normally
separately rated.
There are four main rating agencies, all carrying out similar measures, each with their own
opinion. Standard and Poors, one of the world's largest rating agencies, has kindly provided
material for this book, but other agencies, AM Best, Moody's and Fitch, all offer financial
strength opinions.
The question has to be asked- why does an insurer pay a fee to.an outside company to state an
opinion on its financial strength?
The simple answer is that all customers purchasing an insurance contract are simply buying a
promise that the insurer will honour all valid claims as and when they become due at a future
point in time. Occasionally insurance organisations go into liquidation, so many commercial
customers and brokers rely on financial ratings when making decisions regarding placing
business.
Likewise insurance companies prefer to have a financial strength rating because:
it demonstrates to policyholders that a third party has measured the likelihood of them
meeting their financial commitments;
it allows for financial strength comparisons between different insurers;
it should allow an extremely strong (AAA) insurer to charge a higher premium or be offered
a wider range of business than a good (BBB) insurer as the customer is buying into a
stronger rated (and therefore potentially more secure) company; and
brokers and customers can decide on their risk appetite by choosing the financial strength
rating that they prefer for their insurance carriers, e.g. they may decide that their insurance
Bab 11: Financial strength of insurance companies
policies must be placed with companies that have a financial strength rating of higher than
A-.
Standard and Poor's (S&P) rating methodology uses a wide variety of both qualitative and
quantitative information. Much of the rating process is objective in nature, in other words looking
at a wide range of information and forming an opinion. Although every insurer is going to have a
unique set of dynamics, such as accounting conventions, regulatory needs, different mix of
business and territories, S&P use the following common analytical framework:
Economic and industry risk the environmental framework in which insurance

companies operate. Typical points would be to look at the threat of new entrants, volatility of
the sector and the potential 'tail' to liabilities or risk of catastrophic losses.
Competitive position - the profile of the business mix in terms of the competitive strengths
2
and weaknesses. This is particularly relevant in terms of the insurance company's strategy.
Management and corporate strategy - this is the quality and credibility of an insurer's
senior management team. S&P believe that this is one of the most important elements in
determining how successful the company will be going forward.
Enterprise risk management (ERM) - ERM is the method by which a company manages
risk (both risks that have an upside as well as a downside). ERM provides a framework to
assess the frequency and severity of risks, risk mitigation, monitoring and reporting. S&P
will assess how an insurer identifies, measures, and manages risk. Some insurers' ERM
includes the use of an economic capital model (see section B for more on economic capital
models). S&P will incorporate the results of ERM modelling in their analysis of capital
adequacy.
Operating performance - looking at the performance ratios loss ratio, expense ratio,
combined ratio, return on equity etc.
Investments- of key importance here is how the insurer's investment strategy fits with its
liability profile, and to what extent investment results contribute to total company earnings.
Capital adequacy this looks at the quality and level of capital required to run the
business.
Liquidity - the ability to manage cash flows efficiently and easily borrow money if required.
Financial flexibility looks at the insurer's potential need for additional capital or liquidity
in the future.
These aspects are all analytically interconnected, and their weight in the rating process
depends on company specific circumstances. The confidence level S&P have that a company's
capital is adequate will influence their perception of a company's earnings stability, its ability to
grow capital, and whether it will be able to meet underlying risks.
Rating and Definition

AAAExtremely strong capacity to meet financial commitments. Highest Rating.
AAVery strong capacity to meet financial commitments.
AStrong capacity to meet financial commitments, but somewhat susceptible to adverse
economic conditions and changes in circumstances.
BBBAdequate capacity to meet financial commitments, but more subject to adverse
economic conditions.
BBB-Considered lowest investment grade by market participants.
BB+Considered highest speculative grade by market participants.
BBLess vulnerable in the near-term but faces major ongoing uncertainties to adverse
business, financial and economic conditions.
BMore vulnerable to adverse business, financial and economic conditions but currently
has the capacity to meet financial commitments.
CCCCurrently vulnerable and dependent on favorable business, financial and economic

conditions to meet financial commitments.

CCCurrently highly vulnerable.
CCurrently highly vulnerable obligations and other defined circumstances.
DPayment default on financial commitments.
Note: Ratings from AA to CCC may be modified by the addition of a plus (+) or minus (-)
sign to show relative standing within the major rating categories.
Critics of the credit rating process have commented that credit rating agencies do not
downgrade companies promptly enough. For example, Enron's rating remained at investment
grade four days before the company went bankrupt, despite the fact that credit rating agencies
had been aware of the companys problems for months. Academics have claimed that yield
3
spreads (a yield spread is the difference between the yield on a bond and a benchmark yield) of
corporate bonds start to expand as credit quality deteriorates but before a rating downgrade,
implying that yield spreads may be a good early indicator of deteriorating financial strength.
A1 The rating process

Remember that the insurance company pays the rating agency for the work and allows the
agency to publish its findings. The process is as follows:
The insurance company meets the agency and signs a contract.

At least two analysts spend a day with the senior executives to understand the insurance
company's business.
An exhaustive analysis is undertaken over the next few weeks and may require answers to
further questions.
The lead analyst will then recommend a rating to a committee of eight analysts who then
debate the methods and reasoning.
The committee will vote on the rating.
The insurance company is then told of the rating and can either accept it or appeal and the
committee re-sits. Once agreed the rating agency issues a press release, the wording of
which will normally be discussed by the company and S&P prior to issue.
The rating agency will then monitor the insurer and carry out an annual review.
There is a view that a AAA rating indicates that a company is over capitalised which, from an
investor perspective, means that the return on equity (ROE) is likely to be depressed. Investors
could, of course, earn a higher ROE if the company could deliver the same level of returns
using a lower capital base. Some insurers make public their target financial strength rating and
generally select a rating of A or AA.
Finaily, even if an insurer is not happy with its rating and withdraws from the rating agency
process, the agency is free to rate the insurer's financial strength, using publicly available
information.
B Solvency margins and regulatory requirements

There is an overriding regulatory requirement that 'A firm must at all times maintain overall
financial resources, including capital resources and liquidity resources, which are adequate,
both as to amount and quality, to ensure that there is no significant risk that its liabilities cannot
be met as-they-fall due: (GENPRU1.2.26)

Risk appetite
The board of an insurance company has the responsibility to determine the company's risk
appetite. The risk appetite statement would typically include:
a statement of the risks that it is acceptable for the company to bear; what risks are not
acceptable;
the probability of failure that is deemed to be acceptable; and
the maximum loss that is acceptable from any one incident.
The FSA require that the probability of failure should not be higher than one chance in two
hundred over a twelve-month timescale. An insurance company may wish to target a higher 4
confidence level and would do so if, for example, it wanted to target a strong financial strength
rating.
The risk appetite statement would be used by the insurance company to set:
the risk acceptance criteria;
an investment policy;
a reinsurance policy; and
other financial and risk policy statements.
Be aware
Note that reinsurance can be used to minimise exposure to risks that a company does not
want to bear, limit the exposure to catastrophe events and hence act as a capital substitute
(see section B6).
Economic capital model

Insurance companies increasingly use an economic capital model to assist them in a range of
decisions such as:
pricing:
portfolio target returns;
reinsurance purchasing;
investment selection; and
demonstrating capital adequacy.
Together with the risk appetite set by the board the economic capital model can be used to
judge the appropriate level of capital to hold. In determining the appropriate level of capital to
hold an insurance company will also have regard to maintaining an appropriate buffer in excess
of the regulatory minimum capital requirement.
Clearly a balance has to be struck between having enough capital to minimise the possibility of
breaching the minimum solvency margin and not too much capital which could unduly depress
the returns on equity available to shareholders.
Activity
Understanding how economic capital models work is beyond the scope of this syllabus.
However, If you would like to explore this subject further the following publication prepared by
PwC In conjunction with the Economist Intelligence Unit gives an overview of economic
capital and economic capital models:
www.pwc.com/gx/enlfinancial-servlces/briefing-programme/effective-capltal-management-
economic-capital-as-industry-standard.jhtml

In summary, a company's economic capital model would try to model as broad a range of
risks as possible so that an assessment can be made of the amount of capital that needs to
be held. The parameters would include the range of expected financial outcomes by line of
business expressed In terms of an expected value and a probability distribution. Assumptions
would be made on the correlation between one class and another -that is if one class suffers
a decline what Is the probability of another class also suffering a decline. Details of the
reinsurance In force would be input as would the range of returns available from investments
and the potential impacts from other types of risk such as operational risk.
The link between the use of economic capital models and regulation is set out in this
publication from the FSA:
5
http://www.fsa.gov.uklpubs/other/isb_risk_update.pdf
Economic capital models will be used by some firms as part or their ICA calculations (see 83)
and for Solvency II (see 87).
B1 Summary of regulatory capital requirements

The FSA forms a view on the financial strength of an insurance company in a number of ways
such as:
Reviewing how the board sets and communicates the appropriate level of risk for the
company to hear and from this how the company determines how much capital to hold.
Reviewing the risk management framework in operation in an insurance company. For
instance they would review how risks are identified and managed and how the changing
nature of the risks influences the company's view on the appropriate level of capital to hold.
From the information provided by the company in the regulatory returns to the FSA - as set
out below.
The regulatory requirements have been subject to change in recent years as the EU moves
towards having uniform updated regulatory requirements in all member countries. Table 11.1
provides a useful summary of the various regulatory requirements and which will be developed
and explained in the following sections.
Table 11.1: summary of regular requirements

UK insurers, along with those from other EU (and related) states, were subject for many
years to the solvency rules set out In the Life and Non-Life directives of the 1970s.
These rules became out of date so were replaced by the EU with a Solvency I Directive
specifying a Minimum Capital Requirement (MCR).
The MCR is the higher of two amounts: a Base Capital Resources Requirement (which is a
flat monetary figure designed for very small insurers) and an amount that applies to the
majority of insurers that has to be calculated from the volume and type of business. This is
the General Insurance Capital Requirement (GICR) or, in the case of a life company, the
Long Term Insurance Capital Requirement (LTICR) (plus an extra bit called the Resilience
Capital Requirement (RCR) that protects life companies from market risk).
Solvency I has been implemented into UK law In the form of an MCR requirement In the FSA

Handbook (in the sourcebook GENPRU). Thus all UK regulated Insurers legally must have
capital at least as large as their MCR.
The EU is planning to introduce its Solvency II Directive (see section 87), which will be a risk
based replacement for Solvency I.
The FSA believes that MCR represents about half as much capital as Is needed by an
Insurer in the UK marketplace, and was not prepared to wait for Solvency II. Consequently, it
decided to apply its own more stringent rules.
These are based on one of the threshold conditions for authorisation that a UK insurer must
have capital resources that are adequate having regard to the size and nature of its business
The FSA therefore specified that from 2005, UK insurers had to determine a Capital 6
Resources Requirement (CRR).
The CRR is the greater of the MCR (i.e. must not fall below the EU legal minimum) and a risk
based calculation which results in a higher Enhanced Capital Requirement (ECR), which
must be met if the insurer is to avoid Intervention by the FSA.
The FSA also requires insurers to carry out regular assessments on what the firms think their
own capital should be. This is known as the Individual Capital Assessment (ICA).
Once the FSA is in possession of a firm's ECR and ICA calculations, it will decide whether it
agrees with the firm. If it does not agree, the FSA may provide its own view, the Individual
Capital Guidance (ICG). Calculating the ICA encourages management to take responsibility
for the needs of its own business rather than rely on externally imposed standards.
As a result of all this, UK authorised insurers are now working to capital requirements that are
about twice the amount applicable for their EU counterparts, even those operating in the UK
market but authorised to do so by other EU states. This anomaly is likely to continue until
such a time as the EU Solvency II Directive is implemented.
B2 Minimum capital requirement

As we saw from chapter 7, section D, the amount of regulatory capital held by an insurance
company is the sum of the equity and long-term debt that falls within the FSA's rules to be
classified as Tier 1 or Tier 2 capital. However, the FSA imposes rules on the valuation of assets
that differ from the accounting standards requirements. For instance there will be specified
maximum values for certain types of asset. The purpose of these rules is to ensure that an
insurance company does not have 'too many eggs in one basket'. Hence the equity for
regulatory purposes is likely to be lower than the equity in the published financial statements.
As noted above, the FSA terminology for the capital required under the Solvency 1 basis is the
Minimum Capital Requirement (MCR). The MCR is also known as the Required Minimum
Margin. The MCR is defined as being:
the higher or a flat figure euro amount (the Base Capital Resources Requirement)
and an amount calculated using simple business metrics.
(There are different calculations for non-life and life business and we will concentrate on the
non-life calculations in this text.)

Base capital resources requirement

A base capital requirement is specified as a flat monetary figure in the rulebook which, for most
companies, will be 3,500,000 euros.
Clearly as sterling has weakened compared to the euro the base capital resources requirement
will increase in pound terms. However, this does not change on a daily basis as the FSA
publishes the exchange rate to use once a year at the end of October.
Non-life calculation
For non-life insurers a General Insurance Capital Requirement (GICR) must be calculated, for
most companies this will be the higher of two bases of calculation - premium based and claims
7
based. In addition there is a rule to limit the amount the GICR can fall in any one year to the
percentage by which the technical provisions (the amount set aside for claims together with the
unearned premium provision) have fallen.
A non-life insurer is required to hold an MCR of the higher of the base capital requirement or its
general insurance capital requirement. For most reasonably sized non-life insurers the required
solvency on the Solvency I basis should come out in the range 15%-25% of gross premiums,
depending on the levels of liability business written and reinsurance in place.
Be aware
Despite the above, the FSA has made it clear that it expects all UK regulated firms (non-life and
life) to hold capital of around twice the minimum amounts required under current EU rules under
its requirements for adequate financial resources.
In addition to specifying a generic capital adequacy requirement, the FSA also specifies
requirements for how a firm should ensure capital adequacy, via a risk identification and
management process and stress and scenario testing of its risk assessments and, consistent
with its approach in other areas, requires the process to be documented.
B3 Capital resources requirements

As we mentioned in section B1, the FSA is using the threshold conditions for UK authorisation
to enable it to apply its own, higher, risk-based standards and in 2005 it introduced the Capital
Resources Requirement (CRR). This is whichever is greater of either:
the MCR; or
the Enhanced Capital Requirement (ECR).
The ECR is a new risk-based regulatory capital requirement based on specific rules and is
designed to be about twice MCR. A breach of the MCR triggers a requirement for the firm to
provide the FSA with a plan to restore its financial position above the regulatory minimum and is
a cue for further regulatory attention.
In addition to calculating its ECR, the FSA has instructed every UK authorised insurer to carry
out regular assessments of the amount and quality of capital which in the firm's view is
adequate for the size and nature of their business. This is called the Individual Capital
Assessment (ICA).The FSA does not prescribe the detail of how these ICAs should be arrived
at, but specifies the risk factors firms should consider and the types of assessment they should
carry out. The major sources of risks to be considered include credit risk, market risk, liquidity
risk, operational risk, insurance risk, concentration risk, residual risk, securitisation risk,
business risk, interest rate risk, and pension obligation risk. Guidance is set out in INSPRU. If

an insurance company has an economic capital model it is likely to use this to calculate the ICA.
The FSA will review firms' ECRs and ICAs and other available information as part of their on-
going review of firms, and, where deemed appropriate, provide Individual Capital Guidance (i.e.
guidance that a specific different level of capital needs to be held) for that particular firm. Whilst
such ICG is technically only guidance, it will be expected that a firm would notify the FSA if it
failed to maintain capital equal to ICG under Principle 11 - open dealings with the Regulator.
B4 Group capital issues

Where a regulated firm is a member of a larger group of companies, this creates additional risks
and issues for the firm and requires adjustments to the capital requirement to the firm viewed
on a standalone basis.
8
As a member of a group, a regulated firm:
may have access to additional capital (not on its own balance sheet) from other members of
the group; and
may increase its risk through intra-group trading (e.g. risk accumulation, the value of
investments in, and debts due from, other group companies).
As a result, the FSA has specified additional rules for firms that are part of groups.
B5 Stress and scenario testing

Conducting stress and scenario testing has for some time been an important element in
assessing whether individual insurance companies have an adequate amount of capital. In
December 2009 the FSA issued new rules on stress and scenario testing in Policy Statement
09/20.
A new requirement is to conduct reverse stress-testing which is the process by which an

insurance company identifies and assesses the scenarios most likely to render its business
model unviable.
A firm's business model is described as being unviable at the point when crystallising risks
cause the market to lose confidence in the firm. A consequence of this would be that
counterparties and other stakeholders would be unwilling to transact with or provide capital to
the firm and, where relevant, that existing counterparties may seek to terminate their contracts.
Such a point could be reached well before a firm's regulatory capital is exhausted.
B6 Maintaining capital adequacy

All UK authorised insurers are required to report their MCR and ECR calculations annually to
the FSA, as part of their detailed statistical and financial reporting obligations, though as noted
previously they are 'not formally required to hold capital equal to ECR. These figures are
monitored and reviewed by the FSA both as part of their analysis work and as part of their on-
going monitoring and supervision of individual firms.
Firms are required to maintain adequate capital resources at all times but in practice most firms
will not need to calculate MCR and ECR on a daily basis. It is incumbent on firms' management
to monitor the adequacy of the firm's capital and, if in doubt as to its adequacy, to report to the
FSA. In practice, most firms will maintain capital substantially in excess of the regulatory

requirement so that, except in times of significant turmoil (major catastrophe incidents or major
financial market falls), little needs to be done in between annual calculations of the regulatory
requirements.
Obviously firms with barely adequate regulatory capital, and firms with only a moderate surplus
over the minimum during times of significant turmoil, will need to monitor their capital adequacy
more frequently.
Where firms are unable to provide the FSA with assurance that they have, or will soon have,
access to sufficient capital, the FSA can take appropriate enforcement action against the firm.
If an insurance company breaches its MCR, as a minimum it would be expected to file a plan
9
detailing how it would expect to rectify the position. In addition if a company has issued long-
term debt it is reasonably likely to have a covenant in the debt agreement which would require it
to report regulatory breaches to the lender. From the options set out below it can be seen that
increasing the amount of reinsurance is a realistic alternative to increasing the amount of capital
and hence reinsurance can be regarded as a capital substitute.
What can a company do in the case of a shortfall?

In the case of inadequate regulatory capital there are two basic options:
Raise more regulatory capital

This could be by means of:
issuing new shares in a limited company;
issuing long-term debt that meets the FSA requirements for Tier 1 or Tier 2 regulatory
capital; and
switching out of assets, which are not fully allowable for regulatory capital purposes, into
those that are fully allowable.
Reduce the regulatory capital requirement

This could be by means of:
reducing the volume of business written, particularly in lines which generate a high capital
requirement;
purchasing reinsurance; and/or
switching out of higher risk assets such as equities, into lower risk ones such as
government bonds.
B7 EU Solvency II Directive
Solvency II is a fundamental review of the capital adequacy regime for European insurers and
reinsurers. It was originally planned to go live on by the end of 2012, but the European
Commission has now proposed an amendment to the implementation date to 1 January 2014. It
aims to establish a revised set of EU-wide capital requirements, valuation techniques and risk
management standards that will replace the current Solvency I requirements.
It is worth noting that while the essential concepts and objectives driving the Individual Capital
Adequacy Standards (ICAS) regime are similar to those underlying Solvency II, many detailed
requirements, such as stringent statistical quality tests and rigorous standards of model control,
will differ from those with which insurance companies are familiar. In addition, the FSA has
made it clear that having an effective risk management process is an Integral part of the
Solvency II requirement.

Central elements of the Solvency II regime include:
Demonstrating adequate Financial Resources (Pillar 1): applies to all firms and considers
key quantitative requirements, including own funds, technical provisions and calculation of the
Solvency 2 capital requirements (the Solvency Capital Requirement- SCR, and Minimum
Capital Requirement MCR) through either an approved full or partial internal model or the
European standard formula approach.
Demonstrating an adequate System of Governance (Pillar 2): including effective risk
management System and prospective risk identification through the Own Risk and Solvency
Assessment (ORSA).
Supervisory Review Process: the overall process conducted by the supervisory authority in
reviewing insurance and reinsurance undertakings, ensuring compliance with the Directive
10
requirements and identifying those with financial and / or organisational weaknesses
susceptible to producing higher risks to policyholders.
Public Disclosure and Regulatory Reporting Requirements (Pillar 3).
Solvency II is being created in accordance with the Lamfalussy four-level process:
Level 1: framework principles- this involves developing a European legislative instrument

that sets out essential framework principles, including implementing powers for detailed
measures at Level 2.
Level 2: implementing measures - this involves developing more detailed implementing
measures (prepared by the Commission following advice from the European Insurance and
Occupational Pensions Authority (EIOPA) that are needed to implement the Level l
framework legislation
Level 3: guidance EIOPA works on joint interpretation recommendations, consistent
guidelines and common standards. Additionally, EIOPA undertakes peer reviews and
compares regulatory practice to ensure consistent implementation and application.
Level 4: enforcement- more vigorous enforcement action by the Commission is
underpinned by enhanced cooperation between member states, regulators and the private
sector.
The Level 1 Directive text was adopted by the European Parliament on 22 April 2009 and was
endorsed by the Council of Ministers on 5 May 2009. This was a key step in the creation of
Solvency II; the Directive is now likely 'go live' in January 2014 and will replace the current
regime.
The key message coming from the FSA is that insurance companies need to take action to be
ready to 'be compliant with Solvency II.
Insurance companies will now be heavily involved in preparing for Solvency II. Steps that have
been completed so far include the following:
The specification for the standard model has developed with the results of the Quantitative
Impact Study 5 (QIS5) exercise, published in March 2011. Ferdia Byrne, insurance partner
at KPMG, said: 'Overall, the results demonstrate that the insurance industry as a whole is
well capitalised, in line with the new requirements. Fears expressed by the industry in 2009
that massive capital increases would be required in the UK have not been born out in
practice. This is largely due to the extensive lobbying by industry to adjust the calibration,
and an Improvement in market conditions: (Source: KPMG.)
Those companies planning to use an Internal model (similar to an economic capital model)
as opposed to the standard model, will now have been informed if they have been accepted
in the first wave of companies being considered for approval.

Companies will now be involved in their Own Risk and Solvency Assessment (ORSA).
ORSA is the name given to the processes and procedures to identify, assess, monitor,
manage and report the short and long term risks that an insurance company faces and to
determine the own funds necessary to ensure that the undertaking's overall solvency needs
are met at all times.
Insurers planning to use an internal model have to pass the 'use test' which requires the insurer
to demonstrate that there is sufficient discipline in its internal model development and
application such that it is 'widely used in and plays an important role in' the management of the
firm. In addition, approval to use an internal model will require the firm to demonstrate
compliance with several other mandated tests and requirements, including statistical quality,
data, documentation, calibration and profit and loss attribution. Activities such as sensitivity,
11
stress and scenario testing will also need to be evidenced. The FSA's work with insurance
companies suggests that even the best prepared firms are still some way short of Solvency II
standards in at least some of these areas.
B8 The role of the actuary

The EU Solvency II Directive specifies the requirement for an actuarial function, which will
represent a change for many UK insurance companies. Currently the FSA requires the use of
actuaries in life insurance firms, while nothing is prescribed for firms writing non-life business
(other than at Lloyd's, where formal actuarial opinions are required of all syndicates). The
Directive requires all insurance firms to have an actuarial function and UK insurers should be
preparing to introduce an actuarial function if they do not currently have one.
The European regulators view access to actuarial knowledge as 'indispensable to an adequate

system of governance It may not be necessary for this function to be carried out by someone
with a formal actuarial qualification, but should be 'carried out by persons with sufficient
knowledge of actuarial and financial mathematics and ... able where appropriate to demonstrate
their relevant experience and expertise:
The firm's actuarial function must contribute to the effective implementation of the risk
management system in particular with respect to the design, calibration and build of the internal
model, with a feedback loop being used to improve the model. The actuarial function should use
the outputs of the internal model, for example in providing an improved understanding of its
reserve volatility and may well use the internal model to assess the firm's technical provisions.

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INSURANCE BUSINESS AND FINANCE

Bisnis Asuransi dan Keuangan

Selamat menempuh ujian. Semoga sukses!

Jakarta, 1 Januari 2014

2. Manajemen bisnis asuransi: peran, tanggungjawab, dan gaya

3. Manajemen bisnis asuransi: perencanaan dan kontrol

4. Aspek utama dalam tata kelola perusahaan

6. Sumber daya manusia

7. Prinsip dan praktek utama akuntansi

8. Standar akuntansi dan akun perusahaan asuransi

10. Rasio finansial

11. Kekuatan finansial perusahaan asuransi

Structure and size of the UK insurance industry

The market for insurance

An 'intermediary' is an agent who is authorized by a party, often a commercial company to

An insurance broker is an individual or firm whose full-time occupation is the placing of

Chartered Insurance Institute www.AkademiAsuransi.org repro by: Afrianto Budi SS MM

A Different types of insurance company

A.1 Proprietary companies

Good examples of insurance and reinsurance classes are:

A.2 Mutual companies

Chartered Insurance Institute www.AkademiAsuransi.org repro by: Afrianto Budi SS MM

Good examples of long-term business are as follows:

life and annuity

A.3 Captive insurance companies

A.4 Takaful insurance companies

Chartered Insurance Institute www.AkademiAsuransi.org repro by: Afrianto Budi SS MM

mutuality and co-operation;

Chartered Insurance Institute www.AkademiAsuransi.org repro by: Afrianto Budi SS MM

'Divine intervention' by Timothy Evershed in the Oct/Nov 2009 edition.

B Different sellers of insurance

the types of insurance companies (proprietary, mutuals, takaful) mentioned above;

Chartered Insurance Institute www.AkademiAsuransi.org repro by: Afrianto Budi SS MM

Chartered Insurance Institute www.AkademiAsuransi.org repro by: Afrianto Budi SS MM

B7 Retailers and affinity groups

Chartered Insurance Institute www.AkademiAsuransi.org repro by: Afrianto Budi SS MM

B8 Travel agents and tour operators

An aggregator is an internet-based distribution channel, which relies upon the co-operation of

Chartered Insurance Institute www.AkademiAsuransi.org repro by: Afrianto Budi SS MM

B10 The State

Chartered Insurance Institute www.AkademiAsuransi.org repro by: Afrianto Budi SS MM

C Importance of the customer

Chartered Insurance Institute www.AkademiAsuransi.org repro by: Afrianto Budi SS MM

Chartered Insurance Institute www.AkademiAsuransi.org repro by: Afrianto Budi SS MM

C3 Customer relationship management

offering a relationship focus rather than an enquiry focus;

So the approach means managing a customer on an end-to-end basis, from listening to

Chartered Insurance Institute www.AkademiAsuransi.org repro by: Afrianto Budi SS MM

The following diagram illustrates these points:

Customer Quality of Customer Long Term

Supplier service is By using

C4 Internet and e-commerce

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C5 Direct link to customers

C5B Personal records

C5C Internet portals

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C5D 'Treating Customers Fairly'

1. Relevance for senior management.

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D Importance of other stakeholders

Table 1.1: Stakeholder interest and expectation

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