Financial engineering is a process that uses existing financial instruments to create a new and enhanced product of some type. Just about any combination of financial instruments and products can be used. The process may involve a simple union between two products, or make use of several different products to create a new product that provides benefits that none of the other instruments could manage on their own.
One excellent example of financial engineering is financial reinsurance. Companies that offer reinsurance options essentially provide a way for the ceding insurer to minimize a drain on available resources when a major shift in premium growth or reduction is taking place. In this scenario, the process helps to create a stable environment that will allow the insurer to remain solvent and stable even when extreme conditions exist.
For the consumer, the work of a financial engineer to create new product offerings can be a great advantage. In some instances, the new and improved product is simply a repackage of several independent but complimentary products made available at a lower price. For example, the consumer may find that purchasing insurance coverage that provides dental, hospital, and prescription coverage may be significantly less expensive than purchasing individual plans.
Financial engineering works in other environments as well. The financial theory of offering several existing products under one package has become very common in the telecommunications industry, and many providers today offer bundled service packages that include local phone service, unlimited national long distance, Internet service, and cable or digital satellite television. The end result of this type of arrangement means one lower price to obtain three or more services at significant cost savings to the consumer.
Sometimes known as computational finance, this process relies heavily on mathematically calculating the outcome if various combinations of financial instruments are offered under one umbrella as a package deal. Usually, the calculations indicate that the providers stand to do very well with the new hybrid financial product, as the product holds the potential to attract new consumers who would have foregone use of one or more of the instruments if the only option was to purchase them individually.