,.._I~... --_.“__~-.-- BANK POWERS - Issues Relating to Banks Selling Insurance sb I 11111 I 142418 .--.-~--..--..-~-^“...“_.-.- .-__- -_-- - ..___ - _-.- -~~- (;Ao/(;(;I)-!~o-l 1:1 - ._. ^I... .---_-111- General Government Division B-240696 September 26,lQQO The Honorable John J. LaFalce Chairman, Committee on Small Business House of Representatives Dear Mr. Chairman: This report, prepared at your request, evaluates the potential effects of banks selling insurance on consumers, other insurance sellers, and bank safety and soundness. The report also addresses the extent of coercion in bank sales of insurance and the need for regulatory controls to protect consumers. As arranged with the Committee, unless you publicly announce the contents of the report earlier, we plan no further distribution until 30 days from the date of the report. At that time we will send copies of this report to other appropriate congressional committees, federal banking agencies, and others on request. Major contributors to this report are listed in appendix II. Please contact me on 276-8678 if you or your staff have any questions concerning this report. Sincerely yours, Craig A. Simmons Director, Financial Institutions and Markets Issues I Executive Summ~ If more banks gain powers to sell insurance, both property/casualty and Purpose life/health, opponents charge that banks will coerce consumers to buy insurance as a condition to receive credit. Further, insurance sellers sug- gest that banks selling insurance would compete unfairly with other sellers and endanger bank safety and soundness. In contrast, banks and some consumer groups assert that banks selling insurance would benefit consumers through cheaper premiums and convenient service. The Chairman of the House Committee on Small Business requested GAO to evaluate the potential effects of banks selling insurance on con- sumers, other insurance sellers, and bank safety and soundness. The Chairman also asked GAO to address the extent of coercion in bank sales of insurance and the need for regulatory controls to protect consumers. Background insurance activities, most banks can sell credit insurance-insurance to repay a borrower’s debt if the borrower dies or becomes disabled. More- over, some banks have additional powers to sell insurance. According to a 1987 survey published by the Federal Deposit Insurance Corporation (FIX), about half of the states permitted state-chartered banks to sell most forms of insurance. Also, in towns with populations less than 6,000, bank holding companies, national banks, sandsome state banks can sell all types of insurance. A bank holding company with assets less than $60 million can sell some types of insurance. In this report, GAO discusses bank sales of insurance products under- written by an unaffiliated insurance company, which bears all risk of loss due to policyholder claims. GAO does not deal with the risks that might exist should banks be allowed to underwrite insurance or affiliate with insurance companies. To identify the potential effects of banks selling insurance, GAO met with a judgmental sample of banking and insurance organizations, their regu- lators, consumer advocates, and academic experts. To assess the extent of coercion by banks, GAO reviewed Federal Reserve-sponsored studies of credit insurance sold by banks and spoke with regulators in nine states where banks have limited powers to sell insurance. (See pp. 8-16.) Banks selling insurance could potentially benefit consumers through Results in Brief reduced insurance costs and increased convenience. However, if more banks sell insurance, opportunities may increase for banks to coerce consumers to buy insurance as a condition to receive credit. Page 2 GAO/GGDBO-113 Bank# Selline hwuance Executive sulnmary Available evidence does not indicate that coercion is a widespread problem in existing bank sales of insurance. Tying credit to the sale of other products is already illegal. Additional measures, such as disclosing that insurance purchases are voluntary or separating insurance sales from credit approval, could protect consumers from any increased potential for abuse. Expanded bank sales of insurance would increase competition for other insurance sellers. While a bank could abuse its position as a source of credit to compete unfairly against other sellers, existing regulatory con- trols, if properly enforced, should serve to limit credit abuses. Bank sales of insurance underwritten by an unaffiliated insurance com- pany present no risk to bank safety and soundness. The insurer under- writing the policies bears the financial risk of losses under policies sold by the bank. GAO’s Analysis ConsumersMay Benefit Banks could possibly reduce consumers’ insurance costs if they could but May Also Need lower the costs of selling policies through joint marketing of bank and insurance products. The increased convenience would also save con- Protection sumers’ time and effort in purchasing insurance products. However, it is not possible to anticipate the extent to which banks can lower the costs of selling insurance or whether these savings would result in cheaper insurance premiums. Like other lenders selling insurance, a bank could tie the purchase of insurance to the granting of credit. Coercive tie-ins, where the customer is forced to purchase an additional product to receive credit, are illegal under existing banking law. Also, a bank’s ability to coerce borrowers into purchasing insurance is limited not only by other sources of insur- ance but also by other sources of credit. Although credit insurance is most susceptible to tie-ins, Federal Reserve studies found favorable consumer perceptions, which did not indicate widespread abuse by banks. Ninety percent of credit insurance buyers in 1986 thought credit insurance was a good product and would purchase similar coverage again. The consensus of state banking and insurance regulators GAO interviewed was that, while instances of abuse Page 3 GAO/GGD-f.M-113 Banks Selling Insurance Executive Summary may occur, coercive tie-ins are not widespread in bank sales of insur- ance. Fourteen of 17 regulators GAO interviewed did not believe banks routinely coerce borrowers to buy credit insurance. While coercive tie-ins are already illegal, additional measures could pro- tect consumers from the perception that buying insurance could improve chances of getting loans. Such measures include disclosing that insurance purchases are voluntary and requiring that insurance mar- keting be separated from the credit approval process. However, such a separation might reduce or eliminate the cost savings that would other- wise flow from joint marketing of banking and insurance products. (See pp. 16-26.) Increased Competition for Expanded bank sales of insurance would create a more level playing field among banks and other depository institutions and lenders that Other Sellers now sell insurance. While insurers underwriting policies may benefit from the flexibility of another channel for reaching customers, other insurance retail sellers would face increased competition from banks selling insurance. Banks have potential competitive advantages over other insurance sellers. For example, banks may be able to sell insurance more cheaply through joint marketing of bank and insurance products. Also, a bank- affiliated insurance seller has access to bank customers and customer information and can share overhead costs with the bank. These advan- tages are not unique to banks, and any large insurance seller has an advantage over small agents. Regulatory measures eliminating joint marketing would reduce banks’ competitive advantages over other sellers. For example, a bank could be prohibited from sharing customer information or office space with its insurance operations. While separate marketing for a bank and its insur- ance activities could protect other insurance sellers from increased com- petition, such measures would forestall consumers gaining potential cost savings and increased convenience. Finally, banks could give preferential treatment to affiliated insurance agencies or deny credit to competing insurance sellers. Banking laws and regulations, including sections 23A and 23B of the Federal Reserve Act, limit lending by a bank to its affiliates and require interaffiliate transac- tions to be on a nonpreferential basis. However, similar restrictions do not apply to bank subsidiaries or departments within a bank. (See pp. 26-32.) Page 4 GAO/GGDBO-113 Bmlca Selling Insureme Executive Summiry No Risk to Bank Safety Expanded bank sales of insurance underwritten by unaffiliated insur- and Soundness ance companies would not endanger bank safety and soundness. Unlike underwriting, selling insurance does not involve financial risk of loss for policyholder claims. To the extent that sales commissions contribute to banking profits, diversification into selling insurance could strengthen safety and soundness and protect against bank failures. It is not possible to predict whether bank sales of insurance would be profitable. While selling insurance in itself presents no risk to a bank’s capital, any expan- sion into a new business presents management challenges and could divert management attention away from core business responsibilities, such as careful management of credit risk. Additional measures may be necessary to ensure that consumers do not become confused about whether insurance products sold by a bank are backed by federal deposit insurance. One measure would be to expressly disclose to the consumer that insurance products are underwritten by an insurance company and are not covered by banking deposit insurance. (See pp. 33-34.) While consumers could potentially benefit from bank sales of insurance, Matters for it is not possible to know in advance the potential for future abuses in Congressional tying the granting of credit to the purchase of insurance. If more banks Consideration gain powers to sell insurance, Congress may wish to consider the need for additional regulatory measures, including increased disclosure and separation of insurance marketing from the credit process, to protect consumers from possible coercive tie-in problems. Agency Comments GAO As requested by the Committee, GAO did not obtain written comments on this report. Reserve, FDIC, discussed the report with officials at the Federal and Office of the Comptroller of the Currency and has incorporated their comments where appropriate. Agency officials gener- ally agreed with the conclusions contained in the report. Page 5 GAO/GGlMO-113 Ba.nke Selling Inmranw I contents Executive Summary 2 Chapter 1 8 Introduction Banks Selling Insurance Insurance Delivery Systems 8 11 State Regulatory Control of Insurance Sales 13 Objectives, Scope, and Methodology 14 Chapter 2 16 Consumers May Bank Entry May Have Little Effect on Insurance Premiums 16 Benefit but May Also Bank Sales of Insurance Increase Potential for Abuse of 18 Need Protection From Consumers Potential Abuses Limited Evidence Does Not Indicate Widespread Abuse of 20 Credit Tie-Ins Controls Over Abusive Practices of Banks Selling 22 Insurance Conclusions 26 Matters for Congressional Consideration 26 Chapter 3 26 Increased Competition Competitive Consequences of Banks Selling Insurance 26 Potential Competitive Advantages for Banks Selling 27 for Other Sellers but Insurance No Risk to Banking Banks Could Abuse Credit to Compete Unfairly Against 29 Safety and Soundness Other Sellers Controls Can Limit Abuses and Ensure Competition 30 Insurance Sales Present No Risk to Banking Safety and 33 Soundness Conclusions 34 Appendixes Appendix I: Organizations and Individuals Interviewed 36 Appendix II: Major Contributors to This Report 38 Table Table 1.1: Market Shares for Delivery Systems by Type of 12 Insurance in 1986 Y Page 6 GAO/GGD9@113 Jbnlra Sew Insurance b . Contenti Abbreviations FOE GAO Federal Deposit Insurance Corporation NAIC occ General Accounting Office National Association of Insurance Commissioners Office of the Comptroller of the Currency Page 7 GAO/GGMO-113 Banka Sellin hureme Chapter 1 Introduction In recent years, state legislatures, banking regulatory agencies, and the courts have allowed banking institutions (commercial banks and their holding companies) to expand into selling insurance-property/casualty and life/health. As Congress considers whether nationally regulated banks should be granted powers to sell insurance products, opponents and proponents of expanded powers disagree as to the effect of banks selling insurance on consumers, other insurance sellers, and bank safety and soundness. Insurance agents and industry trade associations allege that banks selling insurance present the following dangers: . banks would charge unreasonably high premiums or coerce consumers to buy insurance as a condition to receive loans, . banks would give preferential treatment to their insurance subsidiaries and affiliates and deny credit to competing insurance sellers, and . inexperienced banks selling insurance could incur losses and endanger the safety and soundness of the banking system. In contrast, banks and consumer groups assert that bank expansion into insurance sales would yield the following advantages: 9 banks’ lower costs would result in lower insurance premiums, . increased competition between insurance sellers would also lower insur- ance premiums and improve service quality, and l diversification into insurance sales would reduce risk and possibly increase bank profits, thereby protecting banking safety and soundness. While the Bank Holding Company Act generally separated commercial Banks Selling banking from insurance activities, some banks have limited powers to Insurance sell insurance. The extent of insurance powers varies depending upon the type of banking institution and its regulatory agency. National Banks Among federal banking regulators, the Office of the Comptroller of the Currency (OCC)has approved the broadest range of insurance selling activities. occ charters and regulates national banks under the terms of the National Bank Act. The act expressly authorizes national banks located in towns with populations not exceeding 6,000 to sell all types of Page 8 GAO/GGD-30413 Banks Selling Ins-u! chapter 1 Introduction insurance.1 cxx has interpreted this authority to allow a national bank with a branch in a qualifying small town to sell insurance nationwide. In addition, occ relies on the general language in the National Bank Act to permit national banks to engage in other limited sales of insurance. The act authorizes national banks to exercise all incidental powers nec- essary to carry on the business of banking. In approving insurance sales activity incidental to banking, occ has allowed national banks to sell credit insurance,2 title insurance,3 and certain annuities.4 In addition, occ has allowed national banks to lease space to an insurance agency, enclose insurance advertisements in bank mailings, sell customer lists to insurance agents, and refer customers to insurance agents and share in resulting sales commissions. State Banks The extent of insurance powers of state-chartered banks varies by state. According to a survey of state banking lawspublished by the Federal Deposit Insurance Corporation (FDIC)in 1987,6 all states except Texas allowed state banks to sell credit insurance. Moreover, as of 1987, about half of the states permitted state-chartered banks to sell most forms of insurance. Of those states granting insurance powers, nine states allowed bank sales of insurance only in towns with populations less than 6,000, and one state allowed such sales in towns with populations less than 200,000. State-chartered banks also may lease space to insur- ance agents in 31 states and share customer lists with insurance sellers in 16 states.6 Since the survey published by FDIC in 1987, several states have taken action to expand bank authority to sell insurance. Proposition 103 in California repealed a law that made bank holding companies and their affiliates ineligible for a license to sell insurance. Delaware, in May 1990, enacted legislation allowing state banks to sell insurance nationwide. ‘12 USC. section92. 2Creditinsuranceis designedto repay a borrower’sdebt if the borrower diesor becomesdisabled. 3Title insuranceprotectsthe policyholder againstundiscovereddefectsin a property’s title. 4An annuity is an investmentfrom which the owner receivesperiodic paymentsfor a numberof years or for a lifetime. sVictor C. Saulsbury,“State BankingPowers:WhereAre WeNow?” RegulatoryReview,Federal DepositInsuranceCorporation(Apr. 1087). 6BankDiversification: Into Insurance?,CongressionalResearchService(Feb.9,lQQO). Page 9 GAO/GGIM@lU Banks Selling Insurance chapter 1 The Congressional Research Service reported that in 1989 legislators in 22 states introduced bills to expand insurance sales by state-chartered banks, and insurance agents had introduced countering legislation in 24 states to limit banks selling insurance. Bank Holding Companies The Bank Holding Company Act expressly limits the insurance activities of holding companies that own at least one bank. The Act generally pro- hibits a bank holding company or its subsidiaries from selling insur- ance.’ Exceptions to the general prohibition permit bank holding companies to engage in limited insurance activities similar to those that occ has approved for national banks. Exceptions to permit selling insur- ance include: . a bank holding company may sell credit insurance; l a finance company subsidiary may sell property/casualty insurance to protect loan collateral; . a bank holding company may sell all types of insurance in a small town with a population not exceeding 6,000; l a small bank holding company with assets less than $60 million may sell insurance, except for life insurance and annuities; and l a bank holding company selling insurance on May 1, 1982, may continue those activities under a grandfather clause.8 Recent decisions by the Federal Reserve Board, which is responsible for administering and interpreting the Bank Holding Company Act, have expanded insurance activities of holding companies. In 1987, the Fed- eral Reserve Board ruled that a bank holding company may sell insur- ance by acquiring a grandfathered holding company. In 1989, the Federal Reserve Board ruled that the general prohibition on insurance activities applies only to nonbank subsidiaries of a bank holding com- pany; therefore, a state bank and its subsidiaries could engage in any insurance selling that the chartering state permits. In other decisions, the Federal Reserve Board has permitted other insurance-related activi- ties, such as advertising insurance products and selling customer lists to insurance sellers. ‘12 USC. 1843(c)(8). *Title VI of the Garn-St.GermainDepositoryInstitutions Act of 1982(P.L. 97-320). Page 10 GAO/GGD9@113 Banks Selling Insurance Chapter 1 IntroductSon Insurance products-property/casualty and life/health-are marketed Insurance Delivery and sold through three insurance delivery systems: independent agen- systems cies or brokerage firms, exclusive agents, and direct writers. Independent Agents and An independent insurance agency generally represents and sells prod- Brokers ucts of several competing insurance companies. On the other hand, a broker represents the insurance buyer in negotiations with insurance companies to tailor coverage for commercial, large, or unusual risks. Independent agents and brokers are contractors and are not employees of an insurance company. Both agents and brokers assist the insurance buyer in comparing costs and coverage of different policies. In addition to selling insurance products, an independent agent also may handle claims reporting for clients. An independent agent’s income is derived solely from commissions paid by insurers for policies sold, whereas a broker may receive both fees from customers and commissions from insurers. When an insurance policy is sold through an independent agent, lists of customers and policy expiration dates become the property of the agency, and all renewals and associated commissions belong to the agency. As a result, insurance companies represented by the agency may not bypass the agency to sell policies directly to the agency’s clients. Exclusive Agents An exclusive agent generally represents and sells the products of one insurance company or group of affiliated companies. An exclusive agent, also referred to as a captive agent, may be an independent con- tractor working for the insurer or an employee of the insurance com- pany. An exclusive agent receives compensation through a mixture of salary and commissions on policies sold. In addition to selling policies, such agents alsomay handle claims for clients. DbirectWriters Direct writers are insurance companies who use direct mailing, media advertising, and telephone solicitation to sell their products directly to customers. An insurer may obtain lists of prospective buyers from diverse organizations, including employee unions and banks. Direct mailing eliminates agents and sales staff and thus can result in lower selling expenses. However, the mail order approach generally offers little personal service to customers in selecting coverage. Page 11 GAO/GGLMO-113 Banks Selling Inmrance chapter 1 Introduction Banks as Insurance Sellers A bank selling insurance may act as an independent agency representing several insurers, or a bank could act as an exclusive agent for one insur- ance company or group of affiliated companies. Finally, a bank can assist insurers or other insurance sellers with direct marketing activi- ties. As indicated above, a bank may sell its customer lists to an insur- ance agency or a direct writing insurer. Also, a bank can include an insurer’s sales material in mailings to bank customers. Trends in Insurance An insurance company may use more than one insurance delivery Delivery system to sell its policies. An insurer may use different delivery systems for different types of insurance or in different geographic areas. For example, an insurer may sell commercial insurance through agents while using direct mail order to market personal property insurance. Also, an insurer may use multiple delivery systems to market the same products. For example, an insurer may sell automobile insurance both through agents and by mail order. Delivery methods also differ between life and property/casualty indus- tries. Table 1.1 illustrates the market shares in 1986 for each delivery system for both life and property/casualty insurance. Life insurance is sold largely through exclusive agents who have 66 percent of the life market, whereas independent agents account for 63 percent of prop- erty/casualty business. Table 1.1: Market Sharer for Delivery Syatemr by Typo of lnrurance in 1988 Delivery rystem Market share Life Insurance Independent Apents and Brokers 43% Exclusive Agents 56% Direct Writers 1% PropertvKasualtv lnsuiance Independent Agents 63% Exclusive Aaents and Direct Writers 37%8 aThis figure is based on A.M. Best Company data, which do not distinguish between exclusive agents and direct writers of property/casualty insurance. Source: Expanded Bank Powers by Sophie M. Korczyk. According to A.M. Best Company, a statistical and publishing organiza- tion, as of 1988, direct writers and exclusive agents sold approximately 40 percent of all property/casualty insurance. However, within the property/casualty industry, direct writers and exclusive agents control more than half of the market for personal insurance. In 1988, direct Page 12 GAO/GGD&O-113 Banks Selling Insurance Chapter 1 Introduction writers and exclusive agents sold 64 percent of private automobile insurance and 62 percent of homeowners insurance. Under the McCarran-Ferguson Act of 1946, states exercise primary reg- State Regulatory ulatory jurisdiction over the insurance business9 Each state has a Control of Insurance department of insurance responsible for, among other things, oversight Sales of insurance sellers, insurance marketing and trade practices, and insur- ance policies and premium rates. All states require insurance sellers to be licensed to transact business within the state. Prospective agents and brokers may be required to pass a written examination or fulfill certain training requirements. Thus, a banking institution selling insurance and selected bank employees are required to be licensed like any other insur- ance agent. State insurance regulators are responsible for enforcing state-enacted unfair trade practices laws and regulations to protect consumers from fraud, abuse, and deception in insurance marketing and sales.‘0 Insur- ance regulators monitor insurance sellers through consumer complaints, review of marketing materials, and market conduct examinations. A market conduct examination is an evaluation of an insurer and its repre- sentatives’ dealings with policyholders and claimants, such as adver- tising and claims handling. If an insurance seller engages in fraudulent, abusive, or deceptive practices, state regulators may take action to sus- pend or revoke the seller’s license. State regulators also review premium rates to ensure that premiums paid by policyholders are adequate, not excessive, and not unfairly dis- criminatory. Some states require prior approval for premium rates, while other states require only that rate plans be filed with the insur- ance department before the ratings become effective. Premiums charged for an insurance policy are set by the insurer underwriting the product and not by the seller of the policy. Sales expenses, including commis- sions paid by the insurer to the seller, represent one component of the premium price. g16USC. sections1011-1016. l”Long-TermCareInsurance:StateRegulatoryRequirementsProvide InconsistentConsumerF’rotec- -tion (GA(s7HRD89-67,Apr. 24,1989). Page 13 GAO/GGDBO-113 Banks Selling Insurance chapter 1 Introduction The Chairman of the House Committee on Small Business requested that Objectives, Scope,and we evaluate the potential effects of banks selling insurance on con- Methodology sumers, other insurance sellers, and the safety and soundness of the banking system. In this report, we discuss bank sales of insurance prod- ucts underwritten by a nonaffiliated insurance company, which bears all risk of loss due to claims of policyholders. The Chairman also asked that we specifically address the practice of cross-selling and potential for coercive tie-in sales of insurance and other consumer abuses and provide insight into what regulatory controls are needed to protect consumers. To identify the advantages and disadvantages of banks selling insur- ance, we interviewed over 60 insurance and banking industry organiza- tions, their regulators, consumer advocates, and academic experts. Our judgmental sample of interviews included banking and insurance industry representatives and regulators likely to be involved with banks already selling insurance. Appendix I lists the organizations and individ- uals that we interviewed. We also reviewed legal opinions, congressional hearing records, and publications prepared by banking institutions and insurance sellers. In an effort to assess the extent of abusive tie-ins and potential for abuse if bank sales of insurance are expanded, we examined banks’ experience with credit insurance, since most banks already can sell this type of insurance. Specifically, we reviewed two studies most often cited by both opponents and proponents of banks selling insurance. Based on consumer surveys sponsored by the Federal Reserve, both studies pro- vide information on the frequency of borrower purchases of credit insurance, borrower perceptions about lender recommendations to purchase credit insurance, and overall borrower attitudes toward credit insurance.11 To analyze tie-ins in bank sales of other types of insurance, we inter- viewed insurance sellers, banks selling insurance, and banking and insurance regulators in two states where banks already sell insurance- Minnesota and North Carolina. In Minnesota, banks have sold insurance for many years, while North Carolina banks recently started to sell insurance. We spoke with banking and insurance regulators in seven “Robert A. Eisenbeisand Paul R. Schweitzer,“Tie-ins Betweenthe Granting of Credit and Saleof Insuranceby Bank Holding Companiesand Other Lenders,”Staff Study 101,Boardof Governorsof the FederalReserveSvstem(Feb. 19791and Anthony W. Cvrnak and GlennB. Canner.“Consumer Experiencewith Credit I~&ance,” FeieraI ReserveBankof SanFranciscoEconomickeview (SummerIOSS), pp. 6-20. Page 14 GAO/GGD-t-M-113 Banka Selljng Inmwance additional states-California, Iowa, Massachusetts, Nebraska, South Dakota, Wisconsin, and Wyoming-where banks have limited powers to sell insurance. We interviewed representatives of 13 bank holding com- panies that have grandfathered powers to sell insurance.12 We also interviewed officials of the three principal federal bank regula- tory agencies-Federal Reserve, FDIC, and occ. We spoke with officials of the National Association of Insurance Commissioners (NAIC). NAIC con- sists of the heads of the insurance departments of the 60 states, the Dis- trict of Columbia, and 4 U.S. territories. NAIC’S basic purpose is to encourage uniformity and cooperation among the states as they individ- ually regulate the insurance industry. We did our work between December 1988 and January 1990 in accor- dance with generally accepted government auditing standards. At the request of the Committee, we did not obtain written comments on this report. We discussed the contents of our report with officials at the fed- eral banking agencies- Federal Reserve, FIX, and ooc-and have incor- porated their comments where appropriate. The officials generally agreed with the conclusions in our report. 12Fourteenbank holding companiesare allowedto continueselling insuranceunder the grandfather provisions of the Garn-St.GermainAct of 1982. Page 16 GAO/GGIM@113 Banka selling Incuran= Chapter 2 Chsumers May Benefit but May Also Need * Protection From Potential Abuses In the debate over expanding bank powers to sell insurance, proponents and opponents disagree on how bank sales of insurance would affect consumers. Banks and consumer groups assert that banks will lower the costs of selling insurance, thereby reducing overall insurance costs, and will expand service to consumers. However, the insurance industry argues that banks would charge higher premiums and reduce service. Moreover, critics of bank sales of insurance contend that banks would take advantage of their position as lenders to coerce consumers to buy insurance. Banks could possibly reduce the cost of insurance if they can lower the Bank Entry May Have costs of marketing and selling policies to customers. However, sales Little Effect on expenses represent only one component of insurance costs, and any Insurance Premiums reduction in the cost of selling insurance may not significantly affect premiums paid by policyholders. Also, state regulatory oversight of insurance premiums may limit, in the short run, any seller’s ability to affect premium rates. However, expanded bank sales of insurance may increase convenience for consumers, thereby reducing consumers’ trans- action costs. Economiesof Scope Banks can reduce production costs if they can achieve economies of Present Potential for Cost scope in selling insurance products. An economy of scope refers to the ability to reduce costs through the joint production or marketing of two Reduction or more products or services. By offering a wider variety of products and services, a company may be able to sell a greater volume overall and lower the overhead costs per unit sold. Cross-selling, the concurrent marketing of several distinct services or products through one seller, is one way to achieve economies of scope. If bank sales of insurance are expanded, banks could use their existing offices and staff to offer more products and services to current customers. Cross-selling is a common practice in both the banking and insurance industries. In addition to traditional deposit accounts and loans, banks offer other banking products and services, such as credit cards, trust services, credit insurance, and financial planning advice to their cus- tomers, Insurance companies routinely offer several types of insurance to policyholders. In fact, an insurer may provide discounts to policy- holders purchasing several types of insurance or offer some types of coverage only to existing policyholders. Page 10 GAO/GGD-W113 Banka f3e.m Inemce Chapter 2 Consumers May BenePit but May Also Need Protection From Potential Abuses While expanded bank sales of insurance present the potential for banks to achieve economies of scope, it is not possible, we believe, to anticipate the extent to which banks could lower the costs of selling insurance. Available statistical studies of banking costs, in general, are based on small banks dealing with existing products and geographic restrictions and do not address bank expansion into insurance sales. Therefore, these cost studies cannot be used to project whether bank sales of insur- ance will lower the costs of selling insurance. Sales Expenses Are a Any reduction in sales costs is unlikely to substantially lower insurance Fraction of Premiums Paid premiums paid by consumers. Sales expenses represent only one compo- nent of an insurer’s cost, while losses and expenses for underwriting by Policy holders and claims handling represent the bulk of insurance costs. According to A.M. Best Company, commissions represented nearly 12 percent of property/casualty premiums in 1988 and almost 10 percent of life/ health premiums. As a result, a l-percent reduction in sales commissions would translate into a premium reduction of, at most, one-tenth of 1 percent. State Regulation Limits State regulatory oversight of insurance premiums may limit, in the short Seller’s Effect on run, any seller’s ability to affect premium rates. First, premiums charged for an insurance policy are set by the insurer underwriting the Insurance Premiums product and not by the seller of the policy. Then, regulators in most states oversee premium rates through rate plans to be filed with the insurance department or by requiring prior approval for premium rates. Since premiums are set by the insurer with regulatory oversight, a bank selling insurance could not unilaterally change premiums charged to consumers. In addition, almost all states prevent insurance sellers from reducing premiums paid by consumers through anti-rebating laws. The ban on rebates prevents an insurance seller from paying a portion of the pre- miums or sharing its commission with the customer. As a result, banks could not immediately reduce premiums paid by consumers to reflect any cost savings. Instead, the insurer marketing its products through a bank would have to revise its rates subject to regulatory oversight. If banks could reduce sales costs, to compete on the basis of price, insurers distributing products through banks would request lower premiums to pass cost savings along to customers. Page 17 GAO/GGD90-113 Banks Selling Insurance chapter 2 Cknunnnera May Benefit but May Also Need Protection From Potential Abuses Increased Convenience Banks could reduce an individual’s overall costs of purchasing insurance May ReduceConsumers’ by reducing the consumer’s transaction costs. The total price of an insurance product is not only the premium paid to the insurer but also Transaction Costs the consumer’s time and effort to obtain information about insurance products and complete the transaction. With expanded insurance sales authority, a bank could provide “one-stop shopping” for both banking and insurance needs. The Consumer Federation of America and the National Insurance Consumer Organization assert that the increased convenience for consumers would be a primary advantage of banks selling insurance. With one-stop shopping, a bank could assist consumers in choosing from a range of banking and insurance products. Both traditional bank prod- ucts and life insurance products are important elements of a consumer’s financial plans. Increasingly, banks and insurance companies offer sim- ilar products. Banks provide financial products, including letters of credit, municipal bond insurance or guarantees, and annuities, that offer insurance-like protection. Life insurers sell policies that offer an invest- ment or savings function. As we reported in January 1989, expanded powers for banks would Bank Salesof increase the diversity of banking, thus increasing the potential for con- Insurance Increase flicts of interest and their abuse.’ However, these conflict situations and Potential for Abuse of potential abuses exist for all insurance sellers. For example, a bank or any other insurance seller has a “salesman’s stake” in promoting prod- Consumers ucts and services while at the same time purporting to provide objective advice. However, unlike other insurance sellers, a bank or any lender also could use its position as a source of credit to coerce borrowers to buy insurance through the bank as a condition to receive loans. Conflicts of Interest Are A conflict of interest is a situation in which a person or business serving Not Unique to Banks more than one interest can benefit by favoring one interest at the expense of others. Conflicts of interest occur during the normal course of many business operations, including banking and insurance. An abuse of a conflict of interest occurs if the bank or its representative takes advantage of the conflict situation in violation of customary industry practices, fiduciary responsibilities, or laws and regulations. ‘Banking: Conflicts of Interest Abusesin Chunercial BankingInstitutions (GAO/GGD-89-35,Jan. 27,1989). Page 18 GAO/GGD9@113 Banks Selling Insurance chapter 2 Ckmmune~ May Benefit but May Also Need Protection From Potential Abuse19 Like other insurance sellers, a bank and its employees routinely encounter situations in which their interests would be better served by actions not in the best interest of the customer. This may occur when the seller has a “salesman’s stake” in promoting products or services while at the same time purporting to provide disinterested investment advice. For example, any insurance seller, including a bank or its employees, could abuse consumers by encouraging purchases of high- profit insurance products while supposedly providing objective advice. To increase income, the seller may recommend those products that yield the highest commissions rather than the best coverage or cheapest pre- miums for consumers. In addition, a bank could abuse a customer’s interest by using confiden- tial customer information in a manner not agreed to by customers. For example, the bank could use lists of prospective borrowers to market insurance products during the credit process or provide information to an insurance seller contrary to customers’ privacy interests. Also, a bank could give preferred treatment to certain customers, such as offering lower interest rates for borrowers who purchase insurance. Tie-Ins Between Insurance To pass along cost savings achieved through economies of scope, a bank and Credit Present may “tie” two or more products and services into a package. Such tie-ins can benefit consumers as long as they have the option not to purchase Opportunity for Abuse the additional goods. An involuntary or coercing tie-in occurs when, in order to purchase the desired product or service, a customer must purchase a second product or service. Involuntary tie-ins may be illegal under federal antitrust laws, and banking laws explicitly prohibit tying credit to any other banking product or service. However, even where the bank does not intend a tie-in, a borrower may purchase an additional product such as insurance from the bank in hopes of improving the chance of receiving a loan. Such implied or perceived tie-ins may result if banks cross-market insurance to borrowers or, in particular, if the bank loan officer sells insurance. Some types of insurance would be particularly susceptible to credit tie- ins. Foremost, credit insurance may be tied to credit transactions, since only consumers who owe on loans or credit accounts purchase credit insurance. According to a Congressional Research Service report, a con- sumer is most likely to purchase credit insurance when a loan is Page 19 GAO/GGD-90-113 Banka Selling Insurance Chapter 2 Consumers May Benefit but May Also Need Protection kom Potential Abuses originated, and as a result, the lender is well placed to offer the insur- ancea2In fact, one study sponsored by the Federal Reserve found 90 per- cent of credit insurance in 1985 was sold by lenders. Property insurance also may be tied to credit when a loan is secured by collateral. For example, any lender that also sells insurance could offer auto insurance policies to borrowers with car loans or homeowner insur- ance to mortgage holders. However, the opportunity for a bank to coerce borrowers into purchasing insurance is limited not only by the existence of other sources of insurance but also by other sources of credit. In 1987, about 40 percent of auto loans and less than 40 percent of home mortgages originated with commercial banks. Many other lenders, in fact, also sell insurance, including automobile finance companies and mortgage companies. While insurance opponents of bank sales of insurance maintain that Limited Evidence Does coercive tie-ins are widespread, little evidence is available to substan- Not Indicate tiate claims that banks coerce customers to buy insurance. Although Widespread Abuse of credit insurance is most susceptible to tie-ins, studies of credit insurance sales have found consumers’ favorable perceptions did not indicate Credit Tie-Ins problems with widespread abuse. As for banks selling other forms of insurance, state regulators in our interview sample said that, while instances of abuse may occur, coercive tie-ins are not widespread. Given banks’ limited experience with credit insurance and the few banks that sell other insurance, we cannot generalize about the extent of abuses if bank sales of insurance are expanded. Little Evidence That Opponents of banks selling insurance claim lenders dominate credit Coercion Is a Widespread insurance sales through overt or implied tie-ins between insurance and credit approval. To support their point, independent agents and their Problem in Credit trade associations cite the fact that two-thirds of borrowers purchase Insurance credit insurance from their lender. In 1985,67 percent of bank bor- rowers also bought credit insurance through their banks. Moreover, these opponents point out, about 20 percent of borrowers with credit 21nsuranceSales:The Effects of PossibleBank Diversification on the InsuranceIndustry, Congres- sional ResearchService(Nov. 30, 1989). Page 20 GAO/GGD!W113 Banks Selling Insurance Chapter 2 Conmmers May Benefit but May Also Need Protection From Potential Abuses insurance in 1985 said their lender strongly recommended or required the purchase of credit insurance.3 However, the fact that borrowers purchased credit insurance from their lender does not necessarily mean that borrowers were coerced to buy insurance from the bank. A Federal Reserve-sponsored study found that, excluding borrowers required to purchase coverage, less than 4 percent of credit insurance buyers in 1985 thought the loan approval process was affected by whether they bought credit insurance. Bankers suggested that borrowers purchase credit insurance from lenders, because this insurance is convenient and relatively inexpensive when compared to the loan. Indeed, 90 percent of those borrowers who pur- chased credit insurance in 1985 responded that credit insurance was a good product. Further, more than 90 percent of those who purchased credit insurance indicated that they would purchase similar coverage in the future. Even among those borrowers who did not purchase coverage, more than half thought credit insurance was a good idea. Little Indication of Abuse Independent agents and some state insurance regulators have suggested in States With Expanded that if banks were granted broad power to sell insurance, banks would coerce their customers into buying insurance. However, 14 of the 17 Bank Sales of Insurance state banking and insurance regulators that we interviewed do not believe that banks routinely coerce borrowers to buy credit insurance. Our discussions disclosed only limited anecdotal evidence of such coer- cive practices in states where banks already sell insurance. Our discussions with regulators, consumer advocates, insurance agents and bankers in Minnesota and North Carolina did not indicate wide- spread coercion by banks selling insurance. In Minnesota, where state banks have sold insurance for over 90 years, the state’s Department of Commerce, which regulates both banking and insurance, has received few complaints about coercive tie-ins by banks. Officials said that the one case involving numerous consumer complaints about coercive credit tie-ins did not involve a banking institution, In North Carolina, where banks recently began selling insurance, the Attorney General’s office and state bank regulators were unaware of any widespread coercion problems in North Carolina banks. 31nmany states,banksmay legally require the purchaseof credit insuranceas a condition to receive credit. They may not, however,require that the insurancebe purchasedfrom a particular source. Under title I of the Truth in LendingAct (16 U.S.C.1606B),the costof credit insurancemust be addedinto the loan’sannual percentagerate. Page 21 GAO/GGD-90-113 Banka gelling Insurance I Chapter 2 Coarnmers May Benefit but May Also Need ProtectIon From Potential Abuses However, we found instances of a situation which could possibly represent coercive tie-ins in insurance products. According to several persons in our interview sample, some banks have refused to accept binders-legally binding promises to provide insurance coverage-from other agents and instead offered to sell their own policies to borrowers during loan closing. A bank’s ability to reject a binder in lieu of an actual policy during closing varies according to state laws and regulations. For example, a bank in North Carolina can refuse to accept binders, while in New York, this practice is prohibited. The difficulty of coercing tie-ins between insurance and banking prod- ucts is illustrated by the low market share held by bank holding compa- nies that sell general insurance. Of the 10 bank holding companies selling insurance in our sample that responded, most estimated that few of their banking customers also bought insurance through the bank or its affiliate. Estimates ranged from less than 1 percent to less than 15 percent. These percentages of bank customers buying general insurance are low compared to the 67 percent of bank borrowers buying credit insurance. The limited experience of national banks and state-chartered banks that sell insurance may not be representative of the extent of abuses that would occur if bank sales of insurance are expanded. Currently, bank holding companies, national banks, and state-chartered banks in 10 states can sell insurance in small towns with populations less than 5,000. Since a bank serving a small town may exercise a near monopoly in providing credit in the community, the small town exemption allows banks with the most opportunities for tie-in abuse to sell insurance. None of the regulators in our sample expressed concern about possible abuses by small town banks. In large markets where consumers can choose from multiple sources of credit and, therefore, are less suscep- tible to coercive tie-ins, most banks are now restricted from selling insurance. As we reported in our 1989 report on conflicts of interest in banks, three Controls Over Abusive factors work to control conflict situations and limit their abuse: competi- Practices of Banks tion, banking internal controls, and regulatory oversight. While this Selling Insurance combination can serve to limit abuses, these factors cannot prevent all abuses. However, after some point, additional controls and oversight Y may hamper banking operations and diminish potential benefits for consumers. Page 22 GAO/GGI.MO-113 Banlra Selling Insurance Chapter 2 Ckmtmmers May Benefit but May Also Need Protectlon From Potential Abunes Competition Competition between financial service providers serves to deter conflict of interest abuses. To maintain business relationships and profitability, banks try to avoid adverse publicity and poor customer relations that could result from abuses. Competition serves as a barrier as long as cus- tomers are aware when they are adversely affected and can easily take their business elsewhere. As pointed out earlier in this chapter, banks are not the dominant source for consumer credit. Faced with unfair insurance sales practices by banks, consumers could find another credit source. Competition between insurance sellers will be discussed in chapter 3. When competition is lacking or when it is difficult or expensive for cus- tomers to obtain necessary information, they may not be able to take their business elsewhere. According to the National Federation of Inde- pendent Businesses, banks are the primary source of credit for small businesses, and a small business may depend upon one bank for all of its credit needs. Generally, a small commercial borrower cannot quickly change lenders because of the lag time in applying for loans and under- going an evaluation of its creditworthiness. In the short run, a small commercial borrower could feel pressured to purchase insurance prod- ucts from the bank if the borrower has no other immediate source of credit. However, in the long run, borrowers can develop relationships with other commercial banks if they find their current banks’ practices unreasonable. Banking Internal Controls Banks use internal control systems to manage conflict situations and limit abuses. A bank may use “Chinese Walls” to limit the passage of sensitive or confidential information between units or even to physically separate operations. The Chinese Wall concept could be used to prevent information about credit applicants from being used to sell insurance or to separate the credit and insurance departments. A bank also may have a code of ethics providing guidance to employees in resolving conflicts of interest. For example, a bank may prohibit a loan officer from dis- cussing insurance with a prospective borrower until the loan decision is final or may require a loan officer to disclose that insurance purchases are voluntary. Regulatory Oversight Federal and state banking laws, regulations, and supervision play an ” important role in protecting consumers from bank abuses. Federal anti- trust laws prohibit certain involuntary tie-ins, and federal banking laws specifically prohibit tying bank credit to other banking products and Page 23 GAO/GGIMO-113 Banks Selling Insurance , Chapter 2 Chwume~ May Benefit but May Aleo Need Protection Prom Potential Abwes services. In addition, the Federal Reserve Board considers the potential for perceived tie-ins in allowing a bank holding company to sell insur- ance, In approval orders to individual banking institutions, the Federal Reserve Board may specify controls necessary to limit potential abuses. CKXlikewise considers the potential for tie-ins by national banks selling insurance and may impose additional controls. Some states where banks have gained power to sell insurance have addi- tional laws and regulations that serve to protect consumers. For example, during every transaction with customers of related companies, Wisconsin requires banks to disclose the relationship and to provide instructions for the consumer to report coercive sales pressure to com- pany management or the Commissioner of Banking. To prevent the “salesman’s stake,” Wisconsin prohibits bank employees who sell insur- ance on a commission basis from making credit decisions, Banks selling insurance are subject to state insurance regulation as well. A bank or its employees may be required to obtain an agent license and are subject to the same state insurance regulations as other insurance sellers. While legal provisions vary from state to state, unfair trade practice laws and regulations generally prohibit coercive tie-in sales for borrowers, as well as misrepresentation and false advertising. Additional Regulatory While existing regulatory controls prohibit coercive tie-ins by a bank Controls May Warrant selling insurance, it is reasonable to expect that the greater the degree of joint marketing, the more likely consumers are to believe credit is tied to Consideration insurance. Thus, consumers may need additional protection from per- ceived tie-ins. While a prohibition on joint marketing may prevent even the perception of tie-ins between credit and insurance, such a measure also would fore- stall consumers benefitting from expanded bank sales of insurance. As banks enter joint ventures with insurance sellers or gain powers to sell insurance directly to customers, other measures for consideration include mandatory disclosure and marketing separation. At the least, banks could be required to disclose that the purchase of insurance is voluntary and does not affect the granting of credit. Also, banking oper- ations, particularly the credit process, may be insulated from insurance marketing by . restricting a bank from offering insurance to a borrower until the loan decision is final, Page 24 GAO/GGD90-113 Banks Selling Insurance Chapter 2 C?.mmmere May Benefit but May Also Need Protection From Potential Abwea . prohibiting loan officers from offering insurance to a borrower or earning commission on insurance sales, and . physically separating insurance marketing staff and office space from other banking operations. Some of these measures, however, may reduce or eliminate the cost sav- ings that might otherwise flow from the joint marketing of banking and insurance services. Expanded bank sales of insurance could potentially benefit consumers Conclusions through reduced insurance costs and increased convenience. However, we do not believe it is possible to predict the extent to which potential benefits may be realized. Similarly, expanded bank powers to sell insurance may increase oppor- tunities for banks to coerce consumers to buy insurance as a condition to receive credit. However, while instances of abuse may occur, coercive tie-ins have not been a widespread problem in banks selling credit insur- ance or in those banks already allowed to sell other forms of insurance. These limited experiences cannot be generalized to predict the extent of future abuses. While coercive tie-ins are already illegal, additional mea- sures could help to protect consumers. While consumers could potentially benefit from bank sales of insurance, Matters for it is not possible to know in advance the potential for future abuses in Congressional tying the granting of credit to the purchase of insurance. If more banks Consideration gain powers to sell insurance, Congress may wish to consider the need for additional regulatory measures, including increased disclosure and separation of insurance marketing from the credit process, to protect consumers from possible coercive tie-in problems. Page 25 GAO/GGD9@113 Banks Selling Iusurance IncreasedCompetition for Other Sellersbut No Risk to Banldng Safety and Soundness Opponents and proponents disagree on how expanded bank sales of insurance would affect insurance sellers. Insurance agents and their trade associations suggest that banks would reduce competition in the insurance market through unfair competition. In particular, agents claim that banks would give preferential treatment to their affiliates and deny credit to competitors. Banks and many consumer groups assert that bank sales of insurance would increase competition. Both sides in the debate over expanded bank powers also disagree on how banks selling insurance would affect the safety and soundness of the banking system. On one side, opponents claim insurance sales would increase the riskiness of banking and endanger the safety and soundness of the banking system. On the other side, banks and their supporters contend that insurance sales would enhance banking profitability, thereby protecting banking safety and soundness. Uniform powers for banks to sell insurance would create a more “level Competitive playing field” among banking institutions, nonbank depository institu- Consequencesof tions, and other nonbank lenders in selling insurance. As discussed in Banks Selling chapter 1, current insurance sales authority for state-chartered banks varies from state to state. Even among national banks, only those banks Insurance operating in towns with populations less than 6,000 may sell insurance. In contrast, other depository institutions, including savings and loan associations, credit unions, and mutual savings banks, can offer insur- ance to customers. Moreover, other lenders, such as finance companies, can sell insurance to their borrowers. Finally, other nonbank financial services firms, including insurance companies, can offer banking prod- ucts, such as savings accounts and loans. This checkerboard of powers does not allow otherwise similar institutions to compete on an equal basis. Within the insurance market, the effect of banks selling insurance on product pricing and availability is uncertain. As discussed in chapter 2, banks could potentially reduce the costs of selling insurance, though any cost saving would not immediately result in lower insurance premiums for consumers. While bank sales of insurance would increase conve- nience for consumers, bank entry, as an agent, to the insurance market would not affect the amount of insurance available. The amount of insurance available depends on the underwriting capacity of insurance companies. Page 26 GAO/GGIMJ@113 Banks Selling Insurance Chspter 3 Ineroa6ed competition for Other Sellers but No Risk to Bankhg Safety and Soundnese Expanded bank sales of insurance could enhance price competition between insurance underwriters. Increasing price competition between insurers has forced many insurance companies to seek lower sales costs as well as to improve marketing for their products, To the extent that banks could sell insurance more cheaply, insurers could pass reduced production costs along to consumers as lower insurance premiums. Insurers also would benefit from the flexibility of another channel for reaching consumers. Many insurers already buy customer lists from banks to take advantage of banking’s customer base. According to a 1988 Louis Harris survey done for Coopers and Lybrand, 34 percent of life insurers and 28 percent of property/casualty insurers surveyed use banks to market or sell their products. Moreover, four out of five insurers surveyed’plan to increase their distribution through banks over the next 6 years. Current insurance sellers-the most vocal opponents of banks selling insurance -are likely to lose market share and some of their profits if bank sales of insurance expand. In particular, independent insurance agents, whose commissions often result in higher costs than other delivery systems, may lose from banks’ entry. Currently, banks may lease space in their offices or sell lists of bank customers to insurance sellers. However, if banks gain powers to sell insurance, agents not affil- iated with banks may lose their bank office space and access to bank customer information. Not surprisingly, independent agents opposing expanded bank powers suggest that banks have unfair competitive advantages in selling insurance. Banks have potential advantages that may enable them to compete suc- Potential Competitive cessfully with other insurance sellers. As discussed in chapter 2, banks Advantages for Banks may be able to sell insurance more cheaply because of economies of Selling Insurance scope achieved through joint marketing. These efficiencies;,however, are likely to be reduced if additional steps are taken to preclude coercive tie- in sales. A bank may market insurance products to current bank cus- tomers through its network of branch offices as well as through mailings to credit card holders, depositors, and borrowers. Besides providing space within its offices and customer lists, a bank could also share over- head functions, such as check clearing, accounting, and other adminis- trative functions, with its insurance operations. However, these advantages are not unique to banks, and any large, diversified firm may have competitive advantages. Moreover, an advantage does not necessa- rily translate into unfair competition. Page 27 GAO/GGLMO-113 Banka Selling Insurance Chapter 3 hwea8ed C!ampetlUon for Other Bellem but No Wak to Banking Safety and Soundnw Physical Access to According to Standard and Poor’s Insurance Rating Service, the branch Customers networks used by banks represent a powerful distribution advantage. Since depositors visit branches frequently, the bank has physical access and contact to market more products to existing customers. Similarly, leasing arrangements and joint ventures by insurers and agents with banks attempt to capitalize on a bank’s position as a point of sale. According to the Minnesota Insurance Agents Association, half of its members work for agencies affiliated with banks. Our sample of bankers and state regulators indicated that banks gener- ally choose to co-locate insurance operations within bank offices. Of the 11 sample banks selling insurance, only one did not co-locate its insur- ance and banking activities. Five sold insurance through bank offices, and the remaining five sold insurance through bank offices as well as in other locations. Of the six states that commented on the location of bank insurance operations, regulators in all six states said banks are not restricted from selling insurance within bank branches. Accessto Customer Banks, like other lenders and financial advisors, possess highly sensitive Information and confidential information regarding customer finances. Opponents of expanded bank sales of insurance assert that banks’ access to credit information presents an unfair advantage. Through its lending opera- tions, a bank could have information that a consumer is purchasing property that requires insurance, such as an automobile or a house. As a result, a bank could offer insurance to the borrower while other sellers are not aware of the opportunity to compete for the borrower’s business. However, the majority of automobile and home loans originate with lenders other than banks. In many cases, these other lenders already have powers to sell insurance to borrowers. Therefore, access to credit information in itself is not necessarily an unfair advantage. Another concern of competing insurance sellers is that banks could pro- vide customer information to affiliated insurance agencies at no charge. Currently, other insurance sellers are able to purchase bank customer lists. The magnitude of any advantage a bank-affiliated agent may gain from access to customer information is unclear. While independent agents in North Carolina said that access to customer records is useful in selling insurance, bank-affiliated agents in Minnesota and representa- tives of several insurers said that only customer names and addresses were helpful. Page 28 GAO/GGLMO-113 Banks SeUng Insurance Chapter 3 Increaned Competition for Other Sellers but No Rialc to F5ankhg Saiety and Soundnwse Shared Overhead Costs A bank could also share overhead and processing functions with its insurance operation. As a result of economies of scope and scale, the bank-affiliated insurance activities may have lower production costs than if the insurance agency operated as a separate entity. These advan- tages, however, are not unique and may exist for all large, diversified financial service providers. For example, in recent years, insurance companies have purchased inde- pendent agencies or agency computer systems serving to consolidate administrative functions and reduce operating costs. Independent agen- cies are joining consortiums and developing information systems to reduce processing costs and achieve economies of scale. Small firms that are unable to attain economies possible through large-scale operations may be unable to offer prices competitive with larger institutions, * including banks. If the number of banks selling insurance is expanded, banks could abuse Banks Could Abuse their position as a source of credit to compete unfairly against other Credit to Compete sellers. A bank could give preferential treatment to an affiliated agency Unfairly Against or deny credit to competing insurance sellers. We do not know the extent to which banks might use credit to influence their competitive position. Other Sellers 9 A bank could subsidize an affiliated insurance agency by providing loans at favorable, nonmarket lending rates or without applying appro- priate credit standards. Opponents of expanded bank sales of insurance argue that, moreover, a bank has access to low-cost insured deposits, which it could use to fund its insurance agency. However, any large, diversified financial company, including large banks, bank holding com- panies, and national insurance agencies, may be able to borrow funds more cheaply than a small independent agent or specialty insurance agency. Lenders may provide lower rates to diversified companies because they believe such institutions are less risky than the less diver- sified insurance agencies. Absent legal restrictions,’ access to low-cost funding, including insured deposits, could provide banks selling insurance with a cost advantage over other sellers. To the extent that a bank could pass along the cost differential in the form of lower premiums, the bank could take over a share of the market from independent insurance sellers. However, two ‘Controls, including regulatory oversight,that serveto protect againstcredit abusesare discussed below. Page 29 GAO/GGDBO-113Banks Selling Insurance chapter 3 Inwaaed cOmpetith for Other Sellers but No Risk to Banking Safety and Soundneea factors serve to limit any advantages of low-cost funding for bank insur- ance operations. First, a bank might use low-cost funding to subsidize its insurance sales activity as a short-term strategy to establish the bank’s presence in the insurance market. In the long run, however, a bank would probably direct its loanable funds to the most profitable activities. Second, as previously indicated, any advantage from low-cost funding would not necessarily affect premiums paid by consumers, since an insurance seller cannot unilaterally change premiums charged to cus- tomers. Even if banks could sell insurance more cheaply, lower pre- miums would result only if insurers are willing to pass cost savings along to consumers and state regulators permit these price changes. Independent agents assert that a bankselling insurance would deny credit or charge an excessive rate of interest on loans to competing insurance sellers. The Congressional Research Service has pointed out the possibility that if every bank in a town sells insurance or is affili- ated with an insurance agency, an independent agency may not be able to get credit in that town2 If competing sellers are unable to get credit and necessary liquidity, independent agencies not subsidized by a bank could be eliminated from the market. As a result, insurance markets in areas with restricted access to credit might be monopolized by banks and their insurance affiliates. CurrentQ, banks in small towns may sell insurance, while banks in larger, more competitive markets cannot. As discussed in chapter 2, competition, banking internal controls, and Controls Can Limit regulatory oversight serve to control credit abuses. In a competitive Abuses and Ensure market, each lender must make loans at competitive interest rates in Competition order to retain business. Thus, a bank subsidizing its affiliates, in the long run, could not offer competitive rates on loans. While one bank might deny loans to an insurance competitor or charge higher interest, banks in unison are unlikely to do so; such action could be challenged under federal antitrust laws. However, where credit abuses are likely or competition is lacking, additional regulatory controls may be necessary to ensure fair competition. %surance Sales:The Effects of PossibleBank Diversification on the InsuranceIndustry, Cmgres- sion JR eswrc rvice( ov. Page 30 GAO/GGD-Q&113 Banks Selling Insurance chapt8r 3 Iucreaeed CornpetItion for Other Bellera but No Reek to Banking Safety and Soundness Banking Internal Controls Banking internal control systems serve to limit credit abuses and ensure that a bank remains competitive. As discussed in our report on banking conflict of interest abuses, “Chinese Walls” or firewalls are an important component of bank controls. These walls are intended to limit the pas- sage of sensitive, critical, or confidential information within the bank and between the bank and affiliates, as well as to limit inappropriate transactions between units. Without an adequate wall, unauthorized or unnecessary possession of information could unfairly give advantage to the bank or its affiliate at the expense of other insurance sellers. For example, information about borrowers could be used by a bank-affiliated insurance agency to market insurance products before the credit process is complete. Of the 11 banks in our sample that responded, 7 banks indicated that they restrict or limit access to customer information by the affiliated insur- ance agency. Regulatory Oversight Federal and state banking laws, regulations, and supervision serve to help control credit abuses. A bank’s ability to give preferential treat- ment and subsidize an affiliated insurance agency is restricted by banking laws and regulations. Section 23A of the Federal Reserve Act (12 U.S.C. Section 371C) limits loan and credit transactions with any one affiliate within a bank holding company to 10 percent of the bank’s cap- ital and the aggregate amount of lending to all affiliates to 20 percent. Such transactions should be fully collateralized. Section 23B of the Federal Reserve Act requires transactions between banks and their affiliates within a holding company to be at arm’s length with fair market pricing. For example, a bank is not to provide customer lists or accounting services to an affiliate for less than the bank would charge an unaffiliated company. Similarly, where a bank shares space or overhead functions with an affiliate, the bank is to charge the affiliate for its share of the costs. We have reported that economic separation between a bank and its affil- iates within a holding company can reduce incentives and opportunities for a bank to give preferential treatment to affiliates.3 Economic separa- tion provides that a bank and its affiliates must be adequately and sepa- rately funded with no commingling of assets, that any services or loans 3BankPowers:Insulating BanksFromthe Potential Risksof ExpandedActivities (GAOIGGD-87-36, Apr. 14,1987). Page 31 GAO/GGD-90-113 Banks Selliug Insurance cllapter 3 Increased Competition for Other Sellers but No Bisk ta BankIng Safety and Soundness obtained from the bank be obtained at rates comparable to those charged nonaffiliated parties, and that the bank be prevented from unduly transferring assets to, or purchasing bad assets from, a weak affiliate. While existing banking laws and regulations restrict credit and require arm’s length transactions for bank affiliates, similar restrictions do not apply to transactions among bank departments or between a bank and its subsidiaries, At this time, banks permitted to sell insurance may do so through an affiliated insurance agency, a subsidiary agency, or an insurance department within the bank. Additional Regulatory While preferential treatment of affiliates and subsidiaries is already Measures Could Protect addressed in the existing regulatory system, additional measures may be necessary to ensure competition in insurance markets if bank powers Competition are expanded. While none of our interviewees could provide an example in which a bank denied credit to a competitor, regulators may have diffi- culties monitoring such situations. Since regulators can identify possible banking abuses through complaint data, one way to identify credit abuses may be to specifically track complaints by insurance sellers that a bank denied credit. Further regulatory measures could reduce banks’ competitive advan- tages over other insurance sellers. For example, a bank and its affiliated insurance agency could be required to use different names and logos, locate in separate space, advertise separately, refrain from selling each other’s products, and develop separate customer bases. Basically, regu- lations could be designed to prevent banks from realizing economies of scope through joint marketing. While such measures would protect other insurance sellers from increased competition, full separation of mar- keting for a bank and its affiliated agency would forestall consumers gaining potential benefits from banks selling insurance. Page 32 GAO/GGIMO-113 Banka Selling Insurance Ckapter 3 Increased Competition for Other Sellers but No Risk to Banking Safety and Soundness Contrary to opponents’ claims, bank sales of insurance underwritten by Insurance Sales an unaffiliated insurance company would not endanger banking safety Present No Risk to and soundness. Unlike underwriting, selling insurance does not involve Banking Safety and financial risk of loss. Insurance underwriters, not insurance sellers, are responsible for paying losses incurred under policies sold to the public. Soundness In marketing insurance products, a bank does not incur liability for poli- cyholders’ claims4 As a result, bank sales of insurance would not jeop- ardize a bank’s capital and financial condition. Moreover, potential commissions earned from insurance sales could enhance bank profitability. In recent years, banks have attempted to remain profitable by diversifying their income sources. Banks have sup- plemented their traditional source of income-the difference between interest earned on loans and interest paid on deposits-by charging fees for services. Insurance commissions would offer another source of income. To the extent that insurance sales result in more stable bank profits, bank diversification into selling insurance could potentially strengthen safety and soundness and protect against bank failures. We cannot predict whether bank sales of insurance would be profitable. Empirical studies of profits in banking and insurance selling suggest that combining insurance selling and regular banking services could increase the stability of overall profits. If insurance commission profits tend to increase when loan profits decrease, overall profits would be more stable. Nonetheless, the extent to which bank sales of insurance could increase the stability of profits and decrease the risk of failure depends on the bank’s management of the two operations and the types of banking services and insurance products sold. Not all banks will find insurance selling to be profitable. For a bank within a holding company, profits earned by an affiliated insurance agency may accrue to the bank holding company, and the bank itself would be no more profitable. Also, in recent years, several banks have abandoned insurance sales because they found it unprofitable. Reasons mentioned for these withdrawals include the following: the banks were not competing successfully against existing insurance sellers, they did not develop a broad enough customer base among the customers of the bank, and bank managers did not like customers substituting insurance products for bank products. 4An insuranceagentmay be liable to policyholdersfor any mistakesmadein selling insurance.Errors and omissionsinsuranceis purchasedby independentagentsto protect againstcapital losses.Any bank selling insurancecould be required by regulatorsto acquiresimilar coverage. Page 33 GAO/GGD-90-113 Banks Selling Insurance Chapter 3 Increased Chmpetkion for Other Sellere but No 6uek to Banking Safety and Soundneae While selling insurance in itself presents no risks to a bank’s capital, any expansion into a new business presents management challenges. Safety and soundness could be at risk if substantial management attention were diverted from core banking responsibilities, such as managing credit risk, to building and managing the insurance line of business. Recent studies of bank and thrift failures found management inadequacies and lack of adequate regulatory oversight contributed to failures. If banks gain powers to sell all types of insurance, regulators need to ensure that banks can manage the expanded powers. The Consumer Federation of America suggested that banking revenues earned from general insur- ance sales should be limited as a percentage of total income to ensure that banking remains the principal focus of banking management. Additional measures may be necessary to ensure that consumers do not become confused about whether insurance products sold by a bank are backed by federal deposit insurance and that the federal financial safety net does not extend to an insurance agency affiliated with a bank. One measure would be to expressly disclose to the consumer that insurance products are underwritten by an insurance company and are not cov- ered by banking deposit insurance. Expanded bank powers to sell insurance would create a more level Conclusions playing field between banks and other depository institutions and credit sources. The entry of banks into the insurance market would have mixed effects on other insurance players. While insurers underwriting products may benefit from the flexibility of another channel for reaching customers, other insurance sellers would face increased compe- tition from banks selling insurance. Banks have potential competitive advantages over other insurance sellers resulting from economies cf scope in joint production of banking and insurance services. An insurance seller affiliated with a bank would not only have access to bank customers and customer information but could share overhead costs with the bank as well. These advantages are not unique to banks, and any large-scale insurance seller has an advan- tage over small independent agents. However, a bank affiliated with an insurance agency could give prefer- ential treatment to its affiliate or deny credit to competing insurance sellers. In addition to competition and banking internal controls, regula- tory oversight can protect against preferential treatment by a bank. Page 34 GAO/GGIMO-113 Lhnh Selling Jnaurance . Chapter 8 @crewed competition for Other Sellers but No Risk to Banking Safety and Soundness While existing banking laws and regulations prohibit a bank from subsi- dizing an affiliate, similar restrictions do not apply to bank subsidiaries or departments within a bank. Regulatory measures prohibiting joint production by banks and affili- ated insurance agencies would prevent banks from using competitive advantages over other sellers. However, measures such as separate logos, offices, and staff would forestall potential benefits for consumers by precluding economies of scope and increased convenience. If insur- ance sales are less attractive to banks, insurance sellers would benefit by being protected from increased competition and pressure to lower costs. Trade-offs exist between allowing consumers to benefit from banks selling insurance and protecting other sellers from competition by banks. These trade-offs must be considered in deciding the degree of joint marketing and production to allow. Stringent measures restricting bank sales of insurance underwritten by an unaffiliated insurance company are not warranted to protect the bank or the safety and soundness of banking. The insurer underwriting the policies bears the financial risk of losses under policies sold by the bank.‘To the extent that bank sales of insurance are profitable, selling insurance could enhance banking safety and soundness. Page 33 GAO/GGD4O-113 Banks Selling Insurance Appendix I Organizationsand Individuals Interviewed Bank Shares, Incorporated Grandfathered Bank Bremer Financial Corporation Holding Companies Citizens & Southern Corporation Crestar Financial Corporation Dacotah Bank Holding Company First Bank Systems, Incorporated First Oklahoma Bancorp First Security Corporation First Virginia Banks, Incorporated First Wachovia Corporation Firstar Corporation Nor-west Corporation Signet Banking Corporation United Banks of Colorado, Incorporated American Bankers Association Banking Industry Association of Bank Holding Companies Organizations Independent Bankers Association of America Insurance/Financial Affiliates of America Massachusetts Bankers Association Minnesota Bankers Association Independent Insurance Agents of America Independent Insurance Independent Insurance Agents of North Carolina Agents’ Associations Minnesota Association of Professional Insurance Agents National Association of Insurance Brokers Professional Insurance Agents Association Professional Insurance Agents of New England AIG Marketing, Incorporated, a subsidiary of American Insurance Holding International Group, Incorporated Companies and Aetna Life & Casualty Company Affiliates Alfa Insurance Corporation Allstate Insurance Company Depositors Insurance Company, a subsidiary of Allied Group, Incorporated Economy Fire and Casualty Company, a subsidiary of Kemper Corporation GEICO Corporation John Hancock Mutual Life Insurance Company Page 36 GAO/GGD-3@113 Banks Selling Jnsurance Appendix I Chfjahatlons and Individuab Interviewed Metropolitan Life Insurance Company Nationwide Insurance Companies The Prudential Insurance Company of America State Farm Insurance Companies Travelers Insurance Company American Council of Life Insurance Insurance Industry American Insurance Association Organizations Health Insurance Association of America Insurance Federation of Minnesota Insurance Information Institute Life Insurance Marketing and Research Association, Inc. Massachusetts Association of Life Underwriters National Association of Life Underwriters Consumer Federation of America Consumer Interest National Insurance Consumers Organization Organizations Lawrence Albright, Editor, Life Insurance Selling Experts Joseph Belth, Professor of Insurance, Indiana University Robert Eisenbeis, Assistant Dean for Research, University of North Carolina at Chapel Hill Steve Germundson, Hales Associates Sophie M. Korczyk, Ph.D., Consultant, Analytical Services Ken L. Williams, Author, Direct Marketing of Consumer Insurance to Bank Customers Page 37 GAO/GGDlUHl3 Banka Selling Insmum Appendix II c Major Contributors to This Report Lawrence D. Cluff, Assistant Director, Financial Institutions and General Government Markets Issues Division, Washington, Mitchell Rachlis, Evaluator-in-Charge MaryLynn Sergent, Evaluator DC. Alfred R. Vieira, Regional Issue Manager bston Re@ona1 Office JosephEv~s Evaluator Gretchen Laisk, Evaluator Y (288261) Page 38 GAO/GGWO-113 Banks SeUing hmnuwe. ;u -. ..~ ...---_--._--_--~._.- ..__.-__I__“I.aL*IYIm.IsIIII--. ,..-..-. . .----- - ---.l .._-“_-l.“--“.__l- .-.-.--.-.------ _-- --.-" . .._..-... --- . .._-_.-. ..-- .-... ",.ll-.. ".-l~l.""l I".cII. -ll".l . ..I ." I.. l.l.l ..- -" ..-. -- . ..-----.-- -_----.-.---.-.-._.._ _-.- _-_... I .-_--- l-_l_l ..-_- (, 1111,-11 ._.________. ~ I:rhitcvl Sti~tw First-( ‘hss Mail (;tbrtt~r;tl Acw~rlrltirq.g Ol’f’icv I’OSl~it~Cb Xr FthChS Pikid WilSltill~t 011, I).(:. 20548 (iA0 I Petwit, No. (; 100 I
Bank Powers: Issues Relating to Banks Selling Insurance
Published by the Government Accountability Office on 1990-09-25.
Below is a raw (and likely hideous) rendition of the original report. (PDF)