- Consulting with Canadians -

Manulife's Submission in Response to Finance Canada's�Large Bank Mergers in Canada:�

Submission To The Department of Finance Canada By Manulife Financial

Regarding the Response of the Government to Large Bank Mergers in Canada: Safeguarding the Public Interest for Canadians and Canadian Businesses a Report of the House of Commons Standing Committee on Finance and Competition in the Public Interest: Large Bank Mergers in Canada a Report of the Senate Standing Committee on Banking, Trade and Commerce

December 2003

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Introduction

Manulife Financial is pleased to provide its comments on the Response of the Government to "Large Bank Mergers in Canada: Safeguarding the Public Interest for Canadians and Canadian Businesses," a Report of the House of Commons Standing Committee on Finance and "Competition in the Public Interest: Large Bank Mergers in Canada," a Report of the Senate Standing Committee on Banking, Trade and Commerce.

Manulife supports the focus of the Committee Reports and the Government Response which recognizes the rapidly changing nature of the financial services industry in Canada and the importance of developing public policies to address the fundamental structural issues facing the industry in a manner that ensures strong Canadian-based financial institutions that can execute their chosen strategies, while at the same time protecting the interests of consumers.

Manulife believes it can contribute to the development of public policy by providing the perspective of a leading Canadian-based international financial institution that is rapidly developing a global franchise. Manulife has achieved its success by expanding both domestically and internationally.

Strategic Importance of Financial Services in Canada

The strategic role of the financial services sector in the Canadian economy and its contribution to the well being of Canadians is well documented.

The Government Response notes that financial services employs 540,000 Canadians and produces more than five per cent of Canada's GDP. These Canadian jobs are skilled and well-paying, and many exist because the head offices of the major financial institutions are located in Canada.

Financial services is a major contributor to federal, provincial and municipal revenues, paying approximately $9 billion in taxes, including 20 per cent of total federal corporate income taxes. This helps to fund health care, education and other government programs that are important to all Canadians.

The financial sector accounts for 33 per cent of the Toronto Stock Exchange market capitalization.

An important development has been the emergence of the large life insurance companies as major players in the financial sector, with growing international operations and market capitalization equal to the major banks. In 2002, the Canadian life insurance industry received 58 per cent of total premium income from operations outside Canada.

Government policy and regulatory regimes must play a critical role in enabling the large and strategically important financial services sector to continue to build on its success and remain an engine of economic growth and job creation.

Given the importance and changing nature of the life insurance industry, now is the appropriate time for the Government to expand its original review of bank mergers in order to develop new policies for cross pillar and large life insurance company mergers.

Accordingly, Manulife Financial's specific recommendations are based upon the following fundamental principles:

• Ensuring Canadian control of an essential industry by maintaining the widely held rule for large financial institutions;
• Allowing market forces to determine consolidation activities, including cross pillar and large life insurance company mergers, subject to appropriate regulatory review; and
• Ensuring that Canadian consumers enjoy the benefit of competition by providing all large financial institutions with a level playing field to execute their business strategies and not favouring any single type of institution or legal structure over another.

Canadian Control of a Strategic Industry

As a proudly Canadian-based financial institution, Manulife supports maintaining Canadian control and regulation of our large financial institutions in order to ensure they remain healthy and strong contributors to our economy.

The widely held ownership requirement is a legitimate and internationally accepted public policy to ensure Canadian control, regulation and prudential oversight. This requirement has been a cornerstone of Government policy since the 1950s and now applies to the major banks and large demutualized life insurance companies. A size-based ownership policy requiring major financial institutions to be widely held is used by many countries, either formally or informally.

Accordingly, Manulife Financial recommends that it should be Government policy that:

• Large, widely held financial institutions that merge should remain widely held and Canadian controlled; and
• The widely held requirement should apply to all large Canadian financial institutions, including existing non-conforming closely held institutions, in order to ensure national policy objectives are met and that all large financial institutions have a level playing field and conform to the same size-based ownership policy.

Cross Pillar and Large Life Insurance Company Mergers

The Government Response recognizes the need to consider a policy change to permit large demutualized life insurance companies to merge with each other or with major banks because of important changes that have taken place in the industry and the competitive environment in Canada and internationally.

The starting point for analyzing this issue should be recognition that competitive market forces inevitably determine business strategies, including consolidation activity, in all industries.

This is demonstrated by how the Canadian life insurance industry has responded successfully to its dramatically changing competitive, policy and regulatory environment. Even after recent consolidation activity, more than 100 domestic and foreign life insurers compete in the Canadian marketplace. A number of these competitors are insurance subsidiaries of major Canadian banks or substantial units of large foreign-based institutions.

Canadian consumers enjoy an impressive choice of insurance products and services, as well as a significant range of substitutes for insurance products. This contrasts with the banking industry where the large Canadian banks dominate deposit taking, securities and other segments, resulting in limited choice for consumers, particularly retail and small business customers. Foreign banks have limited presence in the Canadian retail market.

The Canadian life insurance industry has enjoyed substantial growth and success in the United States and internationally.

Manulife's recently announced merger with John Hancock Financial Services is the leading example of the successful international growth of the Canadian life insurance industry. The combined Manulife/John Hancock company will be the second largest life insurance company in North America and the fifth largest in the world, while maintaining its Canadian ownership and head office.

Manulife's growth in the United States and internationally provides diversified revenues and earnings, financial strength and broadened product offerings. This positions Manulife for further growth and expansion, providing enhanced job security and employment growth for the thousands of Manulife employees in Canada.

All these factors demonstrate that the Government Response is correct in recognizing the fundamental changes that have taken place in the financial sector, including the life insurance industry, since the formulation of the current Government policy prohibiting cross pillar or large life insurance company mergers. The Government Response acknowledges that other countries including the United States, United Kingdom, Australia and the Netherlands permit cross pillar mergers in order to enable their financial institutions to prosper by pursuing alternative strategies to traditional in-market growth.

Cross pillar and in-market mergers among large Canadian life insurance companies would permit these important financial institutions to become Canadian champions by increasing their already strong presence in the United States and international markets, while remaining Canadian owned and controlled.

In-market life insurance mergers and cross pillar mergers can be structured to ensure compliance with Government competition policy and public interest, consumer protection requirements. For example, in a cross pillar merger, the life insurance and banking operations would continue to operate separately in the domestic marketplace.

Accordingly, Manulife Financial recommends that the Government policy should permit large Canadian life insurance companies to merge with each other or with major Canadian banks, provided they remain widely held and Canadian controlled.

The Government Response asked whether cross pillar and in-market insurance mergers should be subject to bank-style public interest review by the Minister of Finance, in addition to regulatory review by the Competition Bureau and the Office of the Superintendent of Financial Institutions.

The formal public review process already in place for large in-market bank mergers, including public hearings and public accountability statements, was instituted because of concerns about disruption to local communities and reduced access to bank services resulting from branch closures. These issues do not arise in the context of cross pillar or in-market life insurance mergers.

The existing regulatory and public interest review process for the life insurance industry is comprehensive involving OSFI review of prudential and financial considerations, Competition Bureau review of competition and market share considerations, public interest review by the Finance Department and final Ministerial approval, as well as review by provincial and foreign regulators in their jurisdictions.

Accordingly, Manulife Financial recommends that cross pillar and in-market mergers among large life insurance companies not be subject to additional regulatory and public interest review beyond those already required, which are extensive and comprehensive.

Guidelines for the Structure of the Canadian Financial Services Industry

The Government Response asked whether the Government should specify any market structure characteristics for the financial services sector in advance of considering merger proposals, including specifying a minimum acceptable number of large institutions and whether "large" should be defined in terms of product offerings, geographic range, market capitalization, assets or equity.

Canada has eight large financial institutions under the existing criteria of having equity greater than $5 billion, including two widely held demutualized life insurance companies, one closely held life insurance company and five banks.

Viewed only through the Canadian domestic marketplace, these institutions would also be considered large in terms of market capitalization and assets. However, this would not always be the case if measured by product offerings. In the Canadian life insurance industry many suppliers compete in the various product markets.

The Competition Bureau merger guidelines are similar to the United States, United Kingdom and Australia in utilizing market share and concentration measures in the assessment of the ability of merged companies to exercise market power in specific markets. The Canadian and Australian assessments involve calculations of market share based on assets and revenues. The UK and US assessments are based on the increase in the Herfindahl-Hirschman Index (HHI) for specific markets, so that a merger review is conducted only if market shares of the merged company exceed specified thresholds in specified markets.

The key point is that the validity of different types of concentration criteria depends on accurately defining the scope and size of products, markets and competitors. It is important that all participants and products are included when defining markets.

For example, in the insurance industry, the group pension market is commonly defined as pension assets held under group annuity contracts including defined contribution plans, investment services-only arrangements and immediate and deferred payout annuity arrangements. Under this definition, Benefits Canada estimates the 12 largest insurers represented $72 billion of pension assets in 2002. Including the remaining insurers could increase the market size to approximately $85 billion. However, including trusteed pension plans managed by banks, trust companies, fund managers and custodians would increase the size of this market to between $600 billion and $700 billion. Under the narrow definition of the group pension market the 12 largest life insurance companies would have a market share of approximately 85 per cent, whereas under the broader market definition their market share is approximately 10 per cent, representing a very different competitive environment.

Accordingly, Manulife Financial recommends that:

• The Government not specify market structure characteristics in advance of considering merger proposals;
• The Government not specify a minimum acceptable number of large financial institutions before considering merger proposals. The number and nature of merger proposals, if any, generated in the marketplace and the results of the thorough regulatory and public interest review by the Competition Bureau, OSFI and the Finance Department, together with the Ministerial approval process, is sufficient to effectively determine the minimum acceptable number of large financial institutions; and
• The Competition Bureau maintain flexibility in its criteria for defining products and participants in specific financial markets, including use of HHI measures, in order to determine the true competitive situation created by a proposed merger.

Process for Reviewing Merger Applications

The Government Response asked whether the Government should establish a window of time, such as sixty days, in which all merger applications received during that time would be reviewed together.

Based on the principle that market forces should be permitted to drive any consolidation that might occur in financial services, the merger review process should not be burdened with artificial timelines or unnecessary additional government intervention. There is already a comprehensive and well-tested legal framework governing the negotiation, timing and announcement of proposed mergers among public financial institutions in Canada, including provisions of the Bank Act, the Insurance Companies Act, general corporate laws and securities laws. Introducing additional, artificial criteria to the existing comprehensive regulatory framework could lead to a situation where the Government, rather than shareholder value and market forces, effectively decides the outcome.

Accordingly, Manulife Financial recommends that the Government not establish a specified window of time during which all merger applications would be considered together.

The Finance Department has indicated it will announce its policy on cross pillar and in-market insurance mergers on June 30, 2004. This policy vacuum creates uncertainty among financial institutions as to which merger options will be available. The major banks and the large life insurance companies are unable to assess the full range of strategic business plans because of the uncertainty as to whether any business combination other than in-market bank mergers will be permitted.

Accordingly, Manulife Financial recommends that the Government announce at the earliest possible date, well before June 30, 2004, its policy on cross pillar and large in-market insurance company mergers.

Summary

Manulife Financial is a leading Canadian-based international financial institution. A healthy and growing financial services industry is strategic to the Canadian economy and the well being of Canadians. It is timely for the Government to revise its policies on industry consolidation in order to ensure the financial industry remains strong and healthy with the ability to serve the best interests of consumers, grow internationally and provide employment opportunities for Canadians. Market forces should be permitted to drive any consolidation in financial services.

Manulife Financial recommends that the Government of Canada:

• Permit large Canadian life insurance companies to merge with each other or major banks, subject to appropriate regulatory review;
• Require that large, merged financial institutions remain widely held and Canadian-controlled;
• Apply the size-based widely held requirement to all large Canadian financial institutions;
• Not specify market structure characteristics or a minimum acceptable number of large financial institutions before considering merger proposals; and
• Not establish a specified window of time during which all merger proposals would be considered together.