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Présentation de la « Power Financial Corporation » en réponse à la consultation sur les fusions de grandes banques du ministère des Finances Canada : 

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Power Financial Corporation Submission to Minister of Finance Future Structure of The Canadian Financial Services Industry

December 2003

Related documents:

• Concentration and competition in the Canadian Banking industry

• Bank/Insurance Mergers Outside Canada: The Lessons for Public Policy

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Executive Summary

This submission responds to the request for comments issued by the Government in its Response of the Government to Large Bank Mergers in Canada dated June 23^rd 2003 ("Government Response").

Power Financial Corporation submits that a policy change to permit large demutualized insurers to merge with large banks would be inappropriate at this time. If such a policy were adopted:

• it would have a disruptive impact on the Canadian life insurance industry, raising concerns that the industry would not survive as a separate, independent sector.
• it could lead to a major reduction in the Canadian life insurance workforce which currently employs approximately 119,000 Canadians.
• it would disrupt the multi-channel distribution system which serves individuals and groups of Canadians from all regions with the right products and services, and threaten the livelihood of some73,500 insurance agents and brokers.
• the cost to consumers of life insurance products and services would likely increase and the access of consumers to insurance products and services would decrease, especially in rural and remote regions of Canada if the banks' behaviour in other financial services sectors is any indication. Our submission includes a recent study of the impact of financial services concentration on Canadian consumers in sectors where the banks have significant market share and related issues by Bain & Co., a leading global business consulting firm.
• it would bring under one roof banks and insurers as major participants on the buy-side in financial markets, thereby potentially distorting these traditional markets.
• it would lead to a significant higher concentration of assets, capital and economic power in fewer large financial institutions, reducing the Government's policy flexibility to address future prudential concerns.
• it would not be in Canada's best interests, as the international experience confirms that a considerable number of the mergers between large banks and large insurance companies actually destroy stockholder value, resulting in subsequent divestitures and a weakening of the merged institution and in its ability to raise capital. Our submission includes a study of the international experience by Davis International Banking Consultants.
• it would lead to the repeal of the Insurance Business (Banks) Regulations and to full bancassurance, with the inappropriate and anti-competitive use of confidential customer information.

Power Financial believes that Canadians are well served by the policy adopted in 1999. Canadian financial institutions are well positioned and evolving effectively under the current policy regime as significant North American and international players.

This evolution should be allowed to continue on its present course. Change in the policy framework at this stage would not be wise.

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1. Introduction

2. Our History

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1. Introduction

The Government is considering changes to financial sector consolidation policy which would significantly affect the future structure of the Canadian financial services industry.

These changes include reversing the policy adopted in 1998 in connection with the demutualization process which prohibit mergers between banks with equity in excess of $5 billion and the two large demutualized insurers, Sun Life Financial and Manulife Financial.

Power Financial believes that the current regulatory regime is working well to achieve the Government's overarching policy goal set forth in the 1999 policy paper Reforming Canada's Financial Services Sector ("1999 White Paper") at p10, of having a policy framework in place that allows the sector to evolve, while preserving its soundness and ensuring that its evolution benefits consumers.

This policy has been effective in facilitating the desired consolidation and strengthening of the financial services sector. Since the policy changes in the 1999 White Paper were adopted in Bill C-8, significant consolidation has occurred in the Canadian insurance sector, and Canada's large insurers are vital and growing. Canadian insurers and banks have also continued to grow with major acquisitions in the United States. Our financial institutions are well positioned to take full advantage of the evolution to a more integrated North American economy.

There are no compelling reasons to change course at this time so as to permit mergers between large banks and the large demutualized insurers. Indeed, it is unwise to reverse the existing policy for the many reasons as outlined in this Submission, including:

• the potential loss of the independent insurance sector
• the potential of major job losses for insurance brokers and agents
• the disruption of the multi-channel distribution system for insurance products
• less access and increased prices for consumers
• the potential adverse effect on insurers as medium and long term holders of government and corporate bonds
• excessive economic concentration
• lessening of competition
• negative experiences in bank/insurer combinations in Europe, and
• future prudential concerns

Of further note, a policy change resulting in a large bank/ demutualized insurance company merger would lead to the repeal of the Insurance Business (Banks) Regulations and thus to full bancassurance with in-bank branch insurance retailing and the use of proprietary customer information. The use of bank branches and the data mining of proprietary customer information would create an unlevel playing field between a merged bank/insurer and its insurer competitors.

In making such a fundamental change to the policy framework, the risk is that the future benefits to Canada of the recent insurance industry consolidations will be lost. Canada now has strong, growing and vibrant insurers effectively serving Canadian and foreign consumers with innovative and cost effective products and services. These insurers have a major international presence, with approximately one-half of earnings being derived outside of Canada.

Maintenance of the current policy framework is therefore, in our opinion, the best available option at this time.

Power Financial welcomes the opportunity to make this submission to the Minister of Finance. In this submission, we will address two of the key questions posed by the Government Response. We will focus on those areas where we can provide substantive input based on our 35 years of experience as owners and managers in the financial services sector.

We have commissioned two studies by internationally respected independent consultants, Bain & Company Canada ("Bain") and Davis International Banking Consultants ("DIBC") which are enclosed with and form part of this submission.

2. Our History

In 1968 Power Corporation acquired control of Imperial Life Assurance as well as significant indirect interests in The Investors Group (now Investors Group Inc.), the Great-West Life Assurance Company and the Montreal Trust Company. These significant interests subsequently became controlling interests. Our controlling interests in Imperial Life and Montreal Trust were sold in 1977 and 1989 respectively.

Power Financial Corporation was created in 1984 as a publicly traded subsidiary of Power Corporation to hold its financial services interests.

Great-West Lifeco Inc., a subsidiary of Power Financial Corporation, acquired London Insurance Group in 1997, and Canada Life Assurance Company in 2003. Investors Group Inc., another subsidiary of Power Financial Corporation, acquired Mackenzie Financial Corporation in 2001.

Great-West Lifeco is a financial services holding company with interests in the life insurance, health insurance, retirement savings and reinsurance businesses, in North America and internationally. Great-West Lifeco and its affiliates have more than C$157 billion of assets under administration.

In Canada, Great-West Lifeco's subsidiaries – The Great-West Life Assurance Company, London Life Insurance Company (Freedom 55 Financial) and Canada Life Assurance Company– are a leading life and health insurance organization, serving the financial security needs of more than 11 million Canadians. Great-West Lifeco and its subsidiaries have a leading market share in Canada in all their product lines, and a multi-channel distribution system with unmatched breadth in the Canadian market.

In the U.S. Great-West Lifeco does business through Great-West Life & Annuity Insurance Company and the Canada Life Assurance Company.

Great-West Lifeco and its affiliated insurance companies are Canadian owned and controlled. As a closely held company, Great-West Lifeco Inc. is unique among large financial institutions in the Canadian financial services sector. Great-West Lifeco Inc. and its parent Power Financial Corporation each have a public float of a significant portion of their voting shares which are listed and traded on the Toronto Stock Exchange. These shares are owned by a wide variety of independent investors.

3.1 Mergers between large demutualized insurers and large banks

The Government Response asked for comments on the following:

• Should the Government consider a policy change to allow demutualized insurers with equity in excess of $5 billion to merge with large banks?

3.2 Existing Policy

The Government's 1999 White Paper (p. 34) outlined the Government's consolidation policy respecting large demutualized insurers:

In keeping with the Government's policy to encourage the development and maintenance of a strong insurance industry, significant mergers between insurers have recently occurred. Under the 1999 policy, Sun Life Financial acquired Clarica Life in 2002 and Great-West Lifeco acquired Canada Life in 2003. Manulife Financial has also announced plans to acquire John Hancock Financial Services Inc. in a significant cross border transaction, which will likely result in the Canadian business operations of Maritime Life, a John Hancock subsidiary, being consolidated with Manulife's Canadian operations.

Canada now has a strong, growing and vibrant insurance sector effectively serving Canadian and foreign consumers with innovative and cost effective products and services. The sector has evolved as exporters over many years, and now has a major international presence, with approximately one-half of earnings being derived outside of Canada.

Banks have also successfully continued their evolution under the Government's policy, which notably permits "in industry" mergers subject to the applicable public policy considerations outlined in the Government Response. Further, under the existing rules, banks are permitted to acquire insurers except for the two remaining large demutualized insurers, thus enabling them to grow in, but not dominate, the insurance sector. This "balance" achieves the highly desirable result of having strong banks and strong insurers driving a vital and growing Canadian controlled financial services sector.

Illustrating the flexibility of the current policy is Royal Bank's recent agreement to acquire the Canadian business operations of Provident Life and Accident Insurance Company, a subsidiary of Unum Provident, in a $500 million transaction, the largest acquisition to date of an insurer by a large Canadian bank.

There are at this time no reasons whatsoever to change the policy outlined in the 1999 White Paper. Indeed, there are compelling reasons for the Government to pause and reflect on the success of the existing policies and the potential adverse consequences which could flow from such a policy change. We outline our reasoning in the following pages.

3.3 An Independent Canadian Life Insurance Sector

Canadians are best served by a life insurance sector which remains independent of Canada's largest banks.

According to the Canadian Life and Health Insurance Association data, at end of 2002:

• there were 109 life insurance companies operating in Canada.
• the largest 3 insurer groups have a combined market share of about 70%.
• approximately 23 million Canadians and their dependents were protected by one or more of the life and health industry's products and services.
• Canadians purchased 871,100 policies during that year.
• the industry held assets of $279 billion on behalf of Canadian life and health policyholders.
• most of these funds are invested in Canada's economy, primarily in Government bonds ($63.5 billion), corporate bonds ($56.5 billion), corporate stocks ($37.2 billion), commercial mortgages ($22.5 billion) and residential mortgages ($17.5 billion).
• more than 118,900 Canadians were employed in the sector, including 73,500 working as agents and brokers.
• Canada's life insurers generated $54.5 billion, or 58% of their total worldwide premiums from foreign clients for life and health insurance and annuities.
• More than 18 million people in more than 20 countries outside of Canada own life insurance policies with Canadian insurers.
• More than 90% of the industry, measured by assets, is Canadian controlled.

Of particular importance is the multi-channel distribution system which provides insurance products and services in all regions to Canadians in all walks of life. The system has four main components. These are:

• Advisors who are exclusively aligned with one insurer, and whose products and services represent their core offering to customers. This core offering is often supplemented with selected products and services accessed through third party suppliers.
• Affiliated advisors and independent brokers who may have a primary alignment with an insurer, but who offer a broad choice of products and services to their customers from a variety of insurers.
• Independent advisors who are affiliated with a Managing General Agency as a means of accessing the products and services of a wide range of insurers.
• Inter-company arrangements, which are referred to as "national accounts". Insurers form distribution agreements with firms (national accounts) that have either exclusive or affiliated advisors. In most cases, the national account has agreements with multiple suppliers and its advisors are able to offer a wide choice of products and services to their customers.

Unlike banks whose branches are proprietary, the insurance distribution system is only partially controlled by insurers, with the attendant benefit to Canadians of meaningful price and product competition. The independence and competitiveness of this distribution system has continued notwithstanding the consolidation which has recently taken place in the insurance sector.

3.4 Disappearance of the Pillars

Life insurance is the only remaining traditional non-banking financial services "pillar" in Canada that is populated predominantly by independent non-bank owned companies. The dominance of large banks of the other financial services pillars is well illustrated in the following table from the Bain Study:

Similar to the disappearance of an independent Canadian securities industry and an independent Canadian trust industry, each of which resulted from changes to consolidation policy, a policy change that allowed the demutualized insurers with equity over $5 billion to merge with large banks would increase the likelihood of the disappearance of an independent life insurance sector.

This risk would exist even if the policy change were to permit only one merger between a bank and a demutualized insurer. Allowing one but not the other remaining demutualized insurer to merge would distort the sector in a fundamental and unsustainable manner.

It is unrealistic for policy makers to believe that the pattern of events experienced in the brokerage, trust and factoring sectors as noted below would not be repeated in the insurance sector. Let us briefly review those events.

After banks became entitled to acquire brokerage firms in 1987, the then largest four Canadian brokerage firms were acquired by the major banks within a nine month period:

Bank of Montreal/Nesbitt Thomson	September 1987
Bank of Nova Scotia/ McLeod Young Weir	March 1988
Royal Bank/ Dominion Securities	March 1988
CIBC/ Wood Gundy	June 1988

There are now only a few independent brokerage firms in Canada; large US based brokerage firms are the only significant competitors of the brokerage divisions of large banks, and more than 60% of Canada's merger and acquisition (M&A) activity in 2003 when measured by size was undertaken by foreign controlled underwriters.

Similarly, the large banks acquired all of the major Canadian trust companies after the 1992 legislation enabled them to do so:

Toronto Dominion/ Central Guarantee Trust	1992
Royal Bank/ Royal Trust	1993
Bank of Nova Scotia/ Montreal Trust 1994	1994
Bank of Nova Scotia/ National Trust 1997	1997
Toronto Dominion/ Canada Trust	1999

There are now only a few remaining independent trust companies operating in Canada.

Moreover, after the banks acquired the major trust companies, significant business units were divested. Corporate trust services, once dominated by the previously independent Canadian trust companies, are now consolidated in two service providers, ComputerShare Trust, an Australian controlled company and CIBC-Mellon Trust, a joint venture controlled by CIBC and US based Mellon Bank. These two companies now account for virtually all of Canada's corporate trust services.

A similar experience occurred some 25 years ago in the factoring sector. An independent factoring industry had existed in Canada for many years, dominated by two successful Canadian-owned companies. The large banks pressed for and were given permission to enter the sector in the decennial revision of the Bank Act. They entered the sector, attempted to compete and disrupted the industry. They were unsuccessful, and withdrew from the sector. The sector was then taken over and dominated by a US based institution.

A pattern emerges. Banks are permitted to enter a new line of business or "pillar". They acquire or merge with or drive out existing participants and come to dominate the sector. Frequently they divest business units for a variety of reasons. This leads to industry disruption and potential loss of Canadian control of at least some of the divested business units.

There is no reason to believe that the patterns experienced in the takeovers of Canada's brokerage, trust and factoring sectors will not be repeated in the insurance sector should mergers between large banks and large demutualized insurers be permitted.

3.5 Impact on Consumers

The history of the last two decades shows that price competition in the pillars taken over by the banking sector has declined significantly. When banks come to dominate a sector, available evidence indicates that they appear to push prices up, not down. As well, consumers' access to products and services declines at the same time. If large banks and demutualized insurers are permitted to merge, there is every reason to believe that these patterns will be repeated in the insurance sector. We elaborate as follows:

3.5.1 Prices

The Bain Study (page 7) notes that

In other words, after the banks essentially took over the field of intermediation, the costs to consumers of intermediation rose and did not fall, contrary to assertions which have been made by the banks and the expectations of consumers.

Illustrating this are the increases in the Bank mortgage/GIC spread identified by the Bain Study (p11) which occurred during and following the takeover of the trust industry:

This finding is supported by evidence of the behaviour of banks' net interest margins on their domestic business. According to the Bain Study (p7):

In interpreting this data, the Bain Study (p7) notes:

A further observation made in the Bain Study (p8) notes that:

Bain illustrates this as follows:

As the Bain Study notes (p3)

As well, Canadians are paying ever increasing fees for services, such as per cheque charges, ABM charges or charges to use branch banking. According to the Bain Study (p13), the Big Six Banks' deposit fee revenue has increased by more than 6% per year:

As has been demonstrated in the Bain Study, price competition in the sectors controlled by banks has declined significantly. Increasing the influence of large banks in the insurance sector could lead to higher prices for consumers for insurance products and services. When banks come to dominate a sector, available evidence indicates that they appear to push prices up, not down.

3.5.2 Access

As also noted in the Bain Study (p18), in the last five years, there are now 2,000 fewer bank branches than there were in 1990, a decline of some 26%.

Commenting on Branch closures, Bain notes (p21):

Conversely, life insurance agencies are growing across Canada, especially in smaller communities which are being abandoned by banks. Unlike bank branches which are location specific, insurance agents in rural and remote communities are mobile, serving Canadians in their homes and places of business in multiple locations within their trading area. Banks are not known for being involved with their customers across the kitchen table after business hours.

The Bain Study notes (p19):

and further (p20):

These statistics illustrate the differences between theory and practice in positions taken by banks. The argument that the distribution of insurance through branches will provide consumer benefits in the form of lower costs, more choice, increased access and more convenient service delivery is false. History shows that these prospective benefits are unlikely to occur.

Further, cross pillar "synergies" have led to distortions in the credit allocation process even for large customers of banks, as has occurred in the aftermath of the bank takeover of the securities sector in the late 1980's.

As noted by Freedman and Goodlet, (The Financial Services Sector: An Update on Recent Developments August 2002 Bank of Canada Technical Report No 91 p5):

Any merger between a large bank and demutualized insurer could accordingly have significant competition implications for consumers. Based on past experiences, such mergers would appear contrary to the goal of having a policy framework in place that allows the sector to evolve, while preserving its soundness and ensuring that its evolution benefits consumers.

3.6 Fundamental Differences between Banks and Insurers

One premise underlying regulatory policy has been that convergence of function has led to the disappearance of the boundaries separating the traditional four pillars. The acceptance of this premise has led to the widespread belief that major changes to policy such as cross pillar mergers are not only inevitable, but are a good thing. This premise is, however, deeply flawed.

There are many fundamental structural differences which, in our view, make it unwise to combine large banks and large demutualized insurers. We comment on four of the major differences which exist in their respective core businesses, liabilities, assets and distribution systems.

Firstly, their core businesses are fundamentally different.

Banks are the country's largest deposit-taking institutions and its main source of short term credit. They are intermediaries in most financial transactions - especially of a short term or immediate nature - and the principal participants in Canada's payment systems. Their core business is deposit taking, in which they generally provide low value-added, commodity type convenience products.

Life insurance companies are not deposit taking institutions. They issue term, whole life and universal life insurance, disability, income and health products on a group and individual basis, some of which have participating components and almost all of which are complex value-added products. Insurance companies have limited participation in Canada's payment systems.

A second fundamental difference is in the nature of their liabilities.

Bank liabilities are certain and fixed, being financial by nature, consisting primarily of deposits which are payable on demand or at specified short term maturity dates. There is very little risk involved for banks with these liabilities.

Insurer liabilities are uncertain, being primarily actuarial liabilities to policyholders, which are due on the occurrence of specified events. There is significant risk with insurer liabilities, which are triggered primarily by events beyond the insurer's control, such as mortality and morbidity (event risk).

The management skills and processes necessary to manage the liability risks of banks and insurers are substantively different. This difference is well illustrated by the role of the Actuary in insurance organizations, who is required by law to annually value and certify the quantum and expected timing of an insurer's event risks.

Mixing the two very distinct risk management cultures and capabilities by combining banks and insurers could potentially cause problems which may lead to serious prudential concerns

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A third structural difference is in the nature of their assets.

To match their liabilities, banks acquire and hold primarily short to medium term assets, such as personal and commercial loans and, residential and commercial mortgages with maturities of 5 years or less.

To match their liabilities, insurers acquire and hold primarily long term assets, such as Government and Corporate bonds, and commercial mortgages with greater than 5 year maturities. They are medium to long term intermediaries.

In this context, banks may be seen as credit institutions, and insurers as investment institutions

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A fourth difference are the distribution channels which serve banks and insurers.

Banks' distribution systems are generally proprietary, with salaried bank employees selling essentially their bank's products and services during fixed working hours using the bank's branch network. It is a distribution network which is well suited to selling simple products and services through ATM's or across a bank counter using a standardised sales approach with little, if any, advice to the consumer.

Conversely, a substantial portion of the overall distribution system which serves insurers (see section 3.3) is composed of independent agents and brokers who provide products from a range of different insurer suppliers. Insurer products and services are generally sold to individuals by commission-based agents and employees with flexible working hours. They are not sold to consumers through branch networks, but in their homes and places of business. Insurance products such as whole life are complex and frequently require tailoring to suit the consumers needs. Insurance products are essentially sold to individuals with advice.

As noted in the DIBC Study (p5), combining these different distribution systems has been problematic in Europe.

Unlike the combining of the distribution systems of the trust sector with those of the banking sector (both of which were similar), combining an insurance distribution system with a traditional branch distribution system represents a major structural impediment to a successful merger. It also raises major public policy issues which policy makers should carefully consider.

These and other fundamental structural differences in the business of banks and insurers are the key drivers of the different institutional cultures which characterize and further differentiate banks and insurers.

Cultural factors are often poorly understood and their implications underestimated in business combinations.

These cultural differences, driven by the fundamental structural differences, are well catalogued in the DIBC Study, and have been a factor working against the success of bank insurer combinations in Europe. The DIBC Study concludes (p1) that:

3.7 Bank Insurer Mergers and Subsequent Divestitures in Europe

The following tables from the DIBC Study (p 4) illustrate bank insurer mergers and subsequent divestitures which have occurred in Europe, frequently as a result of structural and cultural differences:

)

Dominant banks	Insurance partners	Country	Size*	Subsequent sales
KBC    (Kredietbank & CERA)	ABB	Belgium	233
Dexia	DVV Insurance	Belgium	368
Rabobank	Interpolis	Netherlands	393
SNS	Reaal	Netherlands	37
SEB	Trygg-Hansa	Sweden	141	Trygg-Hansa non-life    (sold to Codan)
Handelsbanken	SPP	Sweden	144
Danske Bank	Danica	Denmark	247	Danica non-life    (to TopDanmark)
Nordea (Unidanmark) Nordea (CBK)	Tryg Baltica Vesta	Denmark Norway	67 26	Tryg Baltica & Vesta non-life    (to Tryg Baltica foundation)
Sparebanken NOR	Gjensidige	Norway	36	Gjensidige non-life not included
DnB	Vital	Norway	55
DnB	Storebrand	Norway	55	Failed acquisition attempt
Credit Suisse	Winterthur	Switzerland	689
Deutsche Bank	Deutscher Herold	Germany	795	Deutscher Herold    (to Zurich)
Lloyds Bank Lloyds TSB	Abbey Life Scottish Widows	UK UK	334€¡	Abbey Life salesforce    (to Allied Dunbar)
Abbey National	Scottish Mutual Scottish Provident	UK UK	284
Halifax	Clerical Medical	UK	512€¡
NatWest	Legal & General	UK	649€¡	Failed acquisition attempt

 

Dominant insurers	Bank partners	Country	Size*	Subsequent sales
Fortis (Groupe AG) Fortis (Amev)	ASLK-CGER Generale Bank VSB	Belgium Belgium Netherlands	404 404€¡
ING  (Nationale- Nederlanden)	NMB Postbank	Netherlands	500
Sampo	Leonia	Finland	19€	Non-life business    (sold to If)
Swiss Life	Banca del Gottardo	Switzerland	9€	currently attempting    to sell Gottardo
Allianz	Dresdner Bank	Germany	434
AMB	BfG	Germany	29€	BfG    (to Crédit Lyonnais)
GAN	CIC	France	–	CIC    (to Crédit Mutuel)
Axa (UAP)	Banque Worms	France	5€	Banque Worms    (to Deutsche Bank)
Axa	Banque Directe	France	–
Irish Life	Irish Permanent	Ireland	36
Note: former names are shown in brackets  * total assets, US$ billion at end 2002 (source: The Banker) €¡ now part of larger group whose assets are shown  €  bank assets only

As also noted in the DIBC Study (p7), some European banks have divested their own life insurance operations in favor of buying in the product from a specialist insurance provider:

European banks selling own life insurance operations 
(Figure 3 DIBC Study)

Bank	Details
Barclays	Barclays, one of the UK's four largest banks, established its own in-house life insurance subsidiary during the 1980s. Unlike several of its rivals, it never acquired a life company. In 2001 it sold its life business and also its retail mutual funds operations to Legal & General. It now distributes Legal & General branded products through its branches.
Alliance & Leicester	Alliance & Leicester, a former building society, made the same decision as Barclays, selling its in-house long-term savings and investment business to Legal & General in 2001 and then its life business to L&G in 2002.
Royal Bank    of Scotland	RBS established a joint venture company with Scottish Widows to manufacture life insurance products for branch distribution. When Scottish Widows was bought by Lloyds TSB, RBS acquired 100% of the joint venture. After acquiring NatWest, and thereby becoming one of the four largest UK banking groups, RBS sold 50% of both its own and NatWest's life subsidiaries to Aviva, a leading UK independent life group.
National    Australia Bank (UK)	NAB established its own in-house life business in the 1990s to provide products to distribute through its three UK regional banks. In 2003 it closed this business and now distributes Legal & General products.
ABN Amro	ABN Amro, the largest commercial bank in the Netherlands, did not follow all its major rivals into bank-insurance mergers and acquisitions. It set up an in-house life business but in 2003 sold it to a joint venture company established with Delta Lloyd, a local subsidiary of Aviva. This will supply products for distribution through ABN Amro's branch network.
Banco Bilbao  Vizcaya Argentaria	BBVA, one of the two dominant Spanish commercial banks, controlled traditional insurers Aurora Polar and Plus Ultra. In order to concentrate on its in-house insurer Euroseguros, the group sold Aurora Polar to Axa (in stages between 1992 and 2000) and Plus Ultra to Norwich Union.
Santander    Central Hispano	After Banco Santander merged with Banco Central Hispano (BCH) to form SCH, it sold BCH's 50% stake in insurance company Vitalicio in stages to Italian insurance company Generali. SCH is now concentrating on its own in-house insurer. Vitalicio was a joint venture formed by merging Generali's Spanish insurance interests with those of BCH.
Deutsche Bank	After establishing its own life subsidiary, in 1992 Deutsche Bank (the largest German bank) acquired control of Deutscher Herold, a leading life and non-life company. However, in 2001 it sold Deutscher Herold and three foreign life businesses to Zurich Financial Services.

Overall, the DIBC Study notes (p5) that

Policy makers should consider the consequences which could follow if the European experience were to be repeated in Canada. Divestitures of insurance operations could occur following mergers between the large banks and demutualized insurers. If such an event occurred, it is probable that the only buyers for divested insurers would be foreign based.

If this occurred, the policy change would have achieved the result of eliminating strong Canadian owned and controlled insurers and seriously disrupting the sector, with little, if any, benefit accruing to the large banks or to Canadians.

3.8 Additional Public Policy Concerns

In addition to the foregoing, one or more mergers between large banks and demutualized insurers give rise to a number of critical and interrelated public policy concerns. Such mergers would:

• lead to a much higher concentration of economic power in the hands of fewer, very large financial institutions
• result in a significant reduction of competition
• reduce the government's policy flexibility to address future prudential concerns.

These are not new policy concerns, but are the precise policy reasons stated by the then Minister of Finance in 1998 for refusing to allow the proposed bank mergers between Royal Bank and Bank of Montreal and between Canadian Imperial Bank of Commerce and Toronto Dominion Bank.

Has anything changed since 1999 which would eliminate these policy issues? What has eliminated or mitigated the unacceptable risks of consolidation identified by the Minister of Finance in 1998? Do cross pillar mergers reduce or eliminate these fundamental concerns? Let us carefully examine each of these concerns.

Concentration of Economic Power

According to the Group of Ten (G-10) Report on Consolidation in the Financial Sector in 2001, the banking sectors in Australia, Belgium, Canada, France, Netherlands and Sweden are "highly concentrated". This relative concentration is illustrated by the following chart reproduced from the DIBC Study:

Combined market shares of top five banks (%) 
(Figure 6 from DIBC Study)

First date: Italy 1992
Last date: Spain & Switzerland 1997; Germany, UK & Sweden 1998
Source: Group of Ten

Apart from two relatively small European countries, Canada and Australia are the two most highly concentrated banking industries noted by the G-10 Report. There is good reason to believe that the adoption of the Euro in 1999 has stimulated consolidation in Europe, and there may be very good reasons for such consolidation in the ECM. The same rationale, however, does not apply in Canada.

As stated by the Minister of Finance in 1998,

Mergers between large banks and demutualized insurers will exacerbate these concerns.

Also, as noted in section 3.3, life insurers are significant purchasers and holders of corporate and government bonds in Canada. Banks already provide short term credit, control the underwriting of securities, and play a significant role in the purchase of such securities. Combining banks and insurers under one roof will create larger institutions which will have major influence on the overall functioning of Canada's capital markets, with increased concentration on the buy side and increased potential for conflicts of interest and disruption of financial markets should such institution be required to limit its participation in such markets for any reason.

As noted in the G-10 Report Consolidation in the Financial Sector (p.152), in principle an institutional structure consisting of separate banking and insurance subsidiaries with separate capital bases could limit contagion risk. In practice, there remains the possibility of reputational contagion, for example where losses at Barings Securities in Asia were large enough to lead to the failure of Barings Bank.

Recent European examples of increased cross pillar risk noted in the DIBC Study (p 9) include:

Problem bank-insurance combinations in Europe 
(Figure 4 DIBC Study)

The acquisition of Dresdner Bank by Allianz in 2001 as a distribution vehicle for retail products has, as noted in the DIBC Study (p 9), encountered massive asset quality problems which actually threatened the viability of Germany's leading insurance group with roughly 20% of the market.

The DIBC Study (p 9) also notes that in 1997, one of the two dominant banks in Switzerland, Credit Suisse bought Winterthur, a major insurance company. In 2002 Winterthur plunged into losses and Credit Suisse was forced to provide it with two capital injections totalling 2.6 billion Swiss Francs. In addition, during 2003 the group has been forced to sell many of Winterthur's valuable international businesses. These include Churchill in the UK (for £1.1 billion), its operations in Italy (for ‚¬1.465 billion) and Republic in the US (for US$0.127 billion).

As noted in an IMF Working Paper (Balino and Ubide, June 2000 V 37 #2 pp3-4), the international consolidation of the banking sector, coupled with the growing use of derivatives and off balance sheet operations and the diversification of banks across countries and sectors of banking industries, has quickly made traditional risk management techniques obsolete. These developments have also significantly increased the scope for, and speed of, contagion.

If either the insurance or banking unit of a merged institution experienced financial distress, the operations of the other would likely be adversely affected. Such distress would also affect the proper functioning of Canada's capital markets and its economy as a whole.

Reduction of Competition

The G-10 Report on Consolidation in the Financial Sector (p. 5) notes that research generally finds that higher concentrations in banking markets may lead to less favourable conditions for consumers, especially in markets for small business loans, retail deposits and payment services.

This appears to have occurred in Canada. As we have noted in Section 3.5 above, Canadian consumers

• have less access because of the closure of 26% of bank branches since 1990
• pay more to banks than they have in the past for products and services.

Prices paid by consumers drive bank profitability, and the large Canadian banks are highly profitable. According to the Bain Study (p17), Canadian bank returns are above average when compared to the world's top 250 banks.

According to Bain, the profitability of the top Canadian banks ranks them higher among the world's banks than their asset size would suggest. Canada and Australia, the only major OECD countries with more than 75% of their major bank assets controlled by the top 5 banks, show high profitability relative to their asset rankings among the world's largest banks.

In a competitive industry, the price paid for a particular service usually declines over time as firms will reduce their costs as they gain industry experience and scale. This, however, is not the case for bank dominated products and services in Canada and is to the detriment of consumers. As concluded in the Bain Study (p7):

If the large banks and demutualized insurers are permitted to merge thereby increasing concentration in Canada, there are reasonable grounds to conclude that prices to consumers for insurance products and services would likely rise.

There is, accordingly, no apparent reason for policy makers to believe that permitting large banks to merge with demutualized insurers will lead to more favourable conditions for consumers.

Future Prudential Concerns

In assessing the proposed bank mergers in 1998, the Superintendent of Financial Institutions (OSFI) raised some important issues about the potential impact on the overall financial system of large mergers. The Government ultimately decided that the size of institutions that would result from the mergers would constrain unacceptably the alternatives available to the regulators and to the government in the face of a large financial institution in difficulty.

The same size considerations could arise in the case of a merger between a large bank and a large demutualized insurer. The combination of the smallest big 5 bank with the smallest demutualized insurer would result in a merged institution with a market capitalization of about $40 billion. This institution would be larger in size than the institutions which would have resulted if either of the two proposed mergers which the Minister of Finance rejected in 1998 had been allowed to proceed.

A merger of a large bank and demutualized insurer would not eliminate or significantly reduce the risk of financial distress. The review of mergers outlined in the DIBC Study indicates that contrary to the theory favoured by regulators and policymakers, there is no compelling evidence that stability increases with cross pillar consolidation. As noted in the DIBC Study (p8):

This view is supported by De Nicolo and Kwast (IMF Working Paper March 2002 Systemic Risk and Financial Consolidation: Are They Related) which noted that policymakers should pay close attention to the implications of the changing financial landscape for systemic risk. Some consolidation of the banking industry and the creation of large and complex financial institutions capable of competing on a global basis may have some benefits, but it appears that these developments also may create somewhat different, although not necessarily new, risks.

In the words of the then Finance Minister in 1998 in declining to approve the proposed bank mergers:

The Report of the Task Force on the Future of the Canadian Financial Services Sector (Background Paper #1 p173) notes that Canadians overwhelmingly support a continued policy of Canadian control in the financial services sector. Indeed, few countries have allowed major parts of their financial sector to come under foreign control, particularly their major banks.

There are good policy rationales for this. As concluded by the Financial System Inquiry in Australia in its 1997 Report (p 474):

As stated by Michael Mackenzie, the former federal Superintendent of Financial Institutions in his submission to the Task Force:

Given our highly integrated North American economy and Canada's small size relative to the United States, the potential loss of Canadian ownership of a distressed merged major clearing bank/demutualized insurer could have serious and far reaching consequences.

3.9 Consolidation Policy and Bancassurance

We appreciate that the Response states that the Government does not intend to consider changes to the insurance networking restrictions in considering its consolidation policy.

Nevertheless, combining a large bank and demutualized insurer would create a major banking presence within the insurance sector and inevitably erode the sector's independence. This would lead to increased, if not irresistible, pressure from such merged institution for changes to permit in-bank branch insurance retailing and the use of customer information to realise operational synergies.

After they became entitled to own insurance companies in the 1992 round of financial institutions legislation, large Canadian banks demonstrated limited interest in acquiring or starting insurance subsidiaries and entering into the insurance sector on a stand alone basis. A principal reason for this limited interest appears to be the Insurance Business (Banking) Regulations which prohibit in-bank branch insurance retailing and the use of customer information for marketing purposes.

These restrictions have been the principal factors which have led to a strong, vibrant and Canadian controlled insurance sector which is independent of the large banks. The entry of one or more large banks into the sector through mergers with the large demutualized insurers will diminish the independence of the sector. It could also lead to the end of the multi-channel insurance distribution system and to full bancassurance.

Unlike Canada, full bancassurance is permitted in some other countries. We commissioned the DIBC Study to review and evaluate the bancassurance experience of other developed markets – specifically Europe, the US, South Africa and Australia.

3.9.1 In-Branch Insurance Retailing

As noted in the DIBC Study, the sale of life insurance products by bank branches of bank/insurance financial institutions has generally only been successful with simple, plain vanilla mass market products. In some countries such as France, this success has been fuelled by combining simple interest bearing retirement annuity type products with tax breaks.

For these product offerings to be successful, manufacturing and distribution costs must be kept as low as possible. According to the DIBC Study (p21):

Bancassurance would accordingly undermine the ability of independent non-bank owned insurers to provide sophisticated products traditionally required and used in the Canadian market through the use of a "with advice" delivery network of highly trained agents and brokers. Complex products such as whole life and universal life insurance frequently require tailoring for consumers.

Maintaining a sophisticated delivery network in a full bancassurance environment would be less viable economically, and consumers could be effectively forced to migrate to mass market products which would inadequately serve their needs. This would reduce both consumer choice and competition.

3.9.2 Use of Customer Information

The data bases Canadian chartered banks have at their disposal are an overwhelming competitive advantage as well as a source of concern for those concerned about competition, privacy and possible abuse of customer information.

Massive amounts of customer information are available to banks from many sources, including loan application forms, credit card statements and from cheques and automatic debits. The customer information which banks possess is ideal for target marketing of insurance products. This information could be used in a predatory manner to eliminate competitors.

Combining banks' data bases with those of insurers which contain highly sensitive medical information would also give rise to major privacy issues. The potential use of customer information for purposes other than the purposes for which it was originally collected is an additional serious privacy concern.

The Insurance Business (Banks) Regulations accurately reflect the increasing concerns Canadians have in protecting their personal privacy.

3.9.3 Agents and Brokers

The repeal of the Insurance Business (Banks) Regulations with the resultant emergence of bancassurance would also disrupt the extensive multi-channel insurance distribution system which serves individuals and groups of Canadians from all regions with the right insurance products and services.

As illustrated in the Bain Study and in section 3.5.2 of this Submission, life insurance agents and brokers are serving Canadians well and insurance agencies are growing across Canada, especially in smaller communities which are being abandoned by banks.

The repeal of the Insurance Business (Banks) Regulations and the emergence bancassurance would threaten the livelihood of approximately 73,500 Canadian insurance agents and brokers, many of whom serve these smaller communities.

The experience in this regard under bancassurance in other jurisdictions is instructive. As noted in the DIBC Study (p21):

• [The] Financial Integration Study...notes that the number of French agents fell by 50% during the 1990s.
• in the UK... it is estimated that for every nineteen salesmen in 1990 there is now only one left.

In three other countries – Sweden, Belgium and Italy – the DIBC Study (p20) notes that the deep inroads made by banks occurred at the expense of the agents and broker communities:

Change in Life Insurance Distribution Channels in Selected European Countries: 1995 – 2001 (Figure 9 DIBC Study)

Accordingly, it is unrealistic to make a decision to change the policy framework to allow demutualized insurers to merge with large banks without also considering the implications which a further policy change permitting full bancassurance could have for the independent insurance distribution system and for consumers. As previously noted, this independent distribution system is a key element which underpins competition among insurers.

As concluded by the DIBC Study (p22):

Bancassurance has been rejected by the Government of Canada on several recent occasions following representations and analysis, and is not being considered as part of the proposed policy change. Nevertheless, permitting major banks and demutualized insurers to merge with each other will inevitably once again raise this same issue, and lead to pressure to repeal the Insurance Business (Banks) Regulations and permit bancassurance.

3.10 Are there Benefits to Mergers Between Large Banks and Demutualized Insurers?

Driving the consolidation of financial institutions has been a host of factors such as stockholder value, creation of national champions able to compete with global competition, the advantages of scale, and relative market capitalization as a defence against takeovers. This has resulted in a widely held view that the large merger wave is inevitable. According to the DIBC Study, these arguments clash with equally convincing arguments against consolidation from the academic, analyst and consulting communities. Academics and analysts who have examined the statistics for European and US mergers concluded that, at best, the evidence for and against bank insurer mergers is not conclusive.

This view is supported in a recent study entitled Consolidation and Efficiency in the Financial Sector: A Review of the International Evidence. A 2002 Joint Study prepared by D. Amel of the Federal Reserve Board, C. Barnes of the Department of Finance Canada, F. Panetta and C. Salleo of the Bank of Italy (p38-9):

While "stockholder value" should not play a critical role in the formation of public policy, it is important to note that in the case of financial institutions, their capital strength is a critical "safety and soundness" consideration. As noted in the DIBC Study, the majority view of academics and analysts is that a large number of such mergers actually erode stockholder value. In some cases, this erosion has resulted in a corresponding decrease in such institutions ability to raise capital and the costs thereof, giving regulators much cause for concern.

The creation of a "national champion" to take advantage of international opportunities is frequently put forth as another rationale justifying the merger of large financial institutions. Despite some well-known successful international champions such as ING, there are numerous examples of national champions such as Credit Lyonnais, AMP and Skandia which have encountered serious financial distress. As the DIBC Study notes(p18):

Policy makers should consider the potential downside cost to Canadians of rescuing a distressed foreign unit of a national champion. These costs could be substantial and result in a transfer of wealth from Canada to the country in which such distressed foreign unit operates.

There are also serious questions as to the actual benefits of "scale" to a financial institution. As noted by Freedman and Goodlet in their 2002 study The Financial Services Sector: An Update on Recent Developments (p11-12):

Thus, one potential indirect perverse result flowing from a policy change to permit demutualized insurers and large banks to merge may be to increase momentum for the resulting merged institutions to withdraw from lines of business and become more monoline in nature so as to take advantage of their increased scale in the North American and international markets.

With few large institutions in Canada and no well developed secondary tier of financial service providers, one may well doubt the public policy benefits of this potential outcome, especially for consumers and small businesses in rural and remote regions of Canada.

Increasing "relative market capitalization as a defence against takeovers" does not provide any justification in Canada supporting mergers between large banks and demutualized insurers. The widely held ownership rules which apply to large banks and to the demutualized insurers effectively preclude this result.

Overall, there are not sufficient benefits to be derived from mergers between large banks and large demutualized insurers for policymakers to support a policy change to permit mergers between large banks and demutualized insurers. As we have demonstrated, there are many risks associated with such a policy change.

4.1 Future structure of the Canadian financial services sector

The second question posed by the Minister in his Response to which we wish to make submissions is:

• Are there market structure characteristics of the financial services sector which should be specified in advance of the Government considering merger proposals?

4.2 Policy vs Outcomes

Power Financial believes that Canadians are well served by the current configuration of Canadian based financial institutions.

Canadian banks and insurers have been evolving well under the current policy regime as significant North American and international players. In Canada, mergers are permitted between the large banks, and according to the available evidence, achievable efficiencies of scale have already been realized. More recently, Canada's major insurers have gone through a period of consolidation and the industry is now well positioned to achieve further efficiencies of scale. Banks and insurers are also making acquisitions and growing their businesses outside of Canada. This evolution should be allowed to continue on its present course.

Specifying in advance market structure characteristics of the financial services sector before considering specific merger applications is, in our view, both inappropriate and unworkable. Characteristics such as a minimum number of institutions which may be appropriate today could become inappropriate tomorrow. The "structure" of the "market" has been in a relatively constant state of change for well over a decade, and it is likely that such changes will continue well into the foreseeable future.

Regulatory policy should avoid as much as possible the imposition of a preconceived structure on the financial system. Regulation is needed to ensure soundness and consumer protection.

The Government's focus should be on the policies which ensure that the public interest is protected in these changing markets. The structure of the financial services industry has evolved and will continue to evolve in the context of those policies.

Power Financial believes that each proposed merger of a financial institution should be assessed on its own merits in the context of the structure of the markets as then exists. Each such assessment should be based on appropriate public policy considerations, and not on predetermined market structure characteristics.

The continuation of this approach will foster a dynamic and innovative Canadian financial services sector.

5.1 Conclusion

The Government's role is to ensure that Canada has an appropriate policy framework in place which meets not only the interests of financial institutions, but more importantly, the needs of all Canadians.

The fundamental guiding principles articulated by the Minister in the 1999 White Paper resulted in a new legislative framework enacted in 2001.

Many of the measures adopted by the Government to promote the efficiency and growth of financial institutions have yet to be taken advantage of; for example, strategic alliances and joint ventures with significant share exchanges, the changes to the widely held rule to permit major shareholders having up to 20% of the voting shares and 30% of the non voting shares, and the new holding company regime.

It is also evident that major structural changes have also occurred in the banking industry since 1999. To cite a few significant examples: Royal Bank has developed a significant presence in the United States; TD Bank acquired Canada Trust; CIBC withdrew from the insurance sector and its Amicus division from the US; and Laurentian Bank has sold its entire branch network west of Ontario to TD Bank.

In the insurance industry, major structural changes have also occurred: Sun Life acquired Clarica, Great-West Life acquired Canada Life and Manulife has announced plans to acquire John Hancock Financial Services Inc.

The impact of these and other structural changes has not yet been fully played out. However, the impact of these recent changes needs to be considered in assessing the merits of any further significant policy change.

Similarly, there should be a period of time to permit effective integration and the realization of consolidation benefits in the insurance sector.

Measures outlined in the 1999 White Paper to enhance competitiveness and encourage new entrants have not yet had sufficient time to demonstrate the emergence of a secondary tier of financial service providers capable of meaningful competition.

As we have shown in the preceding pages, a policy change to permit a merger between a large bank and demutualized insurer could result in the loss of an independent life insurance sector. The fundamental structural and cultural differences limit the potential benefits and lessen potential synergies. There are fundamental public interest issues associated with such consolidations as outlined above, including concentration of economic power, reduction of competition and potential future prudential concerns. For consumers, such mergers could mean less access, simplified commodity type products, and higher prices for products and services.

The threat to Canada's many thousands of insurance brokers and agents is obvious.

Finally, the purported benefits such as scale, stockholder value and creation of national champions which may be garnered by merging institutions is not conclusive, and the majority view of academic, analyst and consulting communities is that a large number of such mergers actually destroy stockholder value, thereby giving rise to potential safety and soundness concerns.

For these reasons, a prudential approach to policy making would, in our view, favour caution. The Minister should, at this time, decline to make a fundamental policy change to permit large banks and demutualized insurers to merge with each other. The Minister should also decline to specify in advance of merger proposals market structure characteristics of the financial services sector.

In Power Financial's view, the best available option at the present time is to maintain the current policy framework.