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Banking, Insurance and the Repeal of
the 1933 Glass-Steagall Act
A Concept Paper on How to Act Now
to Position Your Bank for the Future
Background
The Glass-Steagall Act was passed in 1933
by Congress in the belief that stock market speculation by banks led to
their collapse during the Depression. The Act banned any connection between
commercial banks and investment banking. Over the past decade, the Federal
Reserve and other banking regulators have softened some of Glass-Steagall's
separations of securities and banking functions by letting banks sell
certain securities through affiliated companies. Commercial banks have
made inroads into both investment banking and insurance during the last
five years. Community bankers and insurance agents have opposed the repeal
of Glass-Steagall. Many bankers worry that they will not be able to compete
with financial services conglomerates and insurance agents fear extensive
branch banking networks will erode their business.
Proposals to repeal Glass-Steagall's separation
of commercial and investment banking functions and reshape U.S. banking
laws are numerous. To date three versions of Glass-Steagall reform have
been offered: one by Rep. Jim Leach (R. Iowa), chairman of the House Banking
Committee, one by Sen. Alfonse D'Amato (R. New York), chairman of the
Senate Banking committee and Rep. Richard Baker (R. Louisiana) and one
by Treasury Secretary Robert Rubin. Each of the bills differ in the degree
to which the walls that currently separate commercial banking, investment
banking and insurance would be torn down.
Of the three Glass-Steagall reform proposals,
Rep. Leach's legislation offers the most modest changes. The Leach bill
would allow banks and securities firms to merge under umbrella holding
companies. In addition the Leach bill would give the Federal Reserve primary
responsibility for regulating the holding companies created by the merger
of banks and securities firms. The Rubin proposal would allow banks, securities
firms and insurance companies to combine. Rubin would also allow for regulation
by function with the Fed and other banking regulators having oversight
of bank holding companies with securities operations, but leaving oversight
of securities firms that get into banking with the Securities and Exchange
Commission.
The most sweeping of the three proposals
is the D'Amato/Baker bill. Under this bill, separate versions of which
are pending in both the Senate and the House, banks could join with securities
firms and insurance companies but also with industrial companies not currently
involved in financial services. The D'Amato/Baker bill envisions functional
regulation like the Rubin proposal.
While most of the changes proposed will
not occur over-night, repeal would eventually reshape the way banks, securities
firms and insurance companies have operated for more than half a century.
Although some form of Glass-Steagall reform seems likely to occur the
final version will not emerge before the end of May, if then. What does
seem certain is that the stage has now been set for some type of reform
and it is only after Congress has heard from all of the interested parties
and their respective lobbying groups that a clearer picture will emerge.
A New Paradigm
CAPTIVE.COM, LLC believes that the combination
of the banking and insurance industries provides huge economies of scale
especially since insurance has always had such an inefficient distribution
system. The following section outlines an investment interested banks
could make now to position themselves in the event of the reform or repeal
of the Glass-Steagall Act. It is an alternative to fighting the changes
that are sweeping the financial landscape by further enhancing your market
niche.
Small and medium banks need to start
thinking now about their opportunities as risk financing vehicles given
the bills now pending before Congress that would reform or repeal the
Glass-Steagall Act. This outline presents an insurance approach which
may fit very well with the banking community. The approach is divided
into five sections:
- Risk financing vehicle
- Retention and reinsurance
- Product line and marketing
- Accessibility and premium cost
- A New Banking/Insurance Product
Risk Financing Vehicle
Establishment of a vehicle to insure risk
is primarily done in two ways. One method is to start a new insurance
company with adequate capital to write business. As a new company it must
become an authorized insurer which is a company licensed by the state
insurance department to do business in a state. Many states also require
that insurance forms, rules and rates be filed and approved prior to being
used in the state that the company wishes to do business in. A second
method is to purchase an authorized insurer with approved rate fillings
and policy forms.
Capital and control are two major issues
in the formation of a new corporation. One technique is to raise capital
from a pool of banks who have an interest in this type of venture. The
capital would be raised from the banks using two classes of shares. Each
bank would buy set units of common stock for a predetermined value and
set units of preferred stock in an amount equal to the number of mortgages
originated and/or held by the bank in a given year. The common stock would
control the company but have no beneficial interest in the earnings of
the insurer, while earnings would be allocated to the preferred stock.
An alternative would be to guarantee a minimum rate of return on all invested
capital and provide a dividend based on profitability of insurance originated
to each investor. There is currently a Connecticut law that provides tax
credits to investors in new insurance companies formed in the State.
Retention and Reinsurance
The amount of loss retained by the insurance
company and its reinsurance arrangement with reinsurers are very important
issues to a new company which would have inadequate spread of risk in
the early years of operation. A strong reinsurance treaty designed to
insure against catastrophes with a reasonable loss retention would adequately
protect the company. The amount of reinsurance and loss retention can
also be used to leverage the assets of the company which would permit
the company to write more business and achieve the needed spread of risk
within a shorter period of time.
Product Line and Marketing
- Homeowners insurance would seem to be the product
line of choice for banks to insure. The reason stems from the following:
- Homeowners insurance provides predictable risk
when the insurance company has achieved adequate spread of risk. This
line of insurance also does not have great uncertainty of future losses
which are difficult to estimate.
- The service need of this product is not as demanding
as other lines of insurance.
- The underwriting of this product is most effective
when credit reports are used in the evaluation process. (See attached
article)
- Appraisal value could be used to determine the
replacement cost of the home without incurring additional cost if the
applicant is applying for a mortgage.
Banks are in a unique position to promote
this product line without the need of an insurance agent. This would reduce
the cost of insurance to the customer and promote a direct relationship
with the bank in servicing the insurance need of the client. For example
branch offices could be used to promote the insurance product and procure
the information needed to underwrite the risk. The insurer would have
both an 800 number and an internet world wide web store front accessible
to either the customer or bank employee for response to questions and
additional information. Also when a potential buyer of a home is applying
for a mortgage, the bank can provide a high degree of convenience by acting
as a facilitator. This would include obtaining the underwriting information
and merge the insurance need with the mortgage product.
Accessibility and Premium Cost
It is important to note that the insurance
company would be a direct writer and would not be subject to paying commission
to a sale force of agents. It may be required to pay the banks a service
fee for promoting and obtaining the information from the client. Writing
this line of business can be cost effective should the company have an
efficient processing and delivery system. Claims and home inspection can
be subcontracted to service providers.
Banks have a unique opportunity that
the traditional insurance market does not have. Insurance companies servicing
this line of business are not easily accessible to their customers. In
most cases the insured's interaction with the company only happens when
a premium bill is delivered to the residence of the insured. In the proposed
relationship, the insured would interact with the bank for both banking
and insurance services on a frequent basis.
A New Banking/Insurance Product
Competition is a word that the business
world has come to understand better in the global economy. The challenge
for those who manage an insurance company is to demonstrate the advantages
of their insurance products and services to the customer. Should the banking
industry be allowed to write insurance, the product must provide insurance
and a financial advantage. In other words a product which would offers
homeowners an investment opportunity and insurance would probably revolutionize
the homeowners insurance market. First Partners has rights to such a copyrighted
consumer-based insurance product. This product concept would enhance the
relationship between the insurance provider and buyer. The end results
would demonstrate to the insured the present and future value of staying
with the bank.
CAPTIVE.COM, LLC is a limited liability
partnership located in Southington, Connecticut that provides financial
and risk management consulting services. If you are interested in discussing
this concept paper or have general questions please contact us by calling
(860) 276-9775 or writing us at 22 Summit Farms Road, Southington, CT.
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