MILLIMAN & ROBERTSON, INC.
FORECAST
A Publication by Milliman's Boston Casualty Actuarial and Risk Management Consultants
Volume 3 Issue 3 SUMMER 2000
Page One

In This Two-Page Issue:

• Sleeping With The Enemy: Issues Surrounding Financial Services Reform
• Price Increases, Coverage Changes, and ARF: Preparing For the Hard Insurance Market

Historically, banks and insurers have always conducted their affairs in separate bedrooms, jealously guarding their markets. In the past 36 months, however, the line separating the banking and insurance industries has shifted and blurred with the passage of financial reform legislation that allows banks to engage in insurance. Needless to say, the actions and decisions leading to this change met with strong skepticism from certain members of the insurance industry. Despite that initial opposition, today banks and isurers must find a way to live compatibly under one roof, lest the offspring of this marriage - the financial services consumer - is lost.

Historically there has been no federal regulation of the business of insurance. Instead, insurers are primarily regulated by state insurance departments. Banks, on the other hand, have a long history of strict and centralized federal regulation. The 1933 Glass-Steagall Act separated banking from other financial activities, and state anti-affiliation prohibited banks from entering the insurance business. In 1996, however, the United States Supreme Court affirmed in Barnett Bank of Marion County, N.A. v. Nelson that states cannot forbid national commercial banks from selling insurance if the bank has a branch in a town with fewer than 5,000 people. Barnett raised several questions, leading to a flurry of proposals regarding financial services legislation and, ultimately, to the passage of the Gramm-Leach-Bliley Act ("the GLB Act").

The GLB Act repeals many of the banking laws that have been in place restricting banks' ability to sell insurance, allows the establishment of holding companies, and authorizes affiliations among banks, securities firms, and insurance companies. In short, states cannot prevent mergers between banks and insurers, nor can a state prevent an insurance company from establishing a financial holding company. However, the GLB Act maintains "functional regulation" (i.e., state regulation over the business of insurance).

The passage of the GLB Act, and the proposed legislation leading up to the GLB Act, has impacted both the banking and insurance industries across the country. The largest merger so far that received national media attention was between Travelers and Citicorp, who merged to form Citigroup. In the Northeast, the oldest mutual savings bank in Rhode Island recently purchased an insurance agency. Large banks in Massachusetts, including Fleet Financial Group and Citizen's Bank, have all attempted to consolidate with insurance entities of one form or another. Moreover, there is evidence that smaller banks in Massachusetts are just as eager to follow in their competitors' footsteps

Experts differ in their opinion of how the GLB Act will impact the expanding financial services market. Some proponents suggest that mergers with international companies will be easier, and could put the United States in a better competitive position worldwide. Increasing competition domestically and abroad could benefit the ratings of some insurance companies. Some experts also believe that Insurers may find more success by offering a more varied array of products, including products that result from mergers with banks and securities firms. Other people argue that mergers with small insurers may result in better opportunities to compete successfully with large companies. Still others believe that large mergers may result in reduced prices and improved services.

While the GLB Act has finally put to rest the question of whether banks may engage in insurance activities, it raises several issues that underscore the need for banks engaging in insurance activities to retain insurance experts. The following is a list of some of the pitfalls that these banks may face:

• Banks should be aware of the difference between "underwriting" and "writing."
• Banks should realize that insurance risk differs from investment risk, and consists of many complex components such as reserving, pricing, investing, risk selection, and reinsuring.
• An insurer cannot disregard its obligations under an insurance contract no matter how adverse the policyholder's experience becomes in the future. In contrast, many typical banking products, such as property mortgages, contain provisions that allow the bank to cancel the contract.
• The estimation of liabilities is a major risk facing insurers. Underwriting losses account for the biggest liability facing insurers, and underwriting results can vary significantly from year to year. Insurers must attempt to accurately quantify those variations.
• State legislatures have enacted numerous statutes for regulating the business of insurance, and regulators have promulgated complex mechanisms of enforcing those laws, to ensure insurer solvency and protect consumer interests. Insurers also need to comply with the rules of various involuntary pools, residual market mechanisms, guaranty funds, and other state associations.
• The traditional marketing issues that have concerned banks include the number of customers and the type of account each customer maintains (e.g., savings, checking, CDs, credit cards). In contrast, insurers' marketing focuses on the type of customer, as much as on the quantity of customers. Where a bank may be eager to increase its customer base, it may be more prudent for the insurer to underwrite selectively.
• Banks may need to learn new skills as they acquire and attempt to integrate insurance agencies into their operations.
• Banks possess a ready and large source of capital that can be used to expand writings. Banks need to know that rapid growth in the insurance industry, while tempting, is risky.

Banks who do not develop the necessary skills early in their insurance careers may find themselves facing customer dissatisfaction or financial difficulties. It is important for both the banking and insurance industries to be aware of the issues that will accompany the growing involvement of banks in insurance activities over the next several years.

[ Page 2: Price Increases, Coverage Changes, and ARF: Preparing For the Hard Insurance Market ]