Seminario de Entrenamiento IAIS-ASSAL - Convergencia Financiera en Seguros

1. INSTITUTO DE SEGUROS DE PORTUGAL Seminario de Entrenamiento IAIS-ASSAL - Convergencia Financiera en Seguros

2. Financial convergence Summary • The concept of financial convergence • Factors that lead to the financial convergence • Consequences of the financial convergence • How the financial institutions are responding to the challenge of the financial convergence • Advantages of the bancassurance • Threats for the bancassurance • Regulatory answers in the EU • Challenges for the supervisors • Challenges for the financial services providers • Conclusion

3. Financial convergence The concept of financial convergence • Financial convergence is the blurring of conventional boundaries separating the traditional providers of once discrete financial services • The entire financial industry is increasingly being viewed as competing in one market – the market for risk management services • Convergence is creating a new class of provider which seeks to offer its customers a portfolio of integrated financial services

4. Financial convergence Factors that lead to the financial convergence • Technology – Technological innovations permitted the development of new products and drastically lowered the corresponding operational costs • Deregulation and market liberalization– New regulatoryenvironment is reducing barriers between industries (insurance, banking and securities) allowing the offer of complementary or competing products • Globalization of markets – International trade agreements are dismantling tariffs and breaking down barriers to trade allowing more companies to enter new markets

5. Financial convergence Factors that lead to the financial convergence • Demographics – Demographic trends favour the growth of financial products oriented to long-term savings, retirement and the protection of income • Increasingly sophisticated consumers – Consumers know more and are demanding more in value-added services (many consumers want to consolidate their financial relationships) • Increased shareholder pressure for financial performance – The generation of shareholder value is becoming a significant concern for management, leading to pressures for a strategic reorientation driven by the search for revenue enhancement and cost savings through the diversification of business

6. Financial convergence Consequences of the financial convergence • at the product level – Banks and insurance companies are offering more and more competing products: • life insurance used as a saving product, competing with banks savings accounts • unit-linked insurance competing with mutual funds • banks proposing products with financial guarantees • at the financial level – Financial markets are playing an increasing role in banking and insurance activities • giving more flexibility and liquidity to their core business (development of securitization) • banks and insurers are becoming more dependent on the fluctuations of financial markets

7. Financial convergence Consequences of the financial convergence • at the distribution level– Bank networks are used more and more as a channel for distributing insurance products (bancassurance) and vice-versa (assurfinance) • at the institutional level – Appearance of large-scale financial conglomerates • at the supervisory level – There is a need for greater consistency among regulatory and supervisory regimes across financial sectors. Different solutions are in place: • close and confident co-operation between sectoral supervisors • creation of a single supervisory body competent in all three financial sectors

8. Financial convergence How the financial institutions are responding to the challenge of the financial convergence • New competitive strategies – pursuing cross-industry mergers, acquisitions, joint ventures and strategic alliances (distribution agreements) • The focus is on growth – gain market share, create new revenue streams, enter new markets, and thus reduce operating costs and diversify risk • The idea of cross-selling is brilliant in its simplicity – but the execution is neither simple nor easy and has both advantages and threats

9. Financial convergence Advantages of the bancassurance • Banks have a more stable distribution network and generally a more stable customer base than insurance companies • The banking distribution channel has superior customer information • Banks usually own a more extensive distribution network • Large economies of scale could contribute to reduce the distribution costs

10. Financial convergence Threats for the bancassurance • Different cultures in banking and insurance – different skills and different staff incentives may require considerable cost and effort to induce a desirable degree of cooperation • Difficulties and problems in the distribution because – “Banking products are bought and insurance products are sold” • The core product of insurance is risk while that of the banking is money – The insurance product is substantially different from other types of financial products (particularly in non-life insurance)

11. Financial convergence Regulatory answers in the EU • Financial conglomerates directive (2002/87/EC – 16 of December) – Prudential supervision on a group-wide basis for credit institutions, insurance undertakings and investment firms which are part of a financial conglomerate, in particular as regards: • the solvency position and risk concentration at the level of the conglomerate • the intra-group transactions • the internal risk management processes at conglomerate level • the fit and proper character of the management

12. Financial convergence Regulatory answers in the EU • Solvency II Project – Development of a new more risk-sensitive system for assessing the “overall solvency” of an insurance undertaking • Based in a Basle 2 - type three-pillar structure, adapted to the needs of insurance supervision • Development of a risk-oriented approach which encourages insurance undertakings to measure and manage their risks • Should lead to increased harmonisation of quantitative and qualitative supervisory methods and thereby contribute to the creation of a level playing field within the insurance industry, as well as across financial sectors

13. Financial convergence Regulatory answers in the EU • Solvency II Project • Build to ensure consistency across financial sectors • The system should, to the extent necessary, be compatible with the approach and rules used in the banking field • Products containing similar risks should, in principle, be supervised in the same way and be subject to the same capital adequacy or solvency requirements • Aims at a more efficient supervision of insurance groups and financial conglomerates

14. Financial convergence Challenges for the supervisors • Focus on corporate governance practices, risk management processes and capital adequacy at the consolidated level • Constructing a balanced supervisory approach that seeks to gain an understanding of the consolidated entity without imposing an undue regulatory burden • Upgrading of staff skills focused on the understanding of the risks associated with new capital markets products

15. Financial convergence Challenges for the supervisors • Focus on consumer protection – financial privacy, appropriate disclosure and codes of conduct to service providers • The increased complexity of products offered to consumers will require the development of consumer protection safeguards to better ensure that various segments of consumers understand the risks associated with, and can benefit from, the increased product availability

16. Financial convergence Challenges for the financial services providers • A better understanding of the risks arising from different businesses • In general, securities and insurance activities are riskier than banking activities • Banks mainly face financial risk (market, liquidity and credit risks), but insurance companies always face, to some extent, insurance specific risks (underwriting life, health, property, personal and commercial risks) • Insurance is confronted with behavioural risks (adverse selection – the risk of covering only the high risk group – and moral hazard – the incentive for policyholders to adopt a more risky behaviour)

17. Financial convergence Challenges for the financial services providers • Focus on the needs of the consumer • Financial organizations developing out of the today’s trend for convergent activities will not be successful unless they are focused on satisfying the needs of a specific type of consumer • The most successful “convergent” organization will be the one most knowledgeable about consumers needs, most trusted by consumers, and most capable of orchestrating satisfaction of these needs

18. Conclusion • Financial convergence is here to stay, but the current financial crisis will increase the focus on the concept of core competency, and imply a more careful judgement about the application of capital • It is likely that the best use of capital is not going to consist on trying to be all things to all people – even when it comes to distribution • Groups must allocate capital with the goal of developing those channels, target customers and product offerings whose risks they understand and manage well and whose returns will exceed the risk-adjusted costs