Canadian Underwriter

The Future of Financial Services Regulation

October 1, 1999   by Michael Hlinka

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Last June the federal government released its white paper on financial services regulation. While the gist of the paper was very much in favor of protecting the existing rights of members of the property and casualty insurance industry, contained within the proposed legislation are three areas of issue: The future establishment of a federally-charged ombudsman to oversee financial services, an examination of tied-selling tactics versus “packaged services”, and an opening up of the jealously guarded direct payment system. Initial reactions from the document’s literal interpretation was pleasing to industry observers, but change is rapid and the question remains how these changes will impact on the competitive abilities of insurers and brokers.

There is a recent history to the role of an “ombudsman” in Canada’s financial services industries. Since 1996 there has been a self-appointed banking ombudsman, and in 1998 the Canadian Life and Health Insurance Association introduced an ombudservice to provide largely an “information service” to the public. The property and casualty insurance industry at provincial levels has also for sometime installed an ombudsman system for consumer complaints.

However, all of these have been “self-appointed” offices by the industries in question, with no real teeth given to the ombudsman in enforcing rulings made. As such, there has never been anything as comprehensive as the style of the national government-backed ombudsman as proposed by finance minister Paul Martin in his financial services white paper.

All federally incorporated financial institutions will be required to join the proposed Canadian Financial Services Ombudsman (CFSO) while provincially incorporated financial service providers will be eligible to join the CFSO if they wish, something which will no doubt be encouraged by the authorities. The finance minister will have responsibility in setting up the CFSO operation. However, the Ministry will not be involved in the office’s day-to-day operations other than to ensure its independence in any industry political frays.

In bringing in the concept of a national financial services ombudsman, Martin did, however, stop short of creating a “national consumer watchdog”. Although the CFSO will be able to recommend awards to aggrieved customers (which will be publicized), companies affected by such rulings are not bound to serve them. Clearly, the ombudsman office will have minimal effect on the p&c industry given the extensive regulatory apparatus already in place. It appears that the majority of its energies will be directed towards over-seeing the banking sector. Reaction to the new office ranges from neutral to positive.

Ted Belton, director of research at RBC Underwriting Management Services Inc., believes the ombudsmen will not impact the industry, “we’ve had them before and it can’t do any harm as long as the ombudsman is rational and reasonable”. Bob Gunn, president of Royal & SunAlliance, believes, however, that the initiative will impact consumers. “It’s a good idea. Customers need an end-solution point, and this is the proper vehicle”. That said, he concedes there will most likely be some “trial and error” issues arising from decisions.

George Anderson, president of the Insurance Council of Canada (ICC) shares Belton’s conviction that the p&c industry will be unscathed by the consumer legislation. “Our industry is very heavily regulated at the provincial level.” However, Anderson expresses concern over potential overlap that may arise between the federal and provincial bodies, something which Michael Harrison, president of broker network Equisure Financial, hopes will lead to standardization across all provinces.

Consensus would indicate the ombudsman provision has been created to mainly monitor the banking sector’s treatment of consumers. As such, it will not affect the p&c industry as much as it would other players in financial services sectors. In fact, the primary reason for its inception is to respond to complaints from consumer and non-bank financial institutions about the widespread practice of tied and coercive selling.


“Coercive tied-selling occurs when a firm uses coercion to require a customer to buy one product as a condition of purchasing another one…Coercive tied-selling of any product will be prohibited” — extract from the white paper.

These words are music to the ears of established p&c players.

Schedule I Banks have eyed p&c insurance as the next potentially lucrative area of growth. With an extensive consumer database in place — and existing relationships not to mention an established reputation — it would appear banks are inherently prepared to subsume p&c business, much as they have the securities brokerage industry in Canada.

Mark Yakabuski, vice president of government relations for the Insurance Bureau of Canada (IBC) thinks the federal government listened to lobbying efforts by the p&c industry. “You want a mortgage for that dream home? Sure. But you’re going to need insurance for that, and if you could just see Bob over there…” Yakabuski remarks, in illustrating the threat banks present to the insurance industry. However, Yakabuski’s comment illustrates the controversy which has always surrounded the issue of tied-selling: is it inappropriate to sell what could be beneficial complementary products through one institution as opposed to forcing a consumer to purchase the additional products to gain access to that one product.

The words in the white paper are clear and unequivocal on the topic of “tied-selling” — banks or any other financial institution will not be permitted to coercively tie the selling of products. But what are the practical consequences of this statement? Belton suggests that it will be minimal, he believes the debate has been over-charged with political self-interest. “Allegations made by the insurance industry that banks use tied-selling is unfounded. The other side of the coin is that brokers engage as much in tied-selling if you work on the belief that selling complementary products falls under this gambit — it’s not uncommon for someone selling home coverage to suggest auto business as well with an implied price break.”

In essence, the federal government has come out against “tied-selling” without providing a definition of what that amounts to. The planned investigation of tied-selling within financial services should hopefully provide some clarity. However, not many within the financial service industries are overly optimistic of a positive outcome. While the government’s objective with tied-selling is mainly driven by a political cause to satisfy consumers, the behind-the-scenes implications for all financial service providers is laced with potentially over-regulated and costly pitfalls.

For instance, it may well serve the political cause of the p&c sector that banks have been targeted for investigation of tied-selling, however, as the drive for cost-effective delivery of products increases, insurers and brokers alike will be looking to maximize on their own customer relationships. Already, p&c operators have turned to selling a host of products which would not be classified as “traditional insurance”, observers note. As such, the possibility of draconian legislation being introduced which limits the selling of products by all financial service players could ultimately prove an ironic sting for the cost-sensitive p&c industry.

Rick Grass, vice-chairman of Canada Brokerlink, goes further suggesting that more formalized tied-selling may actually be in the consumers’ best interest. Brokerlink is headquartered in the province of Alberta. Commencing in October of this year, after a re-write of the provincial Insurance Act, tied-selling will actually be permitted by insurers. For instance, insurance brokers will be permitted to receive commission from bodyshops to which he directs clients. This practice, previously outlawed, is considered by the Province of Alberta to be in the consumers’ best interest. Bodyshops will not have to market themselves directly to cons
umers — which tends to be expensive and ineffective. Saved money ultimately becomes savings which can be passed along to the consumer. Conversely, brokers will be responsible for ensuring reputable shops do the work and essentially, a virtuous circle is created.

By way of analogy, Grass sees similar possibilities in tied-selling: “Most consumers like dealing with “one face”. He adds, “this should bring about better service as a result…at the end of the day it is not a matter of law, but of conduct”. Still, the objective fact behind attempts to limit tied-selling is that Schedule I Banks hold a disproportionate amount of power over the consumer relative to other financial service providers, partly due to their monopolistic control of the direct payment system in Canada.

Payment system access

“The payments system in Canada is a network of competing and complementary services that facilitates transactions involving the exchange of a means of payment in return for good, services, real assets, and financial assets…Life insurance companies, securities dealers, and money market mutual funds will be part of the payments system” — extract from the white paper.

Willie Sutton, a notorious criminal was once asked why he robbed banks and he answered: “Because that’s where they keep the money!” In 1980, federal statute created the Canadian Payments Association (CPA). Membership to the CPA was limited to federally and provincially regulated deposit-taking institutions. By definition, this excluded financial service operators such as p&c companies. Although the white paper has proposed deregulation of direct payment system access, not much seems to have changed.

There are three key public policy objectives for the CP system: efficiency, safety, and the consideration of consumer interests. It is felt that these three objectives can be met by accommodating the entry of life insurance companies, securities dealers, and money market mutual fund dealers — but only the large need apply.

Under the white paper, membership to the CPA as a direct clearer has been expanded, thus freeing the grip which the banks previously held over other financial institutions in setting the price of transactions. However, under the proposed legislation, CPA membership is still limited to those institutions accounting for a minimum of .5% of total national clearing volume, thus excluding most operators. Due to its limited gross transactional volume, the p&c sector has been effectively blocked from membership — at least for the time being.

According to Yakabuski, the significance of deregulation of the direct payment system under the terms of the white paper are more importance to life insurers who are in wealth management and “spread business”, rather than managing risk. However, as Equisure Financial president Harrison points out, “anything to wrest control of the system from the banks is a good development”.

The result

The white paper was a carefully crafted document, very specific in its recommendations, however, the nature of public policy is that momentum tends to be built by the most innocuous statements and takes an independent life of its own. John Palmer, superintendent of the Office of the Superintendent of Financial Institutions (OSFI) provides proper context for the white paper. “The MacKay Task Force recommended that it would be appropriate to shift the level of risk in the system up a few notches because, when comparing the Canadian financial system with those in other countries, ours was number one in safety and soundness, but not so in competitiveness.”

In Canada, the Schedule I Banks are the 800 lb.-gorillas — the p&c sector is the more vulnerable player. Clearly, the ability of banks to compete in the p&c business has been curtailed. An ombudsman will make it more difficult for practices like tied-selling to occur. As more and more players have access to the payment system, it will take more executive time and energy for banks to protect their current markets, let alone direct their energies and resources into newer ones.

A financial services analyst notes that the sum of these proposals, including a initiative that calls for a holding company component that would allow various financial institutions to be owned by an umbrella corporation, could signal a new trend in the current wave of consolidations.

This past summer saw banks purchasing securities dealers and trust companies (National Bank buying First Marathon and Toronto Dominion purchasing Canada Trust). The new legislation could allow for strategic partnerships to develop between the various financial service players, namely banks and insurance operators, thus providing for business advantages for all. “The white paper infers companies operating as separate entities within a holding structure will be subject to less restrictions, it could make terrific business sense for the banks to partner with p&c insurers, and perhaps effect further cost-effective consolidation within some of the sectors,” the analyst says.

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