25 April 2008

Banks Build Up Their Insurance Business

The Globe and Mail, tara Perkins, 26 April 2008

Customers who pull up in front of the new Royal Bank of Canada branch in Oakville, Ont., might not notice anything unusual. Through the front doors there's a set of ABMs. Turn left and there's an insurance office, turn right and there's a bank branch. Windows and transparent doors divide them.

What's unusual here, even revolutionary, is that those two glass walls separating that bank branch from the coveted world of insurance sales represent one of the biggest growth opportunities that's left for the big banks in this country.

Canada's Bank Act outlaws the promotion of most types of insurance in bank branches, a law that's unique in the developed world. The insurance ban is among the few remaining restrictions banks continue to face in financial services, which is increasingly moving towards one-stop shopping.

If a customer walks into the banking side of the RBC location in Oakville and asks an employee if they know where they can buy some car insurance, the employee's likely to squirm. Responding with "we sell insurance," or "next door," or even just pointing to the insurance office, could be breaking the law. They're instructed to hand over a generic brochure about insurance that does not promote RBC.

Within the next five years, the industry is hoping to demolish the laws that ban banks from selling most insurance products — including life, health, home and auto insurance — in a branch.

In the meantime, banks are diving deeper into insurance. For now, that involves devising clever new ways to get around the rules, and the ingenuity is bridging the divide between banks and insurers, threatening to make Ottawa's rules increasingly irrelevant. Some bankers see the sale of insurance within branches as an initial step toward the eventual amalgamation of the two sectors — something that would radically change how Canadians consume their financial products.

"We're on the thin edge of the wedge here," says Neil Skelding, chief executive officer of RBC Insurance. "It is a terrific potential growth business for the banks."

It's not surprising the insurance charge is being led by the country's biggest bank, RBC, which is increasingly struggling to find growth in this mature banking market. The company has signalled its plan to carve out insurance as a new reporting division; starting in the third quarter, profits from insurance operations will be separated out from the banking figures, making it easier for the market to track just how profitable insurance is becoming for the company.

It's the early stages, but Royal Bank's total insurance operations earned $442-million last year, 46 per cent more than the previous year, making up about 8 per cent of the company's profit. The insurance side has grown faster than the bank as a whole over the past few years, notes Jim Westlake, the new head of international banking and insurance. It's telling that Mr. Westlake, who spent 19 years at Metropolitan Life Insurance Co. and nine years running Royal Bank's insurance strategy, has jumped up the company's senior ranks.

Over at Toronto-Dominion, another bank at the forefront in this area, insurance revenue surpassed the $1-billion milestone last year, contributing just under 10 per cent of total Canadian revenue.

The federal Bank Act attempts to erect a wall between banks and insurers. A bank can own an insurance subsidiary and an insurance company can own a banking subsidiary, but banks can't use their extensive branch networks to sell, or even market, most kinds of insurance.

Royal Bank is doing all it can to make use of its physical locations — as opposed to the phone or Internet, where there are fewer prohibitions — by building insurance offices right next door to some branches. As Mr. Skelding put it, they are "a piece of drywall away from being part of the branch."

Or, in the newest model, two pieces of glass.

RBC has 25 so-called "adjacent" locations, one-quarter of the way to its goal of 100.

The model is proving very successful, and will likely spur duplicates, Mr. Skelding suggested. "I think you will see more retail insurance businesses located near bank branches." Some credit unions in Saskatchewan are trying out the model, testing the limits of that province's regulations. (Credit unions are provincially regulated. Those in Ontario recently lost a battle to obtain more leeway in the insurance arena, while Quebec's have more power.). "Credit unions have been relatively aggressive at building insurance businesses for the simple reason that they know their clients have this need," Mr. Skelding said.

Under the current legislation, if you walk into an RBC Insurance office, they can bombard you with all of the promotional material about banking products that they want. "One of the unique things we found about the retail insurance offices is that 50 per cent of the clients that walk in the door are not RBC clients," Mr. Skelding said. "And we refer them every day to the bank for mortgages, lines of credit and other things."

During a presentation to analysts this month, executives at Bank of Montreal suggested the growth of banks' insurance businesses could play out in a similar way to that of their asset-management businesses.

"This is the same thing that happened with the managed asset business way back when, when we first came out," said Dean Manjuris, vice-chairman of BMO Nesbitt Burns' private client division. "It's only in the last six or seven years that the managed asset business in Canada has really grown, and it looks like insurance is taking on that same kind of track."

Mr. Skelding concurs. Banks made the first big push into asset management about a decade ago, initially focusing on small investors, an "underserved market," he said. Existing financial planners didn't have much interest in people who just put $10 or $20 a month into an RRSP, he said. Banks did. "We had the distribution infrastructure to make that successful, and we could do it in an economic way."

Banks went on to reinvent the business, for instance by coming out with products like no-load funds (mutual funds that don't have a sales charge), and the industry at large grew as a result, he said. "I think if you look at insurance it's going to be a very similar evolution."

At the moment, banks have to squeeze their insurance businesses out through a maze of regulations with a brick wall at the end.

The rules are fairly complex, and have faced few judicial tests. For example, if a customer asks an RBC branch employee "do they sell insurance at that office next door?," then they are allowed to reply that they do, Mr. Skelding said. But "only if you trigger that question."

There are some limited types of insurance banks that are allowed to sell in their branches, mainly those with ties to their lending businesses, such as creditors' insurance, which pays off loans if a customer dies or loses their job. But banking and insurance are naturally more interwoven than the relationship between lending and creditors' insurance, Mr. Skelding said. "Virtually any financial transaction requires some form of insurance, or peace of mind, that goes with it. If you get a mortgage, you're going to need home insurance to close the sale. If you buy a car, you're going to need car insurance. If you retire and you want to buy an annuity, that's an insurance product."

Customers aren't thinking about the Bank Act or the division of financial pillars, they're thinking about the product they need, he said.

Banks often put years into building an investment relationship with a customer. But when it comes time to convert those investments into an income stream to live off of in retirement, the relationship can dissolve.

"When they go to annuitize, we can't actually sell that in the branch," Mr. Skelding said. "To a client, it seems strange. If I've spent 30 years working with RBC on building my investment portfolio and I want to turn it into an annuity, I can't do that, I have to leave RBC 'the bank' and go to an insurance company for that."

It's an unnatural break in the customer relationship imposed by the legislation, Mr. Skelding said. And the "break, this unnatural fissure in the relationship, is going to happen even more as the retired population grows."

Michael Goldberg, an analyst with Desjardins Securities, said "the banks have been heavily involved in wealth products that are associated with the accumulation phase of pension, or retirement, build-up. And insurance companies are going beyond that, to the payout phase of the build-up," ranging from annuities to the guaranteed minimum withdrawal benefit products insurers are now offering. "Because of the way the demographics are going right now, it looks like a lot more product sales are going to be aimed at the payout phase that's beyond the accumulation phase," he said. "Only insurance companies sell those products."

So part of the reason banks don't want to wait for Ottawa to change the rules stems from demographics. As baby boomers move from building up their retirement savings to drawing on those savings, they will turn to insurers for annuities, products that make regular payments to retirees.

Alain Thibault, executive vice-president of insurance at Toronto-Dominion Bank, said "it's not like we're going to be absent from this, because a lot of the business is conducted outside the branches, but obviously it would be more convenient if it was also available in the branches."

(The prohibitions on banks mean they cannot share customer data, even phone numbers or addresses, with their insurance businesses. If an RBC banking customer walks into the insurance office, they'll have to start from scratch.) George Lewis, the executive who runs Royal Bank's wealth management business, said "there is probably a need to look at innovation around products and services that do explicitly provide clients the ability to give us an amount of money to invest when they're 65 or 70, and receive back a lifetime of income or cash flow." It's an area "that we are looking very closely at this year, in terms of coming out with probably a range of products and services to address that."

In Canada's mature banking market, the big five can temporarily steal market share from one another by, for instance, undercutting prices on mortgages or other products. But real long-term growth is harder to come by. Insurance is one avenue.

"We want to understand what role we can fill for Canadians, and what is our right place. And we don't want to be everything to everybody," said Mr. Thibault. "But we believe that insurance can be a real extension of banking services."

While it might seem like the banks are battling Ottawa, their real opponent is the insurance industry.

Dan Danyluk, the chief executive officer of the powerful Insurance Brokers Association of Canada, an organization with much clout among politicians, thinks that even the adjacent branch strategy — which began in 2005, and really ramped up late last year — flouts the intent of the law, if not the letter.

"They never did this before, they wouldn't dare do this before," he said. "But I think what's happening is that they've just decided that they are, after all, the Canadian banks and they're going to do what they want to do."

When Royal Bank began building the adjacent branches, "from the brokers' point of view, we assumed that this was just a little bit of theatrics and we would see these things closed down," he said.

A spokesperson for the country's banking regulator, the Office of the Superintendent of Financial Institutions, said the Bank Act states that banks cannot carry out business in premises adjacent to the office of an insurance company, agent or broker unless there is a clear indication that the two offices are separate. "As long as they are separate, it's legal," he said.

Mr. Danyluk doesn't buy it, and he believes he's got Parliament on his side.

"Our position is that credit-granting institutions, all of them, ought not to be selling insurance at the point of granting credit," he said. The worry is that, as they offer a loan, they'll find a way to make it a quid pro quo that the customer also buys insurance from them — so-called "tied selling." Customers might feel pressure to buy home insurance to get a mortgage, or auto insurance to get car financing, he suggested. "Outside of the shower, can you remember feeling more naked than when you go for credit?"

Banks, which have so much information about their customers' wealth and credit scores, could add to that database information about their health or tendency to get in car accidents, the insurance industry points out.

"Over the last number of years, they've been allowed to sell mortgages, there was a time when they couldn't," Mr. Danyluk added. "They've been allowed to take over the trust industry, there was a time when they couldn't. They've been allowed to own stock brokerages, there was a time when they couldn't.

"I find it appalling quite frankly that they would break the law. And their interpretation of the law, by the way, was the same as mine until the discussions about the last Bank Act (review) when RBC came out and decided, I guess, that they're above the law."

Every five years, Ottawa dusts off the Bank Act and considers if it needs changing. In the lead-up to the latest review, in 2006, banks pushed the issue full throttle. At Royal Bank's annual meeting, chief executive Gordon Nixon said "government should support and defend its key industries through good policies, rather than what sometimes makes for good politics."

Finance Minister Jim Flaherty didn't budge, sticking to the Conservatives' earlier campaign pledge not to allow banks to market insurance in branches.

"The Bank Act passed with no changes to the prohibition against marketing, the only thing that changed was the behaviour of banks," Mr. Danyluk said. "We've erected a two-foot picket fence around a 30-foot giant, and that giant is just not used to anybody telling them they can't do anything they want to do, so they kick through the pickets."
It's legal for banks to be in insurance, he notes, adding "there isn't an insurance broker, an insurance professional in the country that has a problem with that. Our problem is, we just think that at the point of granting credit, which is a bank branch, they shouldn't be offering insurance products because quite frankly consumers are vulnerable."

It's not only the brokers who resist the banks' efforts.

If banks sold all types of insurance in their branches, they would make some of the insurance products themselves, but they could also sell those of the country's big insurers. Given that, you might not suspect strong opposition from the insurers to changing the rules. But that's not the case.

From mortgages to the trust business, banks have come to dominate every sector they've been given the power to enter, notes an executive at one of Canada's largest insurers. Right now banks can have insurance subsidiaries and insurance companies can have banking subsidiaries and the playing field is relatively even, he argued. Combine all of the banks' businesses with their ability to tap into the extensive customer databases they've developed from their lending operations, and "that's a huge advantage," he said.

Manulife Financial Corp chief executive officer Dominic D'Alessandro has noted that banks are already allowed to solicit business exactly the same way insurers do, including direct mail, referrals, and brokers. He's on record saying he's against banks being allowed to distribute or market insurance in branches.

But, he also notes that products offered by banks and insurers are increasingly substitutes for one another and it's no longer useful to think of the sectors as being inherently different. Selling insurance in branches is one thing, but the more fundamental issue that should be dealt with first is the structure of the financial services sector in Canada, Mr. D'Alessandro thinks. And he also believes that banks and insurers should be allowed to merge, and "it is no longer useful to think of the banking and insurance sectors as being inherently different from one another."

While the banks have been setting up tents in the insurers' backyards, Manulife's reciprocating.

Mr. Skelding said that "companies like Manulife are using their adviser channels to do banking. They're saying, 'okay, if you're buying an annuity, you must have an investment portfolio, [and] do you need a mortgage? Do you want a line of credit? And so on."

"You can do it one way, and not the other way."

Many Canadians will have spotted the ads for "Manulife One," which bills itself as the first flexible mortgage account, combining a customer's mortgage with their chequing and savings account so that any income immediately starts paying off their debt.

Manulife Bank is still a relatively puny portion of its parent company, but it's bulking up quickly and executives think it could eventually account for 10 per cent of the insurer's Canadian earnings. They like to joke that it could be Canada's biggest bank if it keeps up its recent growth rate of about 50 per cent per year (something that's clearly not sustainable). The bank's assets surpassed the $10-billion mark for the first time last year, up 26 per cent from 2006, thanks to its loan and mortgage products.

Manulife Bank is a way for the insurance giant to provide bank-type products without having to use another bank, "so they can do things that are a little bit creative with that," Mr. Goldberg said.

The line between banks and insurers is blurring, Mr. Goldberg added.

So will Ottawa step in, like a referee pulling two fighters apart? Or will it change the Bank Act to reflect reality?

Last time the Act was under review, in 2006, the banks watered down their requests, knowing mergers were a non-starter with the Conservatives.

But they did raise the issue of selling insurance in branches. When it became clear that Mr. Flaherty wasn't going to allow that, they asked to be allowed to promote insurance from their branches.

Ottawa instead maintained the status quo — to the delight of the insurance industry and its army of 30,000 brokers.

That may be more difficult next time around. Since the last review, Mr. Flaherty has asked a panel to review the country's competition laws, rekindling the debate over bank and insurance mergers. And the banks are doing all they can to demonstrate that the laws prohibiting the sale of insurance in branches are outdated.

Anyone doubting their plans need only look at new RBC branches like the one in Oakville. The bank is building them in such a way that, should opportunity knock, they can enter another new age for financial services in Canada by just tearing down a strip of drywall.