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General Government Division
B-240696
September 26,lQQO
The Honorable John J. LaFalce
Chairman, Committee on Small
Business
House of Representatives
Dear Mr. Chairman:
This report, prepared at your request, evaluates the potential effects of banks selling
insurance on consumers, other insurance sellers, and bank safety and soundness. The report
also addresses the extent of coercion in bank sales of insurance and the need for regulatory
controls to protect consumers.
As arranged with the Committee, unless you publicly announce the contents of the report
earlier, we plan no further distribution until 30 days from the date of the report. At that time
we will send copies of this report to other appropriate congressional committees, federal
banking agencies, and others on request.
Major contributors to this report are listed in appendix II. Please contact me on 276-8678 if
you or your staff have any questions concerning this report.
Sincerely yours,
Craig A. Simmons
Director, Financial Institutions
and Markets Issues
I
Executive Summ~
Purpose
If more banks gain powers to
sell insurance,
both property/casualty
and
life/health, opponents charge that banks will coerce consumers to buy
insurance as a condition to receive credit. Further, insurance sellers sug-
gest that banks selling insurance would compete unfairly with other
sellers and endanger bank safety and soundness. In contrast, banks and
some consumer groups assert that banks selling insurance would benefit
consumers through cheaper premiums and convenient service.
The Chairman of the House Committee on Small Business requested
GAO
to evaluate the potential effects of banks selling insurance on con-
sumers, other insurance sellers, and bank safety and soundness. The
Chairman also asked
GAO
to address the extent of coercion in bank sales
of insurance and the need for regulatory controls to protect consumers.
Background
insurance activities, most banks can sell credit insurance-insurance to
repay a borrower’s debt if the borrower dies or becomes disabled. More-
over, some banks have additional powers to sell insurance. According to
a 1987 survey published by the Federal Deposit Insurance Corporation
(FIX), about half of the states permitted state-chartered banks to sell
most forms of insurance. Also, in towns with populations less than
6,000, bank holding companies, national banks, sand some state banks
can sell all types of insurance. A bank holding company with assets less
than $60 million can sell some types of insurance.
In this report,
GAO
discusses bank sales of insurance products under-
written by an unaffiliated insurance company, which bears all risk of
loss due to policyholder claims.
GAO
does not deal with the risks that
might exist should banks be allowed to underwrite insurance or affiliate
with insurance companies.
To identify the potential effects of banks selling insurance,
GAO
met with
a judgmental sample of banking and insurance organizations, their regu-
lators, consumer advocates, and academic experts. To assess the extent
of coercion by banks,
GAO
reviewed Federal Reserve-sponsored studies
of credit insurance sold by banks and spoke with regulators in nine
states where banks have limited powers to sell insurance. (See pp. 8-16.)
Results in Brief
Banks selling insurance
could
potentially benefit
consumers through
reduced insurance costs and increased convenience. However, if more
banks sell insurance, opportunities may increase for banks to coerce
consumers to buy insurance as a condition to receive credit.
Page 2
GAO/GGDBO-113 Bank# Selline hwuance
Executive sulnmary
Available evidence does not indicate that coercion is a widespread
problem in existing bank sales of insurance. Tying credit to the sale of
other products is already illegal. Additional measures, such as disclosing
that insurance purchases are voluntary or separating insurance sales
from credit approval, could protect consumers from any increased
potential for abuse.
Expanded bank sales of insurance would increase competition for other
insurance sellers. While a bank could abuse its position as a source of
credit to compete unfairly against other sellers, existing regulatory con-
trols, if properly enforced, should serve to limit credit abuses.
Bank sales of insurance underwritten by an unaffiliated insurance com-
pany present no risk to bank safety and soundness. The insurer under-
writing the policies bears the financial risk of losses under policies sold
by the bank.
GAO’s Analysis
Consumers May Benefit
but May Also Need
Protection
Banks could possibly reduce consumers’ insurance costs if they could
lower the costs of selling policies through joint marketing of bank and
insurance products. The increased convenience would also save con-
sumers’ time and effort in purchasing insurance products. However, it is
not possible to anticipate the extent to which banks can lower the costs
of selling insurance or whether these savings would result in cheaper
insurance premiums.
Like other lenders selling insurance, a bank could tie the purchase of
insurance to the granting of credit. Coercive tie-ins, where the customer
is forced to purchase an additional product to receive credit, are illegal
under existing banking law. Also, a bank’s ability to coerce borrowers
into purchasing insurance is limited not only by other sources of insur-
ance but also by other sources of credit.
Although credit insurance is most susceptible to tie-ins, Federal Reserve
studies found favorable consumer perceptions, which did not indicate
widespread abuse by banks. Ninety percent of credit insurance buyers
in 1986 thought credit insurance was a good product and would
purchase similar coverage again. The consensus of state banking and
insurance regulators
GAO
interviewed was that, while instances of abuse
Page 3 GAO/GGD-f.M-113 Banks Selling Insurance
Executive Summary
may occur, coercive tie-ins are not widespread in bank sales of insur-
ance. Fourteen of 17 regulators
GAO
interviewed did not believe banks
routinely coerce borrowers to buy credit insurance.
While coercive tie-ins are already illegal, additional measures could pro-
tect consumers from the perception that buying insurance could
improve chances of getting loans. Such measures include disclosing that
insurance purchases are voluntary and requiring that insurance mar-
keting be separated from the credit approval process. However, such a
separation might reduce or eliminate the cost savings that would other-
wise flow from joint marketing of banking and insurance products. (See
pp. 16-26.)
Increased Competition
Other Sellers
for
Expanded bank sales of insurance would create a more level playing
field among banks and other depository institutions and lenders that
now sell insurance. While insurers underwriting policies may benefit
from the flexibility of another channel for reaching customers, other
insurance retail sellers would face increased competition from banks
selling insurance.
Banks have potential competitive advantages over other insurance
sellers. For example, banks may be able to sell insurance more cheaply
through joint marketing of bank and insurance products. Also, a bank-
affiliated insurance seller has access to bank customers and customer
information and can share overhead costs with the bank. These advan-
tages are not unique to banks, and any large insurance seller has an
advantage over small agents.
Regulatory measures eliminating joint marketing would reduce banks’
competitive advantages over other sellers. For example, a bank could be
prohibited from sharing customer information or office space with its
insurance operations. While separate marketing for a bank and its insur-
ance activities could protect other insurance sellers from increased com-
petition, such measures would forestall consumers gaining potential cost
savings and increased convenience.
Finally, banks could give preferential treatment to affiliated insurance
agencies or deny credit to competing insurance sellers. Banking laws and
regulations, including sections 23A and 23B of the Federal Reserve Act,
limit lending by a bank to its affiliates and require interaffiliate transac-
tions to be on a nonpreferential basis. However, similar restrictions do
not apply to bank subsidiaries or departments within a bank. (See pp.
26-32.)
Page 4
GAO/GGDBO-113 Bmlca Selling Insureme
Executive Summiry
No Risk to Bank
Safety
Expanded bank sales of insurance underwritten by unaffiliated insur-
and Soundness
ance companies would not endanger bank safety and soundness. Unlike
underwriting, selling insurance does not involve financial risk of loss for
policyholder claims. To the extent that sales commissions contribute to
banking profits, diversification into selling insurance could strengthen
safety and soundness and protect against bank failures. It is not possible
to predict whether bank sales of insurance would be profitable. While
selling insurance in itself presents no risk to a bank’s capital, any expan-
sion into a new business presents management challenges and could
divert management attention away from core business responsibilities,
such as careful management of credit risk.
Additional measures may be necessary to ensure that consumers do not
become confused about whether insurance products sold by a bank are
backed by federal deposit insurance. One measure would be to expressly
disclose to the consumer that insurance products are underwritten by an
insurance company and are not covered by banking deposit insurance.
(See pp. 33-34.)
Matters for
Congressional
Consideration
While consumers could potentially benefit from bank sales of insurance,
it is not possible to know in advance the potential for future abuses in
tying the granting of credit to the purchase of insurance. If more banks
gain powers to sell insurance, Congress may wish to consider the need
for additional regulatory measures, including increased disclosure and
separation of insurance marketing from the credit process, to protect
consumers from possible coercive tie-in problems.
Agency Comments
As requested by the Committee,
GAO
did not obtain written comments on
this report.
GAO
discussed the report with officials at the Federal
Reserve,
FDIC,
and Office of the Comptroller of the Currency and has
incorporated their comments where appropriate. Agency officials gener-
ally agreed with the conclusions contained in the report.
Page 5 GAO/GGlMO-113 Ba.nke Selling Inmranw
.
Contenti
Abbreviations
FOE
Federal Deposit Insurance Corporation
GAO
General Accounting Office
NAIC
National Association of Insurance Commissioners
occ
Office of the Comptroller of the Currency
Page 7
GAO/GGMO-113 Banka Sellin hureme
Chapter 1
Introduction
In recent years, state legislatures, banking regulatory agencies, and the
courts have allowed banking institutions (commercial banks and their
holding companies) to expand into selling insurance-property/casualty
and life/health. As Congress considers whether nationally regulated
banks should be granted powers to sell insurance products, opponents
and proponents of expanded powers disagree as to the effect of banks
selling insurance on consumers, other insurance sellers, and bank safety
and soundness.
Insurance agents and industry trade associations allege that banks
selling insurance present the following dangers:
. banks would charge unreasonably high premiums or coerce consumers
to buy insurance as a condition to receive loans,
. banks would give preferential treatment to their insurance subsidiaries
and affiliates and deny credit to competing insurance sellers, and
.
inexperienced banks selling insurance could incur losses and endanger
the safety and soundness of the banking system.
In contrast, banks and consumer groups assert that bank expansion into
insurance sales would yield the following advantages:
9 banks’ lower costs would result in lower insurance premiums,
. increased competition between insurance sellers would also lower insur-
ance premiums and improve service quality, and
l
diversification into insurance sales would reduce risk and possibly
increase bank profits, thereby protecting banking safety and soundness.
Banks Selling
Insurance
While the Bank Holding Company Act generally separated
commercial
banking from insurance activities, some banks have limited powers to
sell insurance. The extent of insurance powers varies depending upon
the type of banking institution and its regulatory agency.
National Banks
Among federal banking regulators, the Office of the Comptroller of the
Currency (OCC) has approved the broadest range of insurance selling
activities. occ charters and regulates national banks under the terms of
the National Bank Act. The act expressly authorizes national banks
located in towns with populations not exceeding 6,000 to sell all types of
Page 8
GAO/GGD-30413 Banks Selling Ins-u!
chapter 1
Introduction
insurance.1 cxx has interpreted this authority to allow a national bank
with a branch in a qualifying small town to sell insurance nationwide.
In addition, occ relies on the general language in the National Bank Act
to permit national banks to engage in other limited sales of insurance.
The act authorizes national banks to exercise all incidental powers nec-
essary to carry on the business of banking. In approving insurance sales
activity incidental to banking, occ has allowed national banks to sell
credit insurance,2 title insurance,3 and certain annuities.4 In addition, occ
has allowed national banks to lease space to an insurance agency,
enclose insurance advertisements in bank mailings, sell customer lists to
insurance agents, and refer customers to insurance agents and share in
resulting sales commissions.
State Banks
The extent of insurance powers of state-chartered banks varies by state.
According to a survey of state banking lawspublished by the Federal
Deposit Insurance Corporation (FDIC) in 1987,6 all states except Texas
allowed state banks to sell credit insurance. Moreover, as of 1987, about
half of the states permitted state-chartered banks to sell most forms of
insurance. Of those states granting insurance powers, nine states
allowed bank sales of insurance only in towns with populations less
than 6,000, and one state allowed such sales in towns with populations
less than 200,000. State-chartered banks also may lease space to insur-
ance agents in 31 states and share customer lists with insurance sellers
in 16 states.6
Since the survey published by
FDIC
in 1987, several states have taken
action to expand bank authority to sell insurance. Proposition 103 in
California repealed a law that made bank holding companies and their
affiliates ineligible for a license to sell insurance. Delaware, in May 1990,
enacted legislation allowing state banks to sell insurance nationwide.
‘12 USC. section 92.
2Credit insurance is designed to repay a borrower’s debt if the borrower dies or becomes disabled.
3Title insurance protects the policyholder against undiscovered defects in a property’s title.
4An annuity is an investment from which the owner receives periodic payments for a number of
years or for a lifetime.
sVictor C. Saulsbury, “State Banking Powers: Where Are We Now?” Regulatory Review, Federal
Deposit Insurance Corporation (Apr. 1087).
6Bank Diversification: Into Insurance?, Congressional Research Service (Feb. 9,lQQO).
Page 9
GAO/GGIM@lU Banks Selling Insurance
chapter 1
The Congressional Research Service reported
that
in 1989 legislators in
22 states introduced bills to expand insurance sales by state-chartered
banks, and insurance agents had introduced countering legislation in 24
states to limit banks selling insurance.
Bank Holding Companies
The Bank Holding Company Act expressly limits the insurance activities
of holding companies that own at least one bank. The Act generally pro-
hibits a bank holding company or its subsidiaries from selling insur-
ance.’ Exceptions to the general prohibition permit bank holding
companies to engage in limited insurance activities similar to those that
occ has approved for national banks. Exceptions to permit selling insur-
ance include:
. a bank holding company may sell credit insurance;
l
a finance company subsidiary may sell property/casualty insurance to
protect loan collateral;
. a bank holding company may sell all types of insurance in a small town
with a population not exceeding 6,000;
l
a small bank holding company with assets less than $60 million may sell
insurance, except for life insurance and annuities; and
l
a bank holding company selling insurance on May 1, 1982, may continue
those activities under a grandfather clause.8
Recent decisions by the Federal Reserve Board, which is responsible for
administering and interpreting the Bank Holding Company Act, have
expanded insurance activities of holding companies. In 1987, the Fed-
eral Reserve Board ruled that a bank holding company may sell insur-
ance by acquiring a grandfathered holding company. In 1989, the
Federal Reserve Board ruled that the general prohibition on insurance
activities applies only to nonbank subsidiaries of a bank holding com-
pany; therefore, a state bank and its subsidiaries could engage in any
insurance selling that the chartering state permits. In other decisions,
the Federal Reserve Board has permitted other insurance-related activi-
ties, such as advertising insurance products and selling customer lists to
insurance sellers.
‘12 USC. 1843 (c)(8).
*Title VI of the Garn-St. Germain Depository Institutions Act of 1982 (P.L. 97-320).
Page 10 GAO/GGD9@113 Banks Selling Insurance
Chapter 1
IntroductSon
Insurance Delivery
systems
Insurance products-property/casualty and life/health-are marketed
and sold through three insurance delivery systems: independent agen-
cies or brokerage firms, exclusive agents, and direct writers.
Independent Agents and
Brokers
An independent insurance agency generally represents and sells prod-
ucts of several competing insurance companies. On the other hand, a
broker represents the insurance buyer in negotiations with insurance
companies to tailor coverage for commercial, large, or unusual risks.
Independent agents and brokers are contractors and are not employees
of an insurance company. Both agents and brokers assist the insurance
buyer in comparing costs and coverage of different policies. In addition
to selling insurance products, an independent agent also may handle
claims reporting for clients.
An independent agent’s income is derived solely from commissions paid
by insurers for policies sold, whereas a broker may receive both fees
from customers and commissions from insurers. When an insurance
policy is sold through an independent agent, lists of customers and
policy expiration dates become the property of the agency, and all
renewals and associated commissions belong to the agency. As a result,
insurance companies represented by the agency may not bypass the
agency to sell policies directly to the agency’s clients.
Exclusive Agents
An exclusive agent generally represents and sells the products of one
insurance company or group of affiliated companies. An exclusive
agent, also referred to as a captive agent, may be an independent con-
tractor working for the insurer or an employee of the insurance com-
pany. An exclusive agent receives compensation through a mixture of
salary and commissions on policies sold. In addition to selling policies,
such agents alsomay handle claims for clients.
D
birect Writers
Direct writers are insurance companies who use direct mailing, media
advertising, and telephone solicitation to sell their products directly to
customers. An insurer may obtain lists of prospective buyers from
diverse organizations, including employee unions and banks. Direct
mailing eliminates agents and sales staff and thus can result in lower
selling expenses. However, the mail order approach generally offers
little personal service to customers in selecting coverage.
Page 11
GAO/GGLMO-113 Banks Selling Inmrance
Chapter 1
Introduction
writers and exclusive agents sold 64 percent of private automobile
insurance and 62 percent of homeowners insurance.
State Regulatory
Control of Insurance
Sales
Under the McCarran-Ferguson Act of 1946, states exercise primary reg-
ulatory jurisdiction over the insurance business9 Each state has a
department of insurance responsible for, among other things, oversight
of insurance sellers, insurance marketing and trade practices, and insur-
ance policies and premium rates. All states require insurance sellers to
be licensed to transact business within the state. Prospective agents and
brokers may be required to pass a written examination or fulfill certain
training requirements. Thus, a banking institution selling insurance and
selected bank employees are required to be licensed like any other insur-
ance agent.
State insurance regulators are responsible for enforcing state-enacted
unfair trade practices laws and regulations to protect consumers from
fraud, abuse, and deception in insurance marketing and sales.‘0 Insur-
ance regulators monitor insurance sellers through consumer complaints,
review of marketing materials, and market conduct examinations. A
market conduct examination is an evaluation of an insurer and its repre-
sentatives’ dealings with policyholders and claimants, such as adver-
tising and claims handling. If an insurance seller engages in fraudulent,
abusive, or deceptive practices, state regulators may take action to sus-
pend or revoke the seller’s license.
State regulators also review premium rates to ensure that premiums
paid by policyholders are adequate, not excessive, and not unfairly dis-
criminatory. Some states require prior approval for premium rates,
while other states require only that rate plans be filed with the insur-
ance department before the ratings become effective. Premiums charged
for an insurance policy are set by the insurer underwriting the product
and not by the seller of the policy. Sales expenses, including commis-
sions paid by the insurer to the seller, represent one component of the
premium price.
g16 USC. sections 1011-1016.
l”Long-Term Care Insurance: State Regulatory Requirements Provide Inconsistent Consumer F’rotec-
tion (GA(s7HRD89-67, Apr. 24,1989).
-
Page 13
GAO/GGDBO-113 Banks Selling Insurance
chapter 1
Introduction
Objectives, Scope, and
The Chairman of the House Committee on Small Business requested that
Methodology
we evaluate the potential effects of banks selling insurance on con-
sumers, other insurance sellers, and the safety and soundness of the
banking system. In this report, we discuss bank sales of insurance prod-
ucts underwritten by a nonaffiliated insurance company, which bears
all risk of loss due to claims of policyholders. The Chairman also asked
that we specifically address the practice of cross-selling and potential
for coercive tie-in sales of insurance and other consumer abuses and
provide insight into what regulatory controls are needed to protect
consumers.
To identify the advantages and disadvantages of banks selling insur-
ance, we interviewed over 60 insurance and banking industry organiza-
tions, their regulators, consumer advocates, and academic experts. Our
judgmental sample of interviews included banking and insurance
industry representatives and regulators likely to be involved with banks
already selling insurance. Appendix I lists the organizations and individ-
uals that we interviewed. We also reviewed legal opinions, congressional
hearing records, and publications prepared by banking institutions and
insurance sellers.
In an effort to assess the extent of abusive tie-ins and potential for
abuse if bank sales of insurance are expanded, we examined banks’
experience with credit insurance, since most banks already can sell this
type of insurance. Specifically, we reviewed two studies most often cited
by both opponents and proponents of banks selling insurance. Based on
consumer surveys sponsored by the Federal Reserve, both studies pro-
vide information on the frequency of borrower purchases of credit
insurance, borrower perceptions about lender recommendations to
purchase credit insurance, and overall borrower attitudes toward credit
insurance.11
To analyze tie-ins in bank sales of other types of insurance, we inter-
viewed insurance sellers, banks selling insurance, and banking and
insurance regulators in two states where banks already sell insurance-
Minnesota and North Carolina. In Minnesota, banks have sold insurance
for many years, while North Carolina banks recently started to sell
insurance. We spoke with banking and insurance regulators in seven
“Robert A. Eisenbeis and Paul R. Schweitzer, “Tie-ins Between the Granting of Credit and Sale of
Insurance by Bank Holding Companies and Other Lenders,” Staff Study 101, Board of Governors of
the Federal Reserve Svstem (Feb. 19791 and Anthony W. Cvrnak and Glenn B. Canner. “Consumer
Experience with Credit I~&ance,” FeieraI ReserveBank of San Francisco Economic keview
(Summer
IOSS),
pp. 6-20.
Page 14 GAO/GGD-t-M-113 Banka Selljng Inmwance
additional states-California, Iowa, Massachusetts, Nebraska, South
Dakota, Wisconsin, and Wyoming-where banks have limited powers to
sell insurance. We interviewed representatives of 13 bank holding com-
panies that have grandfathered powers to sell insurance.12
We also interviewed officials of the three principal federal bank regula-
tory agencies-Federal Reserve,
FDIC,
and occ. We spoke with officials
of the National Association of Insurance Commissioners
(NAIC). NAIC
con-
sists of the heads of the insurance departments of the 60 states, the Dis-
trict of Columbia, and 4 U.S. territories.
NAIC’S
basic purpose is to
encourage uniformity and cooperation among the states as they individ-
ually regulate the insurance industry.
We did our work between December 1988 and January 1990 in accor-
dance with generally accepted government auditing standards. At the
request of the Committee, we did not obtain written comments on this
report. We discussed the contents of our report with officials at the fed-
eral banking agencies-
Federal Reserve, FIX, and ooc-and have incor-
porated their comments where appropriate. The officials generally
agreed with the conclusions in our report.
12Fourteen bank holding companies are allowed to continue selling insurance under the grandfather
provisions of the Garn-St. Germain Act of 1982.
Page 16
GAO/GGIM@113 Banka selling Incuran=
Chapter 2
*
Chsumers May Benefit but May Also Need
Protection From Potential Abuses
In the debate over expanding bank powers to sell insurance, proponents
and opponents disagree on how bank sales of insurance would affect
consumers. Banks and consumer groups assert that banks will lower the
costs of selling insurance, thereby reducing overall insurance costs, and
will expand service to consumers. However, the insurance industry
argues that banks would charge higher premiums and reduce service.
Moreover, critics of bank sales of insurance contend that banks would
take advantage of their position as lenders to coerce consumers to buy
insurance.
Bank Entry May Have
Banks could possibly reduce the cost of insurance if they can lower the
Little Effect on
Insurance Premiums
costs of marketing and selling policies to customers. However, sales
expenses represent only one component of insurance costs, and any
reduction in the cost of selling insurance may not significantly affect
premiums paid by policyholders. Also, state regulatory oversight of
insurance premiums may limit, in the short run, any seller’s ability to
affect premium rates. However, expanded bank sales of insurance may
increase convenience for consumers, thereby reducing consumers’ trans-
action costs.
Economies of Scope
Banks can reduce production costs if they can achieve economies of
Present Potential for Cost
scope in selling insurance products. An economy of scope refers to the
Reduction
ability to reduce costs through the joint production or marketing of two
or more products or services. By offering a wider variety of products
and services, a company may be able to sell a greater volume overall and
lower the overhead costs per unit sold. Cross-selling, the concurrent
marketing of several distinct services or products through one seller, is
one way to achieve economies of scope. If bank sales of insurance are
expanded, banks could use their existing offices and staff to offer more
products and services to current customers.
Cross-selling is a common practice in both the banking and insurance
industries. In addition to traditional deposit accounts and loans, banks
offer other banking products and services, such as credit cards, trust
services, credit insurance, and financial planning advice to their cus-
tomers, Insurance companies routinely offer several types of insurance
to policyholders. In fact, an insurer may provide discounts to policy-
holders purchasing several types of insurance or offer some types of
coverage only to existing policyholders.
Page 10
GAO/GGD-W113 Banka f3e.m Inemce
Chapter 2
Consumers May BenePit but May Also Need
Protection From Potential Abuses
While expanded bank sales of insurance present the potential for banks
to achieve economies of scope, it is not possible, we believe, to anticipate
the extent to which banks could lower the costs of selling insurance.
Available statistical studies of banking costs, in general, are based on
small banks dealing with existing products and geographic restrictions
and do not address bank expansion into insurance sales. Therefore,
these cost studies cannot be used to project whether bank sales of insur-
ance will lower the costs of selling insurance.
Sales Expenses Are a
Any reduction in sales costs is unlikely to substantially lower insurance
Fraction of Premiums Paid
premiums paid by consumers. Sales expenses represent only one compo-
by Policy holders
nent of an insurer’s cost, while losses and expenses for underwriting
and claims handling represent the bulk of insurance costs. According to
A.M. Best Company, commissions represented nearly 12 percent of
property/casualty premiums in 1988 and almost 10 percent of life/
health premiums. As a result, a l-percent reduction in sales commissions
would translate into a premium reduction of, at most, one-tenth of 1
percent.
State Regulation Limits
Seller’s Effect on
Insurance Premiums
State regulatory oversight of insurance premiums may limit, in the short
run, any seller’s ability to affect premium rates. First, premiums
charged for an insurance policy are set by the insurer underwriting the
product and not by the seller of the policy. Then, regulators in most
states oversee premium rates through rate plans to be filed with the
insurance department or by requiring prior approval for premium rates.
Since premiums are set by the insurer with regulatory oversight, a bank
selling insurance could not unilaterally change premiums charged to
consumers.
In addition, almost all states prevent insurance sellers from reducing
premiums paid by consumers through anti-rebating laws. The ban on
rebates prevents an insurance seller from paying a portion of the pre-
miums or sharing its commission with the customer. As a result, banks
could not immediately reduce premiums paid by consumers to reflect
any cost savings. Instead, the insurer marketing its products through a
bank would have to revise its rates subject to regulatory oversight. If
banks could reduce sales costs, to compete on the basis of price, insurers
distributing products through banks would request lower premiums to
pass cost savings along to customers.
Page 17
GAO/GGD90-113 Banks Selling Insurance
chapter 2
Cknunnnera May Benefit but May Also Need
Protection From Potential Abuses
Increased Convenience
May Reduce Consumers’
Transaction Costs
Banks could reduce an individual’s overall costs of purchasing insurance
by reducing the consumer’s transaction costs. The total price of an
insurance product is not only the premium paid to the insurer but also
the consumer’s time and effort to obtain information about insurance
products and complete the transaction. With expanded insurance sales
authority, a bank could provide “one-stop shopping” for both banking
and insurance needs. The Consumer Federation of America and the
National Insurance Consumer Organization assert that the increased
convenience for consumers would be a primary advantage of banks
selling insurance.
With one-stop shopping, a bank could assist consumers in choosing from
a range of banking and insurance products. Both traditional bank prod-
ucts and life insurance products are important elements of a consumer’s
financial plans. Increasingly, banks and insurance companies offer sim-
ilar products. Banks provide financial products, including letters of
credit, municipal bond insurance or guarantees, and annuities, that offer
insurance-like protection. Life insurers sell policies that offer an invest-
ment or savings function.
Bank Sales of
As we reported in January 1989, expanded powers for banks would
Insurance Increase
increase the diversity of banking, thus increasing the potential for con-
flicts of interest and their abuse.’ However, these conflict situations and
Potential for Abuse of potential abuses exist for all insurance sellers. For example, a bank or
Consumers
any other insurance seller has a “salesman’s stake” in promoting prod-
ucts and services while at the same time purporting to provide objective
advice. However, unlike other insurance sellers, a bank or any lender
also could use its position as a source of credit to coerce borrowers to
buy insurance through the bank as a condition to receive loans.
Conflicts of Interest Are
Not Unique to Banks
A conflict of interest is a situation in which a person or business serving
more than one interest can benefit by favoring one interest at the
expense of others. Conflicts of interest occur during the normal course
of many business operations, including banking and insurance. An abuse
of a conflict of interest occurs if the bank or its representative takes
advantage of the conflict situation in violation of customary industry
practices, fiduciary responsibilities, or laws and regulations.
‘Banking: Conflicts of Interest Abuses in Chunercial Banking Institutions (GAO/GGD-89-35, Jan.
27,1989).
Page 18
GAO/GGD9@113 Banks Selling Insurance
chapter 2
Ckmmune~ May Benefit but May Also Need
Protection From Potential Abuse19
Like other insurance sellers, a bank and its employees routinely
encounter situations in which their interests would be better served by
actions not in the best interest of the customer. This may occur when
the seller has a “salesman’s stake” in promoting products or services
while at the same time purporting to provide disinterested investment
advice. For example, any insurance seller, including a bank or its
employees, could abuse consumers by encouraging purchases of high-
profit insurance products while supposedly providing objective advice.
To increase income, the seller may recommend those products that yield
the highest commissions rather than the best coverage or cheapest pre-
miums for consumers.
In addition, a bank could abuse a customer’s interest by using confiden-
tial customer information in a manner not agreed to by customers. For
example, the bank could use lists of prospective borrowers to market
insurance products during the credit process or provide information to
an insurance seller contrary to customers’ privacy interests. Also, a
bank could give preferred treatment to certain customers, such as
offering lower interest rates for borrowers who purchase insurance.
Tie-Ins Between Insurance
To pass along cost savings achieved through economies of scope, a bank
and Credit Present
may “tie” two or more products and services into a package. Such tie-ins
Opportunity for Abuse
can benefit consumers as long as they have the option not to purchase
the additional goods. An involuntary or coercing tie-in occurs when, in
order to purchase the desired product or service, a customer must
purchase a second product or service. Involuntary tie-ins may be illegal
under federal antitrust laws, and banking laws explicitly prohibit tying
credit to any other banking product or service. However, even where the
bank does not intend a tie-in, a borrower may purchase an additional
product such as insurance from the bank in hopes of improving the
chance of receiving a loan. Such implied or perceived tie-ins may result
if banks cross-market insurance to borrowers or, in particular, if the
bank loan officer sells insurance.
Some types of insurance would be particularly susceptible to credit tie-
ins. Foremost, credit insurance may be tied to credit transactions, since
only consumers who owe on loans or credit accounts purchase credit
insurance. According to a Congressional Research Service report, a con-
sumer is most likely to purchase credit insurance when a loan is
Page 19 GAO/GGD-90-113 Banka Selling Insurance
Chapter 2
Consumers May Benefit but May Also Need
Protection kom Potential Abuses
originated, and as a result, the lender is well placed to offer the insur-
ancea2 In fact, one study sponsored by the Federal Reserve found 90 per-
cent of credit insurance in 1985 was sold by lenders.
Property insurance also may be tied to credit when a loan is secured by
collateral. For example, any lender that also sells insurance could offer
auto insurance policies to borrowers with car loans or homeowner insur-
ance to mortgage holders. However, the opportunity for a bank to coerce
borrowers into purchasing insurance is limited not only by the existence
of other sources of insurance but also by other sources of credit. In
1987, about 40 percent of auto loans and less than 40 percent of home
mortgages originated with commercial banks. Many other lenders, in
fact, also sell insurance, including automobile finance companies and
mortgage companies.
Limited Evidence Does
While insurance opponents of bank sales of insurance maintain that
Not Indicate
coercive tie-ins are widespread, little evidence is available to substan-
tiate claims that banks coerce customers to buy insurance. Although
Widespread Abuse of
credit insurance is most susceptible to tie-ins, studies of credit insurance
Credit Tie-Ins
sales have found consumers’ favorable perceptions did not indicate
problems with widespread abuse. As for banks selling other forms of
insurance, state regulators in our interview sample said that, while
instances of abuse may occur, coercive tie-ins are not widespread. Given
banks’ limited experience with credit insurance and the few banks that
sell other insurance, we cannot generalize about the extent of abuses if
bank sales of insurance are expanded.
Little Evidence That
Opponents of banks selling insurance claim lenders dominate credit
Coercion Is a Widespread
insurance sales through overt or implied tie-ins between insurance and
Problem in Credit
credit approval. To support their point, independent agents and their
Insurance
trade associations cite the fact that two-thirds of borrowers purchase
credit insurance from their lender. In 1985,67 percent of bank bor-
rowers also bought credit insurance through their banks. Moreover,
these opponents point out, about 20 percent of borrowers with credit
21nsurance Sales: The Effects of Possible Bank Diversification on the Insurance Industry, Congres-
sional Research Service (Nov. 30, 1989).
Page 20
GAO/GGD!W113 Banks Selling Insurance
Chapter 2
Conmmers May Benefit but May Also Need
Protection From Potential Abuses
insurance in 1985 said their lender strongly recommended or required
the purchase of credit insurance.3
However, the fact that borrowers purchased credit insurance from their
lender does not necessarily mean that borrowers were coerced to buy
insurance from the bank. A Federal Reserve-sponsored study found
that, excluding borrowers required to purchase coverage, less than 4
percent of credit insurance buyers in 1985 thought the loan approval
process was affected by whether they bought credit insurance. Bankers
suggested that borrowers purchase credit insurance from lenders,
because this insurance is convenient and relatively inexpensive when
compared to the loan. Indeed, 90 percent of those borrowers who pur-
chased credit insurance in 1985 responded that credit insurance was a
good product. Further, more than 90 percent of those who purchased
credit insurance indicated that they would purchase similar coverage in
the future. Even among those borrowers who did not purchase coverage,
more than half thought credit insurance was a good idea.
Little Indication of Abuse
Independent agents and some state insurance regulators have suggested
in States With Expanded
that if banks were granted broad power to sell insurance, banks would
Bank Sales of Insurance
coerce their customers into buying insurance. However, 14 of the 17
state banking and insurance regulators that we interviewed do not
believe that banks routinely coerce borrowers to buy credit insurance.
Our discussions disclosed only limited anecdotal evidence of such coer-
cive practices in states where banks already sell insurance.
Our discussions with regulators, consumer advocates, insurance agents
and bankers in Minnesota and North Carolina did not indicate wide-
spread coercion by banks selling insurance. In Minnesota, where state
banks have sold insurance for over 90 years, the state’s Department of
Commerce, which regulates both banking and insurance, has received
few complaints about coercive tie-ins by banks. Officials said that the
one case involving numerous consumer complaints about coercive credit
tie-ins did not involve a banking institution, In North Carolina, where
banks recently began selling insurance, the Attorney General’s office
and state bank regulators were unaware of any widespread coercion
problems in North Carolina banks.
31n many states, banks may legally require the purchase of credit insurance as a condition to receive
credit. They may not, however, require that the insurance be purchased from a particular source.
Under title I of the Truth in Lending Act (16 U.S.C. 1606B), the cost of credit insurance must be
added into the loan’s annual percentage rate.
Page 21 GAO/GGD-90-113 Banka gelling Insurance
Chapter 2
I
Coarnmers May Benefit but May Also Need
ProtectIon From Potential Abuses
However, we found instances of a situation which could possibly
represent coercive tie-ins in insurance products. According to several
persons in our interview sample, some banks have refused to accept
binders-legally binding promises to provide insurance coverage-from
other agents and instead offered to sell their own policies to borrowers
during loan closing. A bank’s ability to reject a binder in lieu of an actual
policy during closing varies according to state laws and regulations. For
example, a bank in North Carolina can refuse to accept binders, while in
New York, this practice is prohibited.
The difficulty of coercing tie-ins between insurance and banking prod-
ucts is illustrated by the low market share held by bank holding compa-
nies that sell general insurance. Of the 10 bank holding companies
selling insurance in our sample that responded, most estimated that few
of their banking customers also bought insurance through the bank or
its affiliate. Estimates ranged from less than 1 percent to less than 15
percent. These percentages of bank customers buying general insurance
are low compared to the 67 percent of bank borrowers buying credit
insurance.
The limited experience of national banks and state-chartered banks that
sell insurance may not be representative of the extent of abuses that
would occur if bank sales of insurance are expanded. Currently, bank
holding companies, national banks, and state-chartered banks in 10
states can sell insurance in small towns with populations less than
5,000. Since a bank serving a small town may exercise a near monopoly
in providing credit in the community, the small town exemption allows
banks with the most opportunities for tie-in abuse to sell insurance.
None of the regulators in our sample expressed concern about possible
abuses by small town banks. In large markets where consumers can
choose from multiple sources of credit and, therefore, are less suscep-
tible to coercive tie-ins, most banks are now restricted from selling
insurance.
Controls Over Abusive
As we reported in our 1989 report on conflicts of interest in banks, three
Practices of Banks
Selling Insurance
factors work to control conflict situations and limit their abuse: competi-
tion, banking internal controls, and regulatory oversight. While this
combination can serve to limit abuses, these factors cannot prevent all
abuses. However, after some point, additional controls and oversight
Y
may hamper banking operations and diminish potential benefits for
consumers.
Page 22
GAO/GGI.MO-113 Banlra Selling Insurance
Chapter 2
Ckmtmmers May Benefit but May Also Need
Protectlon From Potential Abunes
Competition
Competition between financial service providers serves to deter conflict
of interest abuses. To maintain business relationships and profitability,
banks try to avoid adverse publicity and poor customer relations that
could result from abuses. Competition serves as a barrier as long as cus-
tomers are aware when they are adversely affected and can easily take
their business elsewhere. As pointed out earlier in this chapter, banks
are not the dominant source for consumer credit. Faced with unfair
insurance sales practices by banks, consumers could find another credit
source. Competition between insurance sellers will be discussed in
chapter 3.
When competition is lacking or when it is difficult or expensive for cus-
tomers to obtain necessary information, they may not be able to take
their business elsewhere. According to the National Federation of Inde-
pendent Businesses, banks are the primary source of credit for small
businesses, and a small business may depend upon one bank for all of its
credit needs. Generally, a small commercial borrower cannot quickly
change lenders because of the lag time in applying for loans and under-
going an evaluation of its creditworthiness. In the short run, a small
commercial borrower could feel pressured to purchase insurance prod-
ucts from the bank if the borrower has no other immediate source of
credit. However, in the long run, borrowers can develop relationships
with other commercial banks if they find their current banks’ practices
unreasonable.
Banking Internal Controls
Banks use internal control systems to manage conflict situations and
limit abuses. A bank may use “Chinese Walls” to limit the passage of
sensitive or confidential information between units or even to physically
separate operations. The Chinese Wall concept could be used to prevent
information about credit applicants from being used to sell insurance or
to separate the credit and insurance departments. A bank also may have
a code of ethics providing guidance to employees in resolving conflicts
of interest. For example, a bank may prohibit a loan officer from dis-
cussing insurance with a prospective borrower until the loan decision is
final or may require a loan officer to disclose that insurance purchases
are voluntary.
Regulatory Oversight
”
Federal and state banking laws, regulations, and supervision play an
important role in protecting consumers from bank abuses. Federal anti-
trust laws prohibit certain involuntary tie-ins, and federal banking laws
specifically prohibit tying bank credit to other banking products and
Page 23 GAO/GGIMO-113 Banks Selling Insurance
Chapter 2
Chwume~ May Benefit but May Aleo Need
Protection Prom Potential Abwes
,
services. In addition, the Federal Reserve Board considers the potential
for perceived tie-ins in allowing a bank holding company to sell insur-
ance, In approval orders to individual banking institutions, the Federal
Reserve Board may specify controls necessary to limit potential abuses.
CKX likewise considers the potential for tie-ins by national banks selling
insurance and may impose additional controls.
Some states where banks have gained power to sell insurance have addi-
tional laws and regulations that serve to protect consumers. For
example, during every transaction with customers of related companies,
Wisconsin requires banks to disclose the relationship and to provide
instructions for the consumer to report coercive sales pressure to com-
pany management or the Commissioner of Banking. To prevent the
“salesman’s stake,” Wisconsin prohibits bank employees who sell insur-
ance on a commission basis from making credit decisions,
Banks selling insurance are subject to state insurance regulation as well.
A bank or its employees may be required to obtain an agent license and
are subject to the same state insurance regulations as other insurance
sellers. While legal provisions vary from state to state, unfair trade
practice laws and regulations generally prohibit coercive tie-in sales for
borrowers, as well as misrepresentation and false advertising.
Additional Regulatory
Controls May Warrant
Consideration
While existing regulatory controls prohibit coercive tie-ins by a bank
selling insurance, it is reasonable to expect that the greater the degree of
joint marketing, the more likely consumers are to believe credit is tied to
insurance. Thus, consumers may need additional protection from per-
ceived tie-ins.
While a prohibition on joint marketing may prevent even the perception
of tie-ins between credit and insurance, such a measure also would fore-
stall consumers benefitting from expanded bank sales of insurance. As
banks enter joint ventures with insurance sellers or gain powers to sell
insurance directly to customers, other measures for consideration
include mandatory disclosure and marketing separation. At the least,
banks could be required to disclose that the purchase of insurance is
voluntary and does not affect the granting of credit. Also, banking oper-
ations, particularly the credit process, may be insulated from insurance
marketing by
. restricting a bank from offering insurance to a borrower until the loan
decision is final,
Page 24
GAO/GGD90-113 Banks Selling Insurance
Chapter 2
C?.mmmere May Benefit but May Also Need
Protection From Potential Abwea
. prohibiting loan officers from offering insurance to a borrower or
earning commission on insurance sales, and
. physically separating insurance marketing staff and office space from
other banking operations.
Some of these measures, however, may reduce or eliminate the cost sav-
ings that might otherwise flow from the joint marketing of banking and
insurance services.
Conclusions
Expanded bank sales of insurance could potentially benefit consumers
through reduced insurance costs and increased convenience. However,
we do not believe it is possible to predict the extent to which potential
benefits may be realized.
Similarly, expanded bank powers to sell insurance may increase oppor-
tunities for banks to coerce consumers to buy insurance as a condition to
receive credit. However, while instances of abuse may occur, coercive
tie-ins have not been a widespread problem in banks selling credit insur-
ance or in those banks already allowed to sell other forms of insurance.
These limited experiences cannot be generalized to predict the extent of
future abuses. While coercive tie-ins are already illegal, additional mea-
sures could help to protect consumers.
Matters for
Congressional
Consideration
While consumers could potentially benefit from bank sales of insurance,
it is not possible to know in advance the potential for future abuses in
tying the granting of credit to the purchase of insurance. If more banks
gain powers to sell insurance, Congress may wish to consider the need
for additional regulatory measures, including increased disclosure and
separation of insurance marketing from the credit process, to protect
consumers from possible coercive tie-in problems.
Page 25
GAO/GGD9@113 Banks Selling Iusurance
Increased Competition for Other Sellers but No
Risk to Banldng Safety and Soundness
Opponents and proponents disagree on how expanded bank sales of
insurance would affect insurance sellers. Insurance agents and their
trade associations suggest that banks would reduce competition in the
insurance market through unfair competition. In particular, agents claim
that banks would give preferential treatment to their affiliates and deny
credit to competitors. Banks and many consumer groups assert that
bank sales of insurance would increase competition.
Both sides in the debate over expanded bank powers also disagree on
how banks selling insurance would affect the safety and soundness of
the banking system. On one side, opponents claim insurance sales would
increase the riskiness of banking and endanger the safety and soundness
of the banking system. On the other side, banks and their supporters
contend that insurance sales would enhance banking profitability,
thereby protecting banking safety and soundness.
Competitive
Consequences of
Banks Selling
Insurance
Uniform powers for banks to sell insurance would create a more “level
playing field” among banking institutions, nonbank depository institu-
tions, and other nonbank lenders in selling insurance. As discussed in
chapter 1, current insurance sales authority for state-chartered banks
varies from state to state. Even among national banks, only those banks
operating in towns with populations less than 6,000 may sell insurance.
In contrast, other depository institutions, including savings and loan
associations, credit unions, and mutual savings banks, can offer insur-
ance to customers. Moreover, other lenders, such as finance companies,
can sell insurance to their borrowers. Finally, other nonbank financial
services firms, including insurance companies, can offer banking prod-
ucts, such as savings accounts and loans. This checkerboard of powers
does not allow otherwise similar institutions to compete on an equal
basis.
Within the insurance market, the effect of banks selling insurance on
product pricing and availability is uncertain. As discussed in chapter 2,
banks could potentially reduce the costs of selling insurance, though any
cost saving would not immediately result in lower insurance premiums
for consumers. While bank sales of insurance would increase conve-
nience for consumers, bank entry, as an agent, to the insurance market
would not affect the amount of insurance available. The amount of
insurance available depends on the underwriting capacity of insurance
companies.
Page 26 GAO/GGIMJ@113 Banks Selling Insurance
Chspter 3
Ineroa6ed competition for Other Sellers but
No Risk to Bankhg Safety and Soundnese
Expanded bank sales of insurance could enhance price competition
between insurance underwriters. Increasing price competition between
insurers has forced many insurance companies to seek lower sales costs
as well as to improve marketing for their products, To the extent that
banks could sell insurance more cheaply, insurers could pass reduced
production costs along to consumers as lower insurance premiums.
Insurers also would benefit from the flexibility of another channel for
reaching consumers. Many insurers already buy customer lists from
banks to take advantage of banking’s customer base. According to a
1988 Louis Harris survey done for Coopers and Lybrand, 34 percent of
life insurers and 28 percent of property/casualty insurers surveyed use
banks to market or sell their products. Moreover, four out of five
insurers surveyed’plan to increase their distribution through banks over
the
next 6 years.
Current insurance sellers-the most vocal opponents of banks selling
insurance
-are likely to lose market share and some of their profits if
bank sales of insurance expand. In particular, independent insurance
agents, whose commissions often result in higher costs than other
delivery systems, may lose from banks’ entry. Currently, banks may
lease space in their offices or sell lists of bank customers to insurance
sellers. However, if banks gain powers to sell insurance, agents not affil-
iated with banks may lose their bank office space and access to bank
customer information. Not surprisingly, independent agents opposing
expanded bank powers suggest that banks have unfair competitive
advantages in selling insurance.
Potential Competitive
Banks have potential advantages that may enable them to compete suc-
Advantages for Banks
cessfully with other insurance sellers. As discussed in chapter 2, banks
may be able to sell insurance more cheaply because of economies of
Selling Insurance
scope achieved through joint marketing. These efficiencies;,however, are
likely to be reduced if additional steps are taken to preclude coercive tie-
in sales. A bank may market insurance products to current bank cus-
tomers through its network of branch offices as well as through mailings
to credit card holders, depositors, and borrowers. Besides providing
space within its offices and customer lists, a bank could also share over-
head functions, such as check clearing, accounting, and other adminis-
trative functions, with its insurance operations. However, these
advantages are not unique to banks, and any large, diversified firm may
have competitive advantages. Moreover, an advantage does not necessa-
rily translate into unfair competition.
Page 27
GAO/GGLMO-113 Banka Selling Insurance
Chapter 3
hwea8ed C!ampetlUon for Other Bellem but
No Wak to Banking Safety and Soundnw
Physical A
Customers
ccess to
According to Standard and Poor’s Insurance Rating Service, the branch
networks used by banks represent a powerful distribution advantage.
Since depositors visit branches frequently, the bank has physical access
and contact to market more products to existing customers. Similarly,
leasing arrangements and joint ventures by insurers and agents with
banks attempt to capitalize on a bank’s position as a point of sale.
According to the Minnesota Insurance Agents Association, half of its
members work for agencies affiliated with banks.
Our sample of bankers and state regulators indicated that banks gener-
ally choose to co-locate insurance operations within bank offices. Of the
11 sample banks selling insurance, only one did not co-locate its insur-
ance and banking activities. Five sold insurance through bank offices,
and the remaining five sold insurance through bank offices as well as in
other locations. Of the six states that commented on the location of bank
insurance operations, regulators in all six states said banks are not
restricted from selling insurance within bank branches.
Access to Customer
Information
Banks, like other lenders and financial advisors, possess highly sensitive
and confidential information regarding customer finances. Opponents of
expanded bank sales of insurance assert that banks’ access to credit
information presents an unfair advantage. Through its lending opera-
tions, a bank could have information that a consumer is purchasing
property that requires insurance, such as an automobile or a house. As a
result, a bank could offer insurance to the borrower while other sellers
are not aware of the opportunity to compete for the borrower’s business.
However, the majority of automobile and home loans originate with
lenders other than banks. In many cases, these other lenders already
have powers to sell insurance to borrowers. Therefore, access to credit
information in itself is not necessarily an unfair advantage.
Another concern of competing insurance sellers is that banks could pro-
vide customer information to affiliated insurance agencies at no charge.
Currently, other insurance sellers are able to purchase bank customer
lists. The magnitude of any advantage a bank-affiliated agent may gain
from access to customer information is unclear. While independent
agents in North Carolina said that access to customer records is useful in
selling insurance, bank-affiliated agents in Minnesota and representa-
tives of several insurers said
that
only customer names and addresses
were helpful.
Page 28
GAO/GGLMO-113 Banks SeUng Insurance
Chapter 3
Increaned Competition for Other Sellers but
No Rialc to F5ankhg Saiety and Soundnwse
Shared Overhead Costs
A bank could also share overhead and processing functions with its
insurance operation. As a result of economies of scope and scale, the
bank-affiliated insurance activities may have lower production costs
than if the insurance agency operated as a separate entity. These advan-
tages, however, are not unique and may exist for all large, diversified
financial service providers.
For example, in recent years, insurance companies have purchased inde-
pendent agencies or agency computer systems serving to consolidate
administrative functions and reduce operating costs. Independent agen-
cies are joining consortiums and developing information systems to
reduce processing costs and achieve economies of scale. Small firms that
are unable to attain economies possible through large-scale operations
may be unable to offer prices competitive with larger institutions,
*
including banks.
Banks Could Abuse
Credit to Compete
Unfairly Against
Other Sellers
If the number of banks selling insurance is expanded, banks could abuse
their position as a source of credit to compete unfairly against other
sellers. A bank could give preferential treatment to an affiliated agency
or deny credit to competing insurance sellers. We do not know the extent
to which banks might use credit to influence their competitive position.
9 A bank could subsidize an affiliated insurance agency by providing
loans at favorable, nonmarket lending rates or without applying appro-
priate credit standards. Opponents of expanded bank sales of insurance
argue that, moreover, a bank has access to low-cost insured deposits,
which it could use to fund its insurance agency. However, any large,
diversified financial company, including large banks, bank holding com-
panies, and national insurance agencies, may be able to borrow funds
more cheaply than a small independent agent or specialty insurance
agency. Lenders may provide lower rates to diversified companies
because they believe such institutions are less risky than the less diver-
sified insurance agencies.
Absent legal restrictions,’ access to low-cost funding, including insured
deposits, could provide banks selling insurance with a cost advantage
over other sellers. To the extent that a bank could pass along the cost
differential in the form of lower premiums, the bank could take over a
share of the market from independent insurance sellers. However, two
‘Controls, including regulatory oversight, that serve to protect against credit abuses are discussed
below.
Page 29 GAO/GGDBO-113 Banks Selling Insurance
chapter 3
Inwaaed cOmpetith for Other Sellers but
No Risk to Banking Safety and Soundneea
factors serve to limit any advantages of low-cost funding for bank insur-
ance operations. First, a bank might use low-cost funding to subsidize its
insurance sales activity as a short-term strategy to establish the bank’s
presence in the insurance market. In the long run, however, a bank
would probably direct its loanable funds to the most profitable
activities.
Second, as previously indicated, any advantage from low-cost funding
would not necessarily affect premiums paid by consumers, since an
insurance seller cannot unilaterally change premiums charged to cus-
tomers. Even if banks could sell insurance more cheaply, lower pre-
miums would result only if insurers are willing to pass cost savings
along to consumers and state regulators permit these price changes.
Independent agents assert that a bankselling insurance would deny
credit or charge an excessive rate of interest on loans to competing
insurance sellers. The Congressional Research Service has pointed out
the possibility that if every bank in a town sells insurance or is affili-
ated with an insurance agency, an independent agency may not be able
to get credit in that town2 If competing sellers are unable to get credit
and necessary liquidity, independent agencies not subsidized by a bank
could be eliminated from the market. As a result, insurance markets in
areas with restricted access to credit might be monopolized by banks
and their insurance affiliates. CurrentQ, banks in small towns may sell
insurance, while banks in larger, more competitive markets cannot.
Controls Can Limit
Abuses and Ensure
Competition
As discussed in chapter 2, competition, banking internal controls, and
regulatory oversight serve to control credit abuses. In a competitive
market, each lender must make loans at competitive interest rates in
order to retain business. Thus, a bank subsidizing its affiliates, in the
long
run,
could not offer competitive rates on loans. While one bank
might deny loans to an insurance competitor or charge higher interest,
banks in unison are unlikely to do so; such action could be challenged
under federal antitrust laws. However, where credit abuses are likely or
competition is lacking, additional regulatory controls may be necessary
to ensure fair competition.
%surance Sales: The Effects of Possible Bank Diversification on the Insurance Industry, Cmgres-
sion
JR
eswrc
rvice( ov.
Page 30 GAO/GGD-Q&113 Banks Selling Insurance
chapt8r
3
Iucreaeed CornpetItion for Other Bellera but
No Reek to Banking Safety and Soundness
Banking Internal Controls
Banking internal control systems serve to limit credit abuses and ensure
that a bank remains competitive. As discussed in our report on banking
conflict of interest abuses, “Chinese Walls” or firewalls are an important
component of bank controls. These walls are intended to limit the pas-
sage of sensitive, critical, or confidential information within the bank
and between the bank and affiliates, as well as to limit inappropriate
transactions between units.
Without an adequate wall, unauthorized or unnecessary possession of
information could unfairly give advantage to the bank or its affiliate at
the expense of other insurance sellers. For example, information about
borrowers could be used by a bank-affiliated insurance agency to
market insurance products before the credit process is complete. Of the
11 banks in our sample that responded, 7 banks indicated that they
restrict or limit access to customer information by the affiliated insur-
ance agency.
Regulatory Oversight
Federal and state banking laws, regulations, and supervision serve to
help control credit abuses. A bank’s ability to give preferential treat-
ment and subsidize an affiliated insurance agency is restricted by
banking laws and regulations. Section 23A of the Federal Reserve Act
(12 U.S.C. Section 371C) limits loan and credit transactions with any one
affiliate within a bank holding company to 10 percent of the bank’s cap-
ital and the aggregate amount of lending to all affiliates to 20 percent.
Such transactions should be fully collateralized.
Section 23B of the Federal Reserve Act requires transactions between
banks and their affiliates within a holding company to be at arm’s
length with fair market pricing. For example, a bank is not to provide
customer lists or accounting services to an affiliate for less than the
bank would charge an unaffiliated company. Similarly, where a bank
shares space or overhead functions with an affiliate, the bank is to
charge the affiliate for its share of the costs.
We have reported that economic separation between a bank and its affil-
iates within a holding company can reduce incentives and opportunities
for a bank to give preferential treatment to affiliates.3 Economic separa-
tion provides that a bank and its affiliates must be adequately and sepa-
rately funded with no commingling of assets, that any services or loans
3Bank Powers: Insulating Banks From the Potential Risks of Expanded Activities (GAOIGGD-87-36,
Apr. 14,1987).
Page 31
GAO/GGD-90-113 Banks Selliug Insurance
cllapter 3
Increased Competition for Other Sellers but
No Bisk ta BankIng Safety and Soundness
obtained from the bank be obtained at rates comparable to those
charged nonaffiliated parties, and that the bank be prevented from
unduly transferring assets to, or purchasing bad assets from, a weak
affiliate.
While existing banking laws and regulations restrict credit and require
arm’s length transactions for bank affiliates, similar restrictions do not
apply to transactions among bank departments or between a bank and
its subsidiaries, At this time, banks permitted to sell insurance may do
so through an affiliated insurance agency, a subsidiary agency, or an
insurance department within the bank.
Additional Regulatory
Measures Could Protect
Competition
While preferential treatment of affiliates and subsidiaries is already
addressed in the existing regulatory system, additional measures may be
necessary to ensure competition in insurance markets if bank powers
are expanded. While none of our interviewees could provide an example
in which a bank denied credit to a competitor, regulators may have diffi-
culties monitoring such situations. Since regulators can identify possible
banking abuses through complaint data, one way to identify credit
abuses may be to specifically track complaints by insurance sellers that
a bank denied credit.
Further regulatory measures could reduce banks’ competitive advan-
tages over other insurance sellers. For example, a bank and its affiliated
insurance agency could be required to use different names and logos,
locate in separate space, advertise separately, refrain from selling each
other’s products, and develop separate customer bases. Basically, regu-
lations could be designed to prevent banks from realizing economies of
scope through joint marketing. While such measures would protect other
insurance sellers from increased competition, full separation of mar-
keting for a bank and its affiliated agency would forestall consumers
gaining potential benefits from banks selling insurance.
Page 32 GAO/GGIMO-113 Banka Selling Insurance
Ckapter 3
Increased Competition for Other Sellers but
No Risk to Banking Safety and Soundness
Insurance Sales
Present No Risk to
Banking Safety and
Soundness
Contrary to opponents’ claims, bank sales of insurance underwritten by
an unaffiliated insurance company would not endanger banking safety
and soundness. Unlike underwriting, selling insurance does not involve
financial risk of loss. Insurance underwriters, not insurance sellers, are
responsible for paying losses incurred under policies sold to the public.
In marketing insurance products, a bank does not incur liability for poli-
cyholders’ claims4 As a result, bank sales of insurance would not jeop-
ardize a bank’s capital and financial condition.
Moreover, potential commissions earned from insurance sales could
enhance bank profitability. In recent years, banks have attempted to
remain profitable by diversifying their income sources. Banks have sup-
plemented their traditional source of income-the difference between
interest earned on loans and interest paid on deposits-by charging fees
for services. Insurance commissions would offer another source of
income. To the extent that insurance sales result in more stable bank
profits, bank diversification into selling insurance could potentially
strengthen safety and soundness and protect against bank failures.
We cannot predict whether bank sales of insurance would be profitable.
Empirical studies of profits in banking and insurance selling suggest
that combining insurance selling and regular banking services could
increase the stability of overall profits. If insurance commission profits
tend to increase when loan profits decrease, overall profits would be
more stable. Nonetheless, the extent to which bank sales of insurance
could increase the stability of profits and decrease the risk of failure
depends on the bank’s management of the two operations and the types
of banking services and insurance products sold.
Not all banks will find insurance selling to be profitable. For a bank
within a holding company, profits earned by an affiliated insurance
agency may accrue to the bank holding company, and the bank itself
would be no more profitable. Also, in recent years, several banks have
abandoned insurance sales because they found it unprofitable. Reasons
mentioned for these withdrawals include the following: the banks were
not competing successfully against existing insurance sellers, they did
not develop a broad enough customer base among the customers of the
bank, and bank managers did not like customers substituting insurance
products for bank products.
4An insurance agent may be liable to policyholders for any mistakes made in selling insurance. Errors
and omissions insurance is purchased by independent agents to protect against capital losses. Any
bank selling insurance could be required by regulators to acquire similar coverage.
Page 33
GAO/GGD-90-113 Banks Selling Insurance
Chapter 3
Increased Chmpetkion for Other Sellere but
No 6uek to Banking Safety and Soundneae
While selling insurance in itself presents no risks to a bank’s capital, any
expansion into a new business presents management challenges. Safety
and soundness could be at risk if substantial management attention were
diverted from core banking responsibilities, such as managing credit
risk, to building and managing the insurance line of business. Recent
studies of bank and thrift failures found management inadequacies and
lack of adequate regulatory oversight contributed to failures. If banks
gain powers to sell all types of insurance, regulators need to ensure that
banks can manage the expanded powers. The Consumer Federation of
America suggested that banking revenues earned from general insur-
ance sales should be limited as a percentage of total income to ensure
that banking remains the principal focus of banking management.
Additional measures may be necessary to ensure that consumers do not
become confused about whether insurance products sold by a bank are
backed by federal deposit insurance and that the federal financial safety
net does not extend to an insurance agency affiliated with a bank. One
measure would be to expressly disclose to the consumer that insurance
products are underwritten by an insurance company and are not cov-
ered by banking deposit insurance.
Conclusions
Expanded bank powers to sell insurance would create a more level
playing field between banks and other depository institutions and credit
sources. The entry of banks into the insurance market would have
mixed effects on other insurance players. While insurers underwriting
products may benefit from the flexibility of another channel for
reaching customers, other insurance sellers would face increased compe-
tition from banks selling insurance.
Banks have potential competitive advantages over other insurance
sellers resulting from economies cf scope in joint production of banking
and insurance services. An insurance seller affiliated with a bank would
not only have access to bank customers and customer information but
could share overhead costs with the bank as well. These advantages are
not unique to banks, and any large-scale insurance seller has an advan-
tage over small independent agents.
However, a bank affiliated with an insurance agency could give prefer-
ential treatment to its affiliate or deny credit to competing insurance
sellers. In addition to competition and banking internal controls, regula-
tory oversight can protect against preferential treatment by a bank.
Page 34
GAO/GGIMO-113 Lhnh Selling Jnaurance
.
Chapter 8
@crewed competition for Other Sellers but
No Risk to Banking Safety and Soundness
While existing banking laws and regulations prohibit a bank from subsi-
dizing an affiliate, similar restrictions do not apply to bank subsidiaries
or departments within a bank.
Regulatory measures prohibiting joint production by banks and affili-
ated insurance agencies would prevent banks from using competitive
advantages over other sellers. However, measures such as separate
logos, offices, and staff would forestall potential benefits for consumers
by precluding economies of scope and increased convenience. If insur-
ance sales are less attractive to banks, insurance sellers would benefit
by being protected from increased competition and pressure to lower
costs. Trade-offs exist between allowing consumers to benefit from
banks selling insurance and protecting other sellers from competition by
banks. These trade-offs must be considered in deciding the degree of
joint marketing and production to allow.
Stringent measures restricting bank sales of insurance underwritten by
an unaffiliated insurance company are not warranted to protect the
bank or the safety and soundness of banking. The insurer underwriting
the policies bears the financial risk of losses under policies sold by the
bank.‘To the extent that bank sales of insurance are profitable, selling
insurance could enhance banking safety and soundness.
Page 33
GAO/GGD4O-113 Banks Selling Insurance
Appendix I
Organizations and Individuals Interviewed
Grandfathered Bank
Bank Shares, Incorporated
Holding Companies
Bremer Financial Corporation
Citizens & Southern Corporation
Crestar Financial Corporation
Dacotah Bank Holding Company
First Bank Systems, Incorporated
First Oklahoma Bancorp
First Security Corporation
First Virginia Banks, Incorporated
First Wachovia Corporation
Firstar Corporation
Nor-west Corporation
Signet Banking Corporation
United Banks of Colorado, Incorporated
Banking Industry
Organizations
American Bankers Association
Association of Bank Holding Companies
Independent Bankers Association of America
Insurance/Financial Affiliates of America
Massachusetts Bankers Association
Minnesota Bankers Association
Independent Insurance
Independent Insurance Agents of America
Agents’ Associations
Independent Insurance Agents of North Carolina
Minnesota Association of Professional Insurance Agents
National Association of Insurance Brokers
Professional Insurance Agents Association
Professional Insurance Agents of New England
Insurance Holding
Companies and
Affiliates
AIG Marketing, Incorporated, a subsidiary of American
International Group, Incorporated
Aetna Life & Casualty Company
Alfa Insurance Corporation
Allstate Insurance Company
Depositors Insurance Company, a subsidiary of Allied Group,
Incorporated
Economy Fire and Casualty Company, a subsidiary of Kemper
Corporation
GEICO Corporation
John Hancock Mutual Life Insurance Company
Page 36
GAO/GGD-3@113 Banks Selling Jnsurance
Appendix I
Chfjahatlons and Individuab Interviewed
Metropolitan Life Insurance Company
Nationwide Insurance Companies
The Prudential Insurance Company of America
State Farm Insurance Companies
Travelers Insurance Company
Insurance Industry
Organizations
American Council of Life Insurance
American Insurance Association
Health Insurance Association of America
Insurance Federation of Minnesota
Insurance Information Institute
Life Insurance Marketing and Research Association, Inc.
Massachusetts Association of Life Underwriters
National Association of Life Underwriters
Consumer Interest
Organizations
Consumer Federation of America
National Insurance Consumers Organization
Experts
Lawrence Albright, Editor, Life Insurance Selling
Joseph Belth, Professor of Insurance, Indiana University
Robert Eisenbeis, Assistant Dean for Research, University of
North Carolina at Chapel Hill
Steve Germundson, Hales Associates
Sophie M. Korczyk, Ph.D., Consultant, Analytical Services
Ken L. Williams, Author, Direct Marketing of Consumer Insurance
to Bank Customers
Page 37
GAO/GGDlUHl3 Banka Selling Insmum
Appendix II
c
Major Contributors to This Report
General Government
Lawrence D. Cluff, Assistant Director, Financial Institutions and
Markets Issues
Division, Washington,
Mitchell Rachlis, Evaluator-in-Charge
DC.
MaryLynn Sergent, Evaluator
Alfred R. Vieira, Regional Issue Manager
bston Re@ona1 Office JosephEv~s Evaluator
Gretchen Laisk, Evaluator
Y
(288261)
Page 38
GAO/GGWO-113 Banks SeUing hmnuwe.
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