Scotiabank became the second Canadian bank, after RBC, to begin selling insurance by building insurance retail operations next to their existing bank branches. The rather strange result of having adjoining retail frontage operated by the same business, but selling different products, is a means to circumvent rule not allowing banks to sell insurance out of existing bank branches.

Is this growing trend a good thing for the consumer, the shareholder and the economy as a whole?

THE CONSUMER

On the retail front, we have all heard about financial institutions wanting to capture all of our business as your “one stop” cradle to grave financial services shop. However, anecdotal evidence  suggests that customer loyalty at banks really does not pay and is there any evidence to show that the retail consumer benefits from pricing power from banking, borrowing, trading securities or buying insurance from one shop?

Granted, there are small discounts if you buy different types of product offerings under one umbrella (State Farm Insurance is known to give a discount but you have to move all your insurance to them) but why give up leverage of moving around from financial institution to financial institution if there is no corresponding monetary benefit to shopping under one roof?

More concerning, the dirty little secret of insurance sold by banks is that banks are actually selling other insurer’s products or white-labeled products. Scotiabank will be selling Sunlife products. My insurance broker once told me that, at that time, RBC insurance products were white-labeled Manulife policies. If the banks are acting as distribution channels for insurers, obviously, there are costs of sales and their margins to consider. For a business with such large over-heads as banks, the cost could be great and they will be downloaded to the consumer.

But, to defend the banks for a minute, this may also be a good move if, and only if, this starts a price war. Banks have been selling insurance for years but if they move in scale, this may trigger price movement downwards. The key, as a smart consumer, is to obtain multiple insurance quotes from the banks, insurance brokers, on-line insurance quotes using the same assumptions and determine if different distribution channels have different price structures. If they don’t, I would still purchase insurance from someone other than the banks to avoid giving up all your leverage as a consumer; rarely is the lazy consumer, the smart one.

THE SHAREHOLDER

Increasing revenue sources means increasing revenue which, hopefully, means increased earnings. However, if the banks engage in a pricing war with the insurance companies (assuming the banks underwrite their own products) and vice versa (remember that some insurance companies are beginning to build out their banking divisions as well), what’s good for the consumer is bad for the shareholder. The recent supermarket price wars are a good example of happy consumers and unhappy shareholders.

On the downside, insurance is also a tricky risk management product. Actuarial calculations on probability of payout are really educated guesses into the future. Already juggling fallout from the credit crisis, if a bank dramatically increases its insurance exposure, it may have to build greater capital ratios (both for deposits and insurance exposure) which is a drag on earnings. Once again, the question becomes how well can a bank manage risk?

THE ECONOMY

There’s a rather deafening silence in the dialogue about financial services reform- the reinstitution of the Glass-Steagall Act. This Act, passed at the height of the Great Depression in the U.S., separated banks, investment banks and insurance companies from owning one another. One justification was that traders should be barred from using bank deposits to trade; banks are supposed to limit risk on deposits and they should not allow traders to have access to deposits given their relatively riskier functionality.

The act was repealed in 1999 under intense lobbying by financial institutions. Citigroup was the most well-known institution to consolidate deposit-taking, trading and insurance functions under one financial services holding company after the repeal of the act. Citigroup also became the poster-child for the credit crisis as its large derivatives exposure and imprudent trading practices put depositers’ money at risk.

Many countries continue to prohibit the consolidation of banking and investment trading functions. The U.S. sits on the other extreme of non-regulation. Canada occupies the grey zone. A financial institution can do a bit of everything- as long as its not under the same roof (a rule only a bureaucrat could convincedly think would work in real life).

If banks become insurance juggernauts, are we exposing our deposits and insurance premiums again to traders with much higher risk tolerance than the retail consumer? Perhaps the practical regulatory solution is to mandate higher capital ratio levels on both the deposit taking and insurance side once exposures reach certain levels and limit the use of revenue derived from safer divisions by riskier functions. Certainly,  risk-taking and innovation are opposite  sides of the same coin but one wonders if such risk taking should be done with grandma’s money.