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What's Driving Product Convergence

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Where does “product convergence” fit into todays financial services industry?

Some say it doesnt even exist, or if it does, it is not really something to which todays professionals need to give much attention. Others see it growing in importance.

So, which is it? No-go, or grow?

First, lets distinguish product convergence from the other types of convergence that are also affecting todays financial services business. (See the chart.)

In contrast to the third type of convergence mentioned in the chart–cross-sector convergence–product convergence percolates from the bottom up.

Often, it provides simpler, more direct solutions for businesses that want to blend elements of insurance, securities and/or banking in their corporate strategies.

Indeed, products arguably are where innovation in “convergence” most often occurs. History tells us that convergence is triggered by innovation. In the financial services industry, product innovation is frequently that trigger.

One only has to look at the history of convergence between the securities, banking, and insurance industries to see product convergence in operation.

Seventy years ago Congress split the industries apart. Thirty years ago, successful steps in product innovation started a long inexorable process of pushing the industries back together. The introduction of the money market fund by Reserve Fund and the promotion of a check-writing feature by Fidelity created a powerful hybrid of securities and banking products that changed the marketplace. Merrill Lynchs introduction of its “cash management account” product accelerated the innovation and convergence even more.

Brokered deposits and certificates of deposit expanded the distribution reach of bank deposit products through securities firms. (In some minds, it also added fuel to the savings and loan debacle.) Furthermore, CDs offering returns pegged to securities indexes continued the process.

Helping all this along has been the cross-sector mergers that grabbed headlines throughout the 1990s. As you may recall, thats when many insurance, securities, and banking firms started or bought businesses in other financial service sectors. On it went until Citibank, Travelers, and Solomon Smith Barney merged and precipitated serious focus by legislators on the entire convergence movement.

Enactment of the Gramm-Leach-Bliley Act in 1999, which allows firms in the three sectors to sell one anothers products, was the inevitable result.

It didnt stop there. In the past two years, regulators finally acquiesced and codified most of the ground rules and regulatory structure for convergence by corporations. And, taking advantage of GLB, Chase Life and Annuity Company and others have started underwriting fixed annuities.

Now, although GLB paves a way for inter-sector convergence, it does not mandate the creativity that spawns new, hybrid products and product convergence. Instead, the products emerge as a result of people close to the market recognizing ways to eliminate inefficiencies, disconnects, and complexities they see in products and then moving to introduce better solutions.

Thats important to keep in mind, because the insurance industrys regulatory structure has been less affected than the banking and securities industries by GLB. Even so, convergent product innovation may well accelerate development of new models, particularly for the insurance industry.

There is precedent for that. Insurers ventured into joint manufacture of annuity products with banks a decade ago (in pre-GLB days). This broke down and redefined the respective roles of the players in new ways.

More recently, Bank of America superceded GLB altogether. It has substituted “debt cancellation” for “credit life insurance,” simplifying the solution to a marketplace need. Stepping back, this shift makes perfect sense. Given that banks have practiced the art of managing loan loss reserves (self-insuring for credit losses) literally for centuries, the bank executives must have asked at one point, why should we add an insurance product with its regulatory layer and resultant expense?

At its core, the insurance industry has historically provided guarantees and risk protection, and ancillary tax management benefits, too.

Meanwhile, ever since the Knights Templar traveled to the Crusades, banks have evolved Letters of Credit (LCs) into one of the most flexible vehicles in existence. These, too, provide guarantees and risk protection.

Over on the securities side of things, investment managers of both mutual funds and separate accounts have continued to push the product convergence envelope–by honing their services to manage taxes and tax strategies more effectively.

As you can see, product convergence marches forward in response to market demands, as interpreted by the marketing, sales, and product managers closest to the marketplace.

These demands do not respect historic roles, unneeded complication, or added layers of expense.

One might step back and ask, “How difficult could it be to offer a low expense, tax efficient portfolio service, wrapped in a LC customized to an individuals financial situation?” And then ask, “Who will take the first step? Will it be an actuary who can weigh and price risk, a corporate banker who understands the inherent flexibility of LCs, or the investment manager who can manage portfolios to drive down taxable events and exploit the lowest tax rate?”

J. Heywood E. Sloane is principal of Diversified Services Group and executive director of Bank Securities Association, both of Wayne, Pa. His e-mail is: [email protected]

Reproduced from National Underwriter Life & Health/Financial Services Edition, May 27 2002. Copyright 2002 by The National Underwriter Company in the serial publication. All rights reserved.Copyright in this article as an independent work may be held by the author.