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Shaking Off Technology Paralysis

As consolidation continues throughout the financial services sector, five trends will likely affect the transformation from legacy systems to more efficient processes and technology that banks and insurers need to thrive in a global economy, according to business leaders at Unisys Corp.

“Banks and insurers need to snap out of their paralysis and move their industries forward,” says Dominick Cavuoto, president of the global financial services practice at Unisys. “Business as usual doesn’t cut it anymore. We see financial institutions breaking both physical and philosophical boundaries in how they do business. We see banks and insurers structuring businesses and using technology in new ways. The smart ones have technology as a strategic partner to achieve their vision to transformu00e2u20ac”to look at the world differently and respond faster to global trends.”

Cavuoto elaborates on the top five trends that he believes banks and insurers need to succeed in 2005 and beyond.

Greater acceptance of cooperative arrangements among competitors will emerge in both the banking and insurance industries.u00e2u20ac”In 2005 and the coming years, financial institutions will see greater acceptance of working with competitors to share nonstrategic administrative costs in such areas as insurance policy administration or payments processing. Business transformation utilities will continue to change processes to maximize efficiencies. This is especially true in areas where increasing costs in a declining market dictates a new way of doing business; for example, the new Check 21 law in the U.S. More forward-thinking strategies include sharing technology investments and retail costs to collaborate on branch locations in banking. For example, several banks can open a joint branch, where a niche customer base requires a presence but it is not cost-effective to have a full-service branch. As technology improves and more customers move to self-service, collaborative efforts in ATMs and other retail models can continue to evolve.

Business transformation utilities will further evolve and be considered as a proxy strategy for executing mergers and acquisitions.u00e2u20ac”Often companies tie mergers to gaining greater efficiency by weaning out excess sales, distribution, and technology costs to improve the balance sheet. While 2005 will continue to see consolidation, big deals may likely subside and financial institutions will look to new business models instead of traditional acquisitions. Banks and insurers may consider a “merger of processes” or acquisitions of a single line of business instead of complete companies.

Outsourced utilities, where several financial institutions share common costs in nonstrategic areas u00e2u20ac”such as check processing and image archiving or open and closed book insurance policy administrationu00e2u20ac”will continue to gain acceptance as alternative consolidation strategies in 2005 and beyond.

Industrialized, borderless fraud will grow as criminals take greater advantage of electronic, faceless channels that allow for more easy data manipulation, underscoring the need for a trusted enterprise environment for customers and partners.u00e2u20ac”Financial institutions need to transform their risk monitoring procedures to create a “fraud ecosystem” that coordinates monitoring and detection across ATM, check, online, wire, and other payment channels to better protect customers and deter thieves. As check image exchange continues to grow, digital signatures, and other security concerns will be top-of-mind in developing procedures that maximize technology, but also maintain safeguards to prevent fraud and data manipulation. With chip-and-pin technology in cards mandated in 2005 by the European Union, banks face greater security pressures and fraud challenges.

Banks will see more cross-border activity, primarily in Europe and between Mexico and the U.S.u00e2u20ac”As banks continue to react to the Abbey-Banco Santander merger, more European institutions will explore cross-border discussions, or consider cooperating in utilities, such as payment processing and insurance administration. In 2004, the formation of a payments hub in the Netherlands for paper-based processing underscored the opportunities in Europe. Other new markets include Central and Eastern European countries where economies, cultures, and needs have matured for more sophisticated banking and insurance products. Immigration trends also play a role.

Bank and insurers will see continued opportunities in greater China and Latin America for foreign and local financial institutions.u00e2u20ac”Technology will be a strong enabler to help financial institutions take advantage of deregulation in these regions, and leapfrog restrictions that legacy systems impose elsewhere around the world. Advances in online banking and other Web-based services, credit card processing, and other areas bring more agility to reap benefits in these emerging economies. Financial institutions can harness technology to respond flexibly to burgeoning economies and sophisticated needs from rising-income customers in greater China, and from dispersed economies and new products for lower-income customers in Latin America.

D&O Premiums Decline for First Time Since 1999

Tillinghast’s directors & officers (D&O) liability insurance premium index dropped 10% from 2003 to 2004, the first decline since 1999, according to the 2004 Directors & Officers Liability Survey, by the Tillinghast business of Towers Perrin. However, claim susceptibility, frequency and severity are still soaring. Tillinghast’s survey, which included 2,455 participants, is the 27th in a series of studies on D&O liability claims and insurance purchasing patterns and the most in-depth study of its type.

According to this year’s survey, much of the current softening in the D&O market is not due to a reduction in claim activity, but rather can be attributed to the entrance of new capacity. Competition is particularly fierce in excess layers for large public companies, where rates are dropping 10% to 15%. Despite the softening market, some pockets of hard market conditions remain, particularly in banking, health services, and real estate and construction. Looking at the historical data, it appears that 2003 was a turning point in the market; however, Tillinghast cautions not to expect the trend to continue.

“This soft market for D&O insurance will be shorter and less pronounced due to lower investment returns than in the 1980s when cash flow underwriting was prevalent,” said Jim Swanke, managing principal for the Strategic Risk Financing Practice. “Carriers will likely need to begin increasing rates in the short to medium term in order to maintain their return on equity.”

Capacity increased 11% to $1.5 billion in full limits from 2003, and a record number (99%) of U.S. participants reported having D&O insurance. Fewer respondents cited “cost” as the main reason for going without coverage (44% of participants in 2002 versus 26% in 2004). “The survey tells us that coverage is being offered broadly in the market, with decreased premiums, increased limits and enhancements, and fewer exclusions,” said consultant Elissa Sirovatka, who leads Tillinghast’s D&O Liability Survey program. “What’s disturbing is that this is occurring at the same time frequency and settlement costs are still rising.”

Among repeat participants, claim frequency increased 11% from 2003 to 2004 and claim susceptibility increased 6%. Average severity for repeat participants increased in three out of five claim classes, including employees/unions/physicians, competitors/suppliers/contractors, and shareholders/investors.

“The continued increase in the average cost to settle D&O claims combined with the significant number of open megaclaims makes a tough case for a sustained soft market. The claim conditions we’re seeing justify premium increases rather than decreases,” said Sirovatka.

Top sources of allegations from shareholder claimants (general breach of fiduciary duty, inadequate/inaccurate disclosure, including financial reporting and stock or other public offering) and employee claimants (discrimination and wrongful employee dismissal or termination) were the same for 2003 and 2004. Surprisingly, though, allegations citing accounting fraud also remained the same at 2%.

More than half (56%) of claims against 2004 participants are still open, which is up from 37% in last year’s survey. “The increase in open claims along with the increasing settlement costs will make it difficult for insurers to get a handle on their reserves for D&O liabilities,” said Sirovatka. “Couple this with premature pricing declines and a softening market, and insurers could be heading toward a D&O reserve shortfall if we don’t start to see more disciplined underwriting and adequate pricing.”

Bank Insurance Brokerage Fee Income Rises

Based on analyses of FDIC preliminary data, bank insurance brokerage fee income was up 21.2% year-to-date through September 30, 2004, compared to the same period in 2003, according to Michael White Associates, LLC.
Total insurance brokerage fee income in the first nine months of 2004 was $2.60 billion, up 21.2% from $2.15 billion in the first three quarters of 2003. Nine months through the year, 3,755 banks reported insurance brokerage fee income, constituting of 46.2% of all 8,129 commercial and savings banks.

Banks over $10 billion in assets had the highest participation (71.0%) in insurance activities and produced $1.91 billion in insurance brokerage fee income in three quarters in 2004, 27.9% more than the $1.49 billion they produced in the same period in 2003. These large banks accounted for 73.3% of all bank insurance brokerage fee income earned in first three quarters of 2004.

Banks under $10 billion in assets recorded $693.6 million or 26.7% of all bank insurance brokerage fee income. Four of the five bank-asset classes under $10 billion experienced increases of 5.5% to 24.1%. Only banks with assets between $100 million and $300 million recorded a decrease (-1.9%) in insurance brokerage fee income.

Nationally, the ratio of mean insurance brokerage fee income to noninterest income continued to increase to 2.5%.

Twelve of the top 15 banks exceeded that mean ratio. Four of them reported insurance brokerage fee income representing more than 30% of their noninterest income. Six of the top 15 banks had a ratio of 15% or greater.

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