Although all of you are in some sense in the business of predicting the future, attempting to predict where the life insurance industry will fit into the financial services world of the 21st century is particularly difficult.

The financial services business is unique in two respects: it is heavily regulated at both the state and federal levels—and its shape depends critically on the regulatory policies that these governments pursue—but these policies are very seldom of interest to the general public or the media, and even less frequently the subject of controversy in political campaigns. Thus, the regulation of financial services is something of an "insiders’ game," in which legislative and regulatory decisions are made by a relatively few individuals, and the shape of industry, and the position of the insurance business within it, will be determined ultimately by legislative action.

Under these circumstances, it would appear to be very difficult to predict the direction of developments because the real changes over time are the result of a rather obscure political process, heavily influenced by interest group politics, and highly dependent on both the personalities involved and the evolving views of the key players.

But this turns out to be true only for the details of how change is occurring. Looked at from a broad perspective, over the last 20 years there has been a clear trend toward the integration of financial services sectors that were formerly separate industries. This has certainly not been a Congressional initiative—in fact, until recently Congress has opposed it—but the result of regulators slowly responding to pressure from the regulated. Banks have been permitted, within certain limitations, to establish or combine with securities firms, and to offer various kinds of insurance; at the same time, insurance companies and securities firms have been able to acquire limited service banks and S&Ls.

There are several reasons to believe that this trend will continue. Principal among them is the fact that the three industries involved—banking, insurance and securities—has each begun to offer products that are similar to, and in some cases substitutes for, the traditional products of the others.

One of the first of these was the variable annuity, which had elements of a standard annuity contract, but looked enough like a security to require registration with the SEC. Universal life policies offer investment opportunities that compete with mutual funds. Through a CMA account, Merrill Lynch was able to offer a close substitute for a bank checking account, backed by a money market fund invested in short-term Treasury securities rather than federal deposit insurance. The Comptroller of the Currency has developed and partially implemented theories under which banks can offer as a banking product what used to be considered financial guarantee insurance. And recently, there have been publicly offered structured financings in which investors can take degrees of risk that a mortgage portfolio will prepay, or that default levels on a mortgage portfolio will reach certain levels; here, a securities product has many of the elements of a financial guaranty.

Indeed, it is becoming clear that just about any financial product can be deconstructed and reinvented as a banking product, an insurance product or a securities product. Ultimately, the only real distinction between these products is the regulatory regime under which they are perceived or designed to fall, and since this distinction is almost entirely artificial it cannot be expected to endure for very long.

In addition, the imperatives of selling services in today’s marketplace seem to reward the ability to cross-sell—that is, to offer more than one product to a customer with whom a relationship has previously been established. Thus, financial services companies are acting as though it is a significant advantage to be able to offer insurance and securities services—as well as a full range of other financial services—to a customer who is already using the firm’s banking services. Perhaps there are economies of scale, or perhaps consumers are so confused by the welter of offers with which they are bombarded that they give the benefit of the doubt to a single provider of services with which they have been generally satisfied.

Whatever the reason, there is very little likelihood that this trend will reverse. It’s difficult to think of a reason why any one of the financial services players would give up trying to win customers from the other two. So it seems likely that when banks, securities firms and insurance companies are all offering roughly the same range of products to roughly the same customers they are on their way to forming a single financial services industry. The implications of this are significant:

• Eventually, the dominant financial institution of the 21st century is likely to be a conglomerate company, offering a range of what we now categorize separately as banking, insurance and securities services. This kind of institution, which already exists in Europe, could be built around an insurance company, a bank, or a securities firm—or like Citigroup could be the result of a merger between large organizations already established in separate fields. It is also possible that this conglomerate institution could evolve into what the Europeans call a "universal bank"—a financial institution that can offer banking, insurance and securities services itself, without resort to subsidiaries—but given the pace of change in regulatory policies that will be far in the future.
  
• Whether the structure is conglomerate or universal, it will make no sense to regulate these entities functionally—that is, to have a separate regulator for the banking component, the insurance component, and the securities component. The regulation of this entity would have to be managed centrally, by a single financial services regulator. Indeed, since these three industries will be competing directly with one another, differing regulatory policies could place some industries at a competitive advantage, while inhibiting the ability of another industry to compete. In 1997, the bank regulatory authority of the Bank of England was transferred to a new Financial Services Agency, which now has responsibility for regulating banking, insurance and securities in England; similar actions have been taken in other developed countries. It is hard to believe that the Federal Reserve’s regulatory authority with respect to banks will be able to survive the conglomerate trend in financial services.
  
• Among other things, this means that serious thought will have to be given to the chartering and regulation of insurance at the federal level. As in banking, some form of state regulation could be preserved within a federally-dominated structure, but it would be very difficult to preserve exclusive state regulation in a market where banking and securities firms are able to offer substitutes for insurance products within a completely different regulatory and supervisory environment.

How would we get there from here? I noted earlier that the financial services industry is particularly subject to a kind of legislative caprice, and that the legislative changes needed to bring about significant restructurings are frequently hostage to the peculiar beliefs and prejudices of individual lawmakers and the obscure compromises of interest group politics in Washington. These factors, however, have more to do with the pace of change than with its ultimate direction. The market is more powerful over time than any legislated structure; it will force competitors to adapt to consumer desires, even though it may compel them to do things in a more costly way in order to accommodate regulatory requirements. That’s why so much change in the structure of the financial services industry has occurred despite the fact that Congress has not passed any significant deregulatory legislation in almost two decades. In effect, Congress rushes to catch up with and ratify what the market and the regulators have already done.

There is no better illustration of this than the gradual evolution in the bills that Congress has not passed in the last 15 years. In the early 1980s, for example, Congress members and Senators routinely held forth on the dangers of permitting banks to affiliate with securities firms. It was far too risky, they said, and might threaten the safety and soundness of the affiliated bank. At that time, the great fight was over whether banks—which could already underwrite municipal general obligation bonds—would also be allowed to underwrite municipal revenue bonds. Even that modest proposal did not pass. However, in the legislation currently before Congress, repeal of the affiliation restrictions of the Glass-Steagall Act—which would allow banking organizations to acquire securities firms that underwrite and deal in corporate equities and debt—is not even a matter of controversy.

When the Reagan administration proposed in the early 1980s that bank holding companies be permitted to acquire insurance companies, and that insurance companies should be able to acquire banks, Congress responded with legislation that prohibited the Federal Reserve from approving such a transaction. However, in the bills recently reported out of the House and Senate Banking Committees, permitting bank-insurance affiliations is almost the principal reason for the legislation. In a classic case of legislative catch-up, Congress must pass legislation permitting bank-insurance company combinations or Citigroup will have to divest either its banking business or its insurance business.

Finally, when the Bush administration proposed that the Bank Holding Company Act be amended so that any commercial company could acquire a bank, Congress balked at the idea that the wall between banking and commerce might be breached. In the last Congress, a provision that would have created a commercial "basket" for bank holding companies was defeated on the House floor and was not even considered in the Senate. This Congress, however, will consider changes in the Bank Holding Company Act proposed by the Banking Committees of both Houses that will permit bank holding companies also to control businesses that are "complementary" to financial activities—a term that could permit a substantial amount of commercial activity by bank holding companies if the provisions are adopted in roughly their current form. It would not be irrational to think that the principle of separating banking and commerce is now receiving respectful and necessary lip service, while Congress is moving gradually in the direction of abandoning it.

All these examples show that while legislative change in the financial services business is difficult to obtain, and often capriciously given or withheld, over time the pressures of the market’s overall direction work their will. Even while it fails to enact legislation, Congress is gradually adopting ideas that will ratify and regularize the financial industry structure that the market and the regulators have been creating.

Thus, while I can’t predict whether Congress will pass a particular provision among the current items before it, it is possible to predict fairly confidently that the insurance industry will be drawn increasingly into contact and competition with the banking and securities industries, and that eventually these currently separate industries will be viewed as one.

This is the long-term prospect for the insurance industry in the 21st Century. In the more immediate term, what will be the environment after this Congress finishes its work? For all the reasons I outlined at the outset, no one can seriously be expected to predict what Congress will actually do—if it adopts any legislation at all.

However, a consensus seems to be developing in Congress on a number of elements that would be part of a financial services reform bill in this Congress or the next, or the one after that. The fact that these items seem to be agreed does not in any sense mean that they will be enacted into law; there are many areas of disagreement, and –historically—because there is no public or press interest to pressure Congress into action on specific items, legislation fails unless a complete package acceptable to all the major players has been assembled.

The following are the major items on which there seems to be agreement:

• Banks, securities firms and insurance companies would be able to form affiliations through financial services h olding companies or bank holding companies with expanded powers. These institutions would be subject to a less intrusive form of regulation by the Federal Reserve Board than traditional bank holding companies. Thus, the structure of such an institution could consist of an insurance company controlling a bank and a securities firm, or a securities firm controlling a bank and an insurance company. But most likely, the parent company would be a holding company without operating functions, with subsidiaries engaged in securities, banking and insurance.
  
• There will be no "commercial basket" under which a financial services holding company might have been permitted to control one or more companies engaged in a limited amount of nonfinancial "commercial" activity. This seems to implement the policy of separating banking and commerce. However, financial services holding companies would be permitted to engage in activities that the Fed regards as (i) "financial in nature", (ii)"incidental" to such financial activities or (iii)"complementary" to such activities. In addition, it appears that securities firms and insurance companies that are subsidiaries of financial services holding companies will be able to control nonfinancial companies in the ordinary course of their businesses. Finally, the ownership of unitary S&Ls by commercial firms will be grandfathered, and the S&Ls already approved are permitted to be sold to other nonfinancial firms. Taken together, these authorities appear to significantly weaken the policy of separating banking and commerce.
  
• With respect to insurance, banks will not be permitted to underwrite insurance unless they were doing it before January 1, 1999; state law will be pre-empted to the extent that it restricts insurance sales by banks, but not insofar as it is intended to protect consumers in certain enumerated ways; and restrictions are placed on the sharing of insurance-related information between insurance companies and their affiliates in financial services holding companies.

While these are areas of broad agreement, the language of the Senate and House bills is not identical in each case, and action on the floor of either House—or in the House Commerce Committee, where the House bill goes next—may substantially modify any of these provisions.

Finally, there are still major areas of disagreement between the Senate and House versions, and between the Senate version and the Administration. In an unusual move, the President threatened a veto of the Senate bill as it emerged from Committee—even before it had reached the floor—because of the bill’s provision limiting the application of the Community Reinvestment Act, and limiting the power of the Comptroller of the Currency to authorize financial activities for the subsidiaries of national banks.

While it is unusual for the Banking Committees to act so early in a Congress—providing an extended period for compromise—the disagreements in certain areas such as CRA and the authority of the Comptroller of the Currency are very deep. It would not be surprising if Congress again fails to reach the necessary compromises. For example, responding to a provision in the House Banking bill that imposed huge fines on bank executives who violate CRA, Senate Banking Chairman Phil Gramm said: "There is no possibility that that’s ever going to become the law of the land as long as I live and breathe and serve in the United States Senate."

On the other hand, a political imperative for the Republicans is the enactment of legislation—they must show that they can accomplish something when they control Congress—and this may be the decisive factor in bringing about action in this Congress.