Evaluating the Impact of Consolidation on the Life Insurance Industry

Notes for remarks by Richard Taylor
Acting Assistant Deputy
Director of Investigation and Research
Competition Bureau

To the Canadian Life Insurance National Conference

May 21, 1998

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Introduction

I would like to begin my presentation by thanking the conference organizers for providing me with the opportunity to address this congress.

As all of you are aware, there has been a great deal of public discussion regarding the financial services sector over the past few months. Much of this discussion has been prompted by the rapid pace of change within the sector. Factors such as globalization and evolving technologies have accelerated this pace of change. A recent article in the Globe and Mail noted that with competition intensifying and non-insurance companies gaining ground in the industry, the number of companies that offer life insurance in Canada has fallen from 160 at the end of the 1980s to 100 at the present time. In the article Raymond McFeetors, the Chief Executive Officer of London Life Insurance Co. is quoted as saying that “We believe it makes more sense to pursue integration with targets for efficiency and effectiveness...” Clearly, the point here is that the industry appears to have chosen a path of consolidation to respond to changing competitive pressures in the market. No one should find this trend particularly surprising as the life insurance industry is subject to the same forces which have led to the consolidation wave in other parts of the economy and within the financial services sector.

Of course, at the Competition Bureau, we are only too aware of the ongoing merger wave as we have the statutory responsibility to review all of the mergers to see whether they substantially lessen competition. The fact that only a minuscule number of proposed mergers do raise competition issues, suggest that, by and large, they are being undertaken for the purposes of achieving efficiency and generating shareholder value. Furthermore, many of these mergers represent a consistent response to an increasingly complex and competitive market environment.

It is important to bear in mind, however, that not all consolidations have a benign effect on the market from a competition standpoint. In a limited number of instances, competition issues arise from a merger as a result of there being too few existing competitors left to discipline the market, and minimal likelihood of new entry doing the same due to the presence of significant barriers to entry or expansion in the market.

While one of the great strengths of a market economy is its ability to adapt to change, there is a need in mixed economies to ensure that the regulatory framework which oversees the market remains adaptive, effective and clearly focussed on achieving its intended objectives. It is precisely this challenge that prompted the work of the Task Force on the Future of the Canadian Financial Services Sector.

While I have neither the time, nor the expertise, to address the broad range of challenges regarding the regulatory framework affecting the life insurance industry, I would like to say a few words about the importance of competition and , more specifically, the role of competition policy and the Competition Bureau in the context of consolidation within the life insurance industry.

The Importance of Competition

From a competition policy perspective, competition should act as the fundamental driving force of our economy. Competition within markets provides a much better vehicle than regulation for creating the incentives that encourage the development of new products, services and the methods of delivery to consumers. Competitive market forces drive the prices of goods and services toward their relative costs of production. This minimizes the misallocation of resources in the economy which in turn enhances economic welfare.

This is not to say that market intervention and regulatory oversight is not sometimes warranted. In some instances, market forces alone cannot be relied upon to meet public policy objectives. And, in these instances, the reality is that achieving these public policy objectives may come at the expense of competition. One only needs to look at the public policy objectives underlying employment to appreciate this point.

However, where regulation restricts competition, it is essential to constantly re-assess the need for the regulation and, if it is necessary, question whether it could achieve its policy objectives while being less restrictive of competition. In this regard it should be noted that the Bureau will continue its efforts to obtain greater access to the payments system for all who need it to more effectively compete and can cover off the incremental risk associated with their access.

A variety of factors and considerations are exerting pressure for regulatory reform in the financial services sector. There seems little doubt that the direction is towards a greater reliance on market forces, and the relaxation of regulation, to ensure the continued innovative, competitive and prosperous financial sector in Canada. With changes in the regulatory environment, and greater reliance on market forces, it is important that our competition policy framework legislation, and the institutions which surround it, be effective in dealing with any competition issues that may arise.

Competition Policy

At the core of Canada’s competition policy regime is the Competition Act which was enacted in 1986. The purpose of the Act is to maintain and encourage competition in Canada to promote the efficiency and adaptability of the Canadian economy. It contains substantive criminal and non-criminal provisions to deal with a broad range of anti-competitive activities.

The Director of Investigation and Research is the statutory official responsible for the administration and enforcement of the Act. The Director has responsibility for undertaking investigations to determine whether a particular form of business conduct raises an issue under the Act.

The Director does not regulate business conduct, nor does he adjudicate competition related matters. In the case of the criminal provisions of the Act, which include conspiracies to lessen or prevent competition unduly, bid rigging, price maintenance, price discrimination, and predatory pricing, as well as misleading advertising and other deceptive marketing practices, the Director refers evidence, which has been obtained, to the Attorney General of Canada who is responsible for taking appropriate action before the courts. In the case of the civil provisions of the Act, which include mergers and abuse of dominant position that substantially lessen or prevent competition, the Director has the sole authority to apply to the Competition Tribunal for remedial orders in situations where competition issues cannot or will not be resolved by the parties involved. The Tribunal has broad discretion to issue orders that it determines as necessary to overcome the effects of anti-competitive behaviour and to restore competition in markets. Such orders can include a requirement for the divestiture of assets or shares if the circumstances so warrant. Any decisions made by the Tribunal are subject to review by the appellate courts. This process ensures a transparent and impartial forum where all parties can present their arguments.

I do not want to convey the impression that ensuring compliance with the Act only involves litigation in the courts or before the Tribunal. The Competition Bureau has instituted a very comprehensive set of policies and guidelines designed to assist businesses to avoid coming into conflict with the Act. For example, our Program of Advisory opinions assists business people and their counsel by providing opinions on whether the adoption of certain business proposals would cause the initiation of an inquiry by the Director and by suggesting, where appropriate, modifications to the proposal which could be incorporated to avoid coming into conflict with the law. In addition, the Bureau has developed and published a variety of guidelines and information bulletins aimed at keeping the public better informed about our policies and approach in enforcing the Act. Our goal is to promote a proactive compliance approach aimed at ensuring maximum conformity with the law. Obtaining conformity with the law involves a continuum that begins with education and climbs the scale to guidelines, advisory opinions, information contacts, voluntary codes, settlements, consent orders , charges, guilty pleas, fines, and, at the other extreme, potential imprisonment of individuals. This approach does not mean that there will be a lenient approach available to those who engage in serious anti-competitive behaviour. The basic principle underlying our approach is that business people generally want to comply with the Act. However, if specific business people choose not to do so, the Bureau will use every tool at its disposal to resolve the situation.

To this point I have talked in general about the role of competition policy. I would like now to focus on the role the Competition Bureau plays with respect to consolidation within the life insurance industry.

Consolidation unilaterally undertaken by one institution to rationalize its operations generally does not warrant scrutiny by the Competition Bureau. Our focus is on joint-corporate activities which reshape the structure and competitive dynamic of the marketplace. These include strategic alliances, mergers and joint-ventures .

The Act has the flexibility to remedy any anti-competitive alliances, whatever form they may take, if they create, maintain or enhance market power and are likely to substantially lessen competition. While most strategic alliances will not pose a competition issue, those few that do may be scrutinized under a number of provisions of the Act that involve a test of market power. These include the provisions of the Act related to conspiracy, specialization agreements, mergers, joint ventures and abuse of dominant position.

The assessment of the competitive impact of consolidation in an industry requires an analytical approach. The Competition Bureau looks at whether activities associated with consolidation have resulted in granting a firm or firms the ability to exercise significant market power over the prices or terms or conditions of sale for any products or services.

We also look to see if the market power is attributable to some pro-competitive consequence associated with superior competitive performance.

The usual proxy for market power is whether the firm or firms in question could impose a significant non-transitory price increase (or successfully thwart the reduction of a price) in the market. Non-transitory is usually considered to be for a period of two years while a significant price increase is usually considered to be 5 per cent. It should be noted that both of these measures are only guidelines.

Superior competitive performance is usually associated with the ability of a firm or group of firms to exploit least cost methods of production distribution or other processes associated with bringing products to market.

I would like to discuss each of the provisions of the Competition Act which are applicable to business conduct associated with industry consolidation. Unfortunately, time will not permit me to do so. Therefore, I will use the remainder of my time to talk a little about the most prominent part of the Act as it relates to industry consolidation, the merger provisions.

Merger Provisions

Mergers and acquisitions are examined under the Act to determine whether they are likely to substantially lessen or prevent competition. The Bureau considers whether a merger is likely to cause harm to consumers as the result of either the

unilateral exercise of market power by the merging firms or through the increased potential, resulting from the merger, for interdependent behaviour among firms in the market.

In instances where it is determined that a merger is likely to substantially lessen or prevent competition, the Bureau considers whether the merger creates efficiencies which are unique to the transaction and which are likely to be such that they will offset the anti-competitive effect.

The first stage in the analysis of a proposed merger is a determination of the relevant markets that are likely to be affected by the transaction. This involves identifying the merged parties competitors, customers and suppliers and the geographic areas within which competition takes place.

Once product and geographic markets are identified, the Bureau calculates market shares of the merged parties. At this stage, threshold tests are applied to assist in determining whether the merger is likely to result in a substantial lessening or prevention of competition.

The Bureau is unlikely to be concerned that the merger will enhance the ability of the merging firms to unilaterally exercise market power if the sum of the pre-merger market shares of the merging parties in the relevant market is less than 35 per cent. The assumption here is that there is effective competition remaining in the market to thwart any attempt by the merged entity to exercise market power. The Bureau will not be concerned that the merger will increase the likelihood of interdependent behaviour if the pre-merger four firm concentration ratio is less than 65 per cent. Again, it is important to remember that these percentages are only guidelines.

As I previously mentioned, it has been estimated that there are approximately 100 life insurance companies in Canada. Given the magnitude of this number, while it would appear that there is room for further consolidation in the industry before the market share thresholds that I have just described would be crossed, it is important to emphasize that the Bureau’s competition analysis is done on a market by market basis. Although there are markets where almost all life insurance companies are participants, in other markets there are fewer players. Examples of the latter include individual medical and dental insurance, as well as individual disability insurance. In view of current market conditions, it is unlikely at this point in time that a merger transaction in the life insurance industry would raise competition issues across all markets. However, it is possible that divestiture of certain lines of business could be required in order to alleviate competition concerns in specific markets.

As a final point, I should note that the Bureau will not conclude that a merger is likely to substantially lessen or prevent competition solely on the basis of market share information. This would be an extremely narrow and inflexible means by which to conduct merger review. The Bureau will look at a host of other factors as part of an overall assessment to reach a determination. Section 93 of the Act sets out a series of factors that should be taken into account when reviewing a merger. These facilitate a much more balanced rule of reason approach to evaluating the competitive impact of a merger in the marketplace. One of the key factors to be considered is whether there are effective barriers to new entry into the market in question. Where barriers are very low, there is less concern over current market shares. The rationale here is that any attempts to exercise market power by the merged entity will be limited by the threat of entry by new competitors or thwarted by actual entry. In this context, it needs to be recognized that the most significant barriers in some industries have often been regulatory ones.

To sum up, I would say that mergers in your industry, as in other industries, may very well be inevitable due to competitive pressures being exerted on the marketplace. The vast majority of these mergers do not raise issues from a competition policy perspective and in some instances may very well enhance efficiency in the marketplace. Those few that do raise competition concerns will be dealt with to ensure that consumers continue to enjoy the benefits that competitive markets provide.

I hope that my comments have proven to be useful to you and I would welcome any questions or comments that you may have. I must caution you however, that it would be inappropriate for me to answer any specific questions regarding the recently proposed mergers within the financial service sector as they are currently being reviewed.

Thank you.