The present condition of a local insurance company (i.e. insurance carriers) – American International Assurance Company (Hong kong) when competing with banks providing insurance plan and investment plan
CHAPTER 1: INTRODUCTION
Background
As the market of goods and services had globalized, competition between firms intensified. The market can only observe improving product features, declining prices and increased channel distribution of various products without in-depth knowledge on what really happens to producers. Competitors in an industry generally face adversaries when global products are being traded within their target geographies and markets. It will entail additional marketing campaigns, more efficient production, value-adding supply chain, upgrade of quality standards, lucrative offers to big customers, creating subsidiaries and recruitment of quality human resources. As competition increases, the cost of having these strategies being executed also rise that can deplete corporate resources without any assurance that they will hedge competition or be successful. As a result, competition inflames both risks and costs to industry players including new entrants and current companies.
Hong Kong is known as one of the most developed economy in the world particularly in the Asian region. This makes a continuing flow of foreign direct investments in its financial industry. The globalization of the financial industry of Hong Kong is inevitable knowing that the country is one of the global players in manufacturing products and providing services. The particular issue that this paper is in concern is the increasing competition in the insurance sector. The rise in competition is evidenced by numerous literature citing the emergence of new trends such as business combinations and vertical integration of financial services. For example, banks are now offering insurance and investment services that are traditionally being offered by insurance companies and their agents. As explained, when firms start to enter an existing market where there are already producers who cater a particular need, adverse consequences will be applied to current companies and new entrants. This paper intends to address the issues that must be addressed by current companies (i.e. insurance carriers) to protect their market leadership or market share from new entrants (i.e. banks).
Significance of the Study
This study intends to contribute on how regulation should address the issue of business combinations and vertical integration in the financial industry where protection of insurance sector and integrity can be adversely affected. The costs and risks that can arise in the operations of pure insurance companies can be very substantial if the strategies of banks can trigger to monopolizing tendencies. In this regard, implication to regulation can be derived. The company that is sampled (i.e. AIA-Hong Kong) can also use the findings of this data to create new strategies on how to maintain their market share and leadership despite the increasing entry of local and international banks in the assurance sector. Banks can use the findings to determine any patterns that the insurance companies are using to respond to the increasing entry of banks to assurance sector. Since AIA-Hong Kong will be studies, it can bring awareness on how assurance companies plan and implement strategies to minimize adverse effect of increase in competition. Lastly, investment banks can also gain insight on how they will be impacted by the commercial banks entry to investment activities where investment banks have relative upper hand.
Approach to Investigate the Problem
Although AIA-Hong Kong is a subsidiary of AIG, a global insurance company, the study will focus on Hong Kong market. This will make the investigation simple and in-depth. The initial effort will involve reading of voluminous journals to review the relevant conclusions such as the benefits of business combinations or integration between banks and assurance/ investment companies. Literature review will be used to analyze the findings. After the financial industry and trends are clear to the researcher, there is a need to execute interview questions to employees and managers of AIA-Hong Kong. The data will build the findings section of this study where analysis, recommendations and conclusion will be implicated. Interview questions will be prepared based on prior knowledge and eminent restrictions such as cultural differences. The responses are important because they will serve as the heart of the research. It avoids blurred depiction of vision, mission and press releases of AIA-Hong Kong regarding their strategies amid bank competition because respondents are the one who bring effort to implement them in actual operations.
CHAPTER 2: LITERATURE REVIEW
Insurance versus Banking
By offering services for deposit, loan, commercial paper and letters of credit, banks provide its clients supplementary liquidity and choice of risk-taking. They do this by converting and diverting different kinds of savings (e.g. cash, property, etc.) to more lucrative form of investments. Compared to personal saving, banks can create a savings pool supported by wider information and monitoring systems that enable savers to place investment in less risky (riskier) engagements with stable (higher) returns. On the other hand, liquidity offered by insurance can provide significant gains for financial as well as legal stability. Insurance plans enable different forms of capital to minimize risks of failure and other shocks leading to accumulation of substantial and sudden costs. Life insurance diverts savings on non-productive goods to productive ones while property insurance can protect liquidity against disastrous losses.
In most cases, the interaction of banks and insurers are complementary. The specialization is where banks focus on short-term investments for small and large firms while insurers focus on long-term investments for corporate/ government bonds, mortgages and equity. There are also cases that interdependence exists. For example, banks require insurance on top of the credit which will serve as collateral (e.g. loans on residential housing) while insurers place vital concern on periodic payment capacities that are observed in bank transactions. There is the evidence that banks and insurers are distant competitors. As an illustration, insurance policies are classified as whole life absent to high liquidity offers and payment system services of bank deposits. Even there are fixed-term bank services; they do not come close to life investment services of insurers.
In less developed economies, however, the market situates banks and some insurance companies head-to-head. The high cost of insurance plans in these particular economies disables the interest of the market and sees bank savings as cheaper. These bank savings are then regarded as safety net against future risk on property loss and other potential liabilities. Often, banks and insurance companies have adopted the complementary framework leading to three major types of alliances structural models. Cross-selling agreement is an alliance model wherein participants confirm to market each other’s products to their respective customers. In most cases, however, banks sell insurance products while few cases involve the vice versa. There are potential problems in cross-selling agreements such as overlapping service channels leads to competition. This is aggravated by the non-cooperation and lack of coordination of the parties leading to conflict and hostile actions.
Further, alliance of independent partners is a structural model where parties confirm to have minority interest in each corporate share. In cases only one party enjoys this benefit, it can evidence its asymmetry and superiority in the alliance. Cross-selling agreement is almost a given provision in this type of alliance and it is rarely excluded. The last type is the control by ownership. It is a model in which control lies in either bank or insurance and even an interested third party. By choosing to be complementary entities, banks and insurers prevent direct competition as observed in developing economies. But by not choosing control by ownership, they are still at risk of competition in a predatory way. This happens when the product of insurers (banks) compete with the additional offerings of banks (insurance) in relation to the provisions of alliance.
Banking-Insurance Combinations or Bancassurance
In Europe, the development of bancassurance is divided in three stages. In 1980s, this type of bank operations is limited to certain insurance services such as consumer credit, home property and currency theft. Post-1980s enabled savings insurance into the operations which is also the time when Europe deregulated bancassurance. Finally, the 1990s started the era where banks offered insurance not only on savings but also investment and whole-life contracts. The services offered by this combined operation resulted to lucrative opportunities for customers to use relationship pricing. This enabled them to obtain banking and insurance services for a better price than engaging to two different companies for separate service.
The growth of banks offering insurance services to clients is triggered by historical longevity, deregulation, similarities, non-traditional competition, and changing of distribution channels (e.g. online) prominent in both banking and insurance industries. Earlier studies found that bank-insurance mergers resulted to increase wealth of bidders and targets approximated at 1% and 5% respectively. Other qualitative characteristics of such mergers can provide synergies, diversification and economies of scope. Diversification advantages can be derived by reduced risks particularly pertaining to lower probability of business failure. This feature is offered by insurance companies that participated to bank mergers. However, there are also studies that undermine such activities. Diversified assets are found to have less added-value compared to focused assets. The latter is eminent on horizontal integration. In addition, although risk of failure is reduced in such mergers, return on assets (ROA) had no significant changes attributed to them.
There are specific commonalities of banks and insurance carriers (i.e. carriers). They pool savings, compete for public funds and channel them in investing to capital expenditures. They have priorities and crucial emphasis on law of large numbers, economies of scale, liquidity creation and risk management. All such activities serve as basic frameworks in their strategy and decision-making. For banks, integration of insurance services is important to simplify the process of extending loans and then selling insurance to protect them. Further, although carriers have longer maturity structures in its terms and contracts compared to short-term offers in bank practice, both institutions have primary objective to manage asset-liability portfolios. It means that the reason behind such practices is directed to maximize their portfolios. Finally, their value chain is optimized as insurance brokers/ agents are diluted due to introduction of new technologies and increase geographical expansion of their branches. This propelled direct marketing with less to zero intermediary.
The impacts of bancassurance to merging parties are attached to four hypotheses; namely, information, scale economies, diversification and scope economies. These are hypotheses as they require empirical proof to formally and objectively attach to parties and establish less generalization. A specific empirical record is available for 136 bank-insurance mergers among US and non-US companies from 1997 to 2002. The research found that there is a positive abnormal return for the bidder during merger announcement reflecting its positive wealth creating impact. This advantage is attributed to the emergence of strong evidence of scope economies and weak evidence of scale economies. In-country deals, higher profit targets, and lower systematic risk are causes attached to obtaining higher bidder returns during mergers. In this case, the reduced systematic risk is attributed to diversification hypothesis although supported by weak evidence.
Information hypothesis is a bancassurance phenomenon from increased debt monitoring that can lead to higher borrower value and enhanced certification services and market signaling. In separate operations, banks and carriers have accessed to valuable information about their clients and also the market. The former holds the information concerning private deposit accounts while the latter have the non-bank debt information (i.e. information relating to capital financial market and stock exchanges). Scale economies hypothesis is the phenomenon where the combination of bank-insurance services enables broader customer base and corporate clients. Legal restrictions on underwriting maintain asset specialization between the institutions where banks pull out credit via short-term floating rate deposits while carriers via long-term fixed rate contracts. Diversification hypothesis is largely contributed by carriers as mentioned earlier. It is obtained to empirical studies that concluded that carriers have low risk than banks. However, there is no evidence that earnings are more robust in insurance industry. Lastly, scope economies hypothesis mean that bank-insurance combination can produce two or more outputs more efficiently that separate entities.
There are other catalysts of bancassurance occurrence. The US Financial Services Act of 1999 broadened bancassurance capacities in underwriting and selling insurance products. In Europe, single licensing of carriers within the region is implemented leading to mobilization of regional mergers. According to , bancassurance led to cheaper insurance premium rates and more efficient finance products and services. However, there are three main set-backs. Customers who traditionally keep bank deposits substituted life insurance savings in this position or vice versa. Second, reputation of well-known banks is exposed to carrier risks as the former is more popularly and historically-tested for client relationship based on trust. Lastly, as assets and capital of both institutions are combined, limits situated by regulators on capital requirement are easily reached that causes capacity constraints.
In a study, samples are gathered from European acquiring banks and European targeted carriers to measure the effects of risk and wealth to each party based on 1983-2004 data. The research found that acquirers had reduced systematic risks but their total risks remained constant in relation to home banking indices. This is coupled with negative and significant short abnormal returns that caused reduction in systematic risks or beta. Consequently, with lower beta and high leverage of merged firm, the wealth of shareholders is transferred to debt holders. Further, it is also found that greater synergy is obtained when the size of deal is comparatively larger than the market value of the bidder. Alternatively, the market punished bidders that overpaid for their targets. Finally, the benefits from the merger are greater when acquirers and targets are operating in geographically diverse locations. This is a partial deviation to the preceding study in US that found that in-country deals resulted to higher bidder returns.
In the US, banks-insurance mergers had developed into an interesting transformation where carriers and insurance brokers/ agents (i.e. middlemen) are appropriately classified as prospect for combinations. The role of middlemen in the US bancassurance escalated during late 1990s where large increasingly acquired small agents resulting to consolidated middlemen industry. This progress is compatible with the efforts of carriers to also consolidate in their industry and alternatively internalize the role of middlemen. Prior to these ramifications, 30% of US middlemen are composed by small agents providing risk analysis (i.e. coverage provisions) to customers and screening services for carriers. Profit targets are attained in a cyclical manner wherein they are obtained easily during hard market but difficult during soft market. This periodic value seen by carriers to agents had facilitated fee-based compensation (i.e. commissions) to arrive at reasonable profits even during soft markets as commission is a percentage of insurance sales.
However, the agency relationship of carriers and middlemen did not last long due to several reasons. The deregulation of bancassurance reduced yield on commissions which is aggravated by tighter regulation to profit margins of middlemen, rising insurance costs and introduction of new technology (i.e. internet transactions). The selling of relatively expensive insurance became difficult while internet provided efficient services to customers through direct contact with carriers. Due to these, consolidation in middlemen industry began and predation of carrier roles by large agents followed. As competition between traditional partners is gradually initiated, bancassurance had developed into two broad options. Negotiating banks can choose either middlemen or carriers for the purpose of merger.
Middlemen are traditionally focused on distribution while carriers are on underwriting insurance products/ services. In the interest of merging banks, there are several and distinct advantages of preferring the former. The combination can result to expansion of non-interest revenues (i.e. fee incomes) which is used to diversify risks on net interest rate without sacrificing profitability. Economies of scope can also be obtained wherein middlemen can increase customer base that are customarily bank-based clients, the geographical dispersion of bank branches can augment middlemen channels and bank employees can serve as agents themselves. Another, the merger can create one-stop banking to the benefit of banks. Middle-income bank clients that are traditionally not interested in insurance services can have heightened interest from the merger supported by reputation that is built by banks in previous transactions. Finally, banks can choose whether to create insurance subsidiary or simply act as agent for carriers depending on their strategy.
In the study that sampled mergers and acquisitions of US middlemen industry from 1990 to 2005, the investigation is focused on comparing abnormal stock returns from consolidation between agents, vertical integration between carriers and agents, and bancassurance between banks and agents. It is found that middlemen consolidation can provide wealth effects to shareholders. This is stronger when shareholders of banks merge to them creating bancassurance. In the contrary, vertical integration between property-casualty insurance carriers and agents did not provide significant wealth gains. This phenomenon is possible largely due to the defensive nature of such strategy against middlemen concentration and competing banks. As banks can easily internalize life-health than property-casualty services, mergers and acquisitions (M&A) of banks to agents of the latter led to larger abnormal returns than M&A to agents of the former. Also, distribution of property-casualty insurance can minimize the risks of bank revenues with non-interest fee income and aid in enhancing bank’s performance indicators. Lastly, it is found that large banks entering bancassurance experienced diseconomies of scope and smaller abnormal returns compared to smaller banks. This indicated the size effect or possibility of outweighing scope economies by the scope diseconomies.
Banking-Investment Combinations or Universal Banking
In the US, regulation on bank-investment combination are intended to assure protection of the high value consulting abilities of investment banks and prevention of taking substantial risks by commercial ones. Before the Glass-Steagall Act of 2000 is launched totally banning bank-investment integration, the bank-investment service operations in the US under a more lenient Glass-Steagall version in 1970s and 1980s are forecasted for piecemeal reunification. The Act under these earlier periods is argued to have substantial flaws in which not only commercial and investment banks had exploited but also the legal profession. Although the current regulation put bold measures to eradicate these loopholes, it is useful to discuss the history of bank-investment services industry. There are two main flaws of the pre-2000 Act. With respect to commercial banks, there are no barring of underwriting instrument of Federal Government and general obligation bonds extended by states or municipalities and exemption of foreign securities.
As the primary function of commercial banks is for depository and credit, the loopholes provided attractive opportunities to them to enter investment banking albeit excessive risks to potential investment clients and more importantly depositors. However, these adversaries are partially traded-off by several benefits not only to commercial banks but also to entire economy. Using 1975-1984 data, it is found that security underwriters (16.2%) and investment banks (21.5%) have higher return on equity (ROE) than commercial banks (12.3%). The entry of commercial banks to investment banking can improve this profitability measure. In analyzing 1985 data, findings showed that high salaries and profit-sharing schemes enjoyed by employees of investment banks can be concealed if competition increases leading to compress investment banking sector. Clients can afford relatively cheaper investment service. Commercial banks can also re-use and optimize their risk evaluation skills and experience on loan grants for underwriting works. Prominent advantage in bancassurance, the network of relationship eminent in commercial banking including the domestic government and corporate clients abroad can be transferred to investing business.
Further, as experienced by absence of restriction in Europe reflected in Glass-Steagall, securities and investment markets can enjoy lower underwriting spreads fees due to increased competition. The evidence is Europe’s lower concentration ratio (i.e. market share) in its five firm Eurobond market. When such costs are reduced, the economy is in better position to prosper due to increased capital expenditure from government and corporations. Primary beneficiaries of this cost reduction are customers of merger advisory services as this business area is where the bulk of earnings of investment banks are derived (i.e. far larger than underwriting contribution) due to its unique value-added and knowledge-based features. By allowing bank-investment services, US financial industry can improve because companies will channel their funds directly in New York and not the more lenient London market. For commercial banks, the argument that entering investment services can lead to substantial risks is undermined by the fact that underwritten assets last only for days while default on loan can proceed until the due date is reached. Also, loans are more illiquid than deals in underwriting.
Lucrative prices on investment services that commercial banks can offer to their large customer base are a win-win situation to commercial banks, their clients and competition in investment banking. These are the motivation why commercial banks in the US find ways to circumnavigate the loopholes of Glass-Steagall in pre-2000 version. In contrast, risks of combination to commercial banks are hypothesized into two categories; namely, risk to conflict of interest and affiliation risk. The former is observed when combination leads to commercial banks extending credit to finance purchases of securities to support the underwriting affiliate. The latter is a condition wherein the historically-proven steady earnings of commercial banks can be adversely affected by high earnings variability from an underwriting affiliate. Commercial banks have minimal experience in trading activities that can aggravate the inherent risks.
In other studies, the differences and incompatibilities of bank-investment integration are further categorized in three hypotheses. Bank certification hypothesis states that bank-investment services executed by commercial banks reduced information costs and lead to improve financing option to clients. Conflict of interest hypothesis states that commercial banks can misuse this superior information to shift bad debts/ loans to capital markets. Finally, distribution disadvantage hypothesis states that commercial banks are new participant to investment banking that time and funding is required to construct its own distribution channels. This delay and additional expenditure can harm the interest of large clients especially in integrated services. However, commercial and investment bank mergers are unstoppable particularly in 1996 when revenues allowed to commercial banks are increased from 10% to 25%.
Before recent studies, prominence is applied to the notion that commercial banks are better underwriters than investment banks derived from the former practice to underwrite bonds with lower net yields. In contrast, such tendency is attributed to client-underwriting matching wherein both institutions have their own market base that has specific needs. A specific research is conducted on the data from non-utility and non-financial underwriting clients for the period 1991-2000 contradicted the earlier notions about superiority of commercial banks. Consistent with bank certification hypothesis, most of the clients of commercial banks are small firms. The rationale behind this inclination is that flexible future financing is enjoyed by commercial banks when offering service to low cash holding and less capital investment needs of small firms. Consistent to conflict of interest hypothesis, clients of commercial banks with high interest expense resulted in payment for higher net yield to repay bank debts. With superior better information, commercial banks can easily trashed clients to capital market than offering new loan. Consistent to distribution disadvantage hypothesis, the target of commercial banks are size with smaller issues particularly during early entry. Subsequently, clients will pay greater yields when the size of the issue increases in the long-run.
It is also found that the absence of positive net yield differential from commercial bank clients supported the non-dominance of commercial banks in terms of technology or human resource contrary to investment banks. The study found that specific market needs drive market share of each institution. The research implicated that its findings would serve as evidence for both institutions to serve different market segments in domestic environment while operating in cross-border setting can also be tapped. Their separation is also supported because they exist to provide valuable and unique services to their specified markets. As illustration, the upper-hand of commercial banks to provide loan monitoring and effective certification of bond issue is attracted to some firms. This option can intensify preference during re-certification as it is found to create positive market reaction to re-certified firms. On the other hand, investment banks can serve as safety net of firms to prevent private loans to be dumped in capital markets when commercial banks uncovered negative information in its evaluation. Without significant economies of scope from this practice (i.e. lemon-dumping behavior) of the latter institution, the dumped securities of client-firms will be heavily discounted by the market.
The amendments in Glass-Steagall Act in 2000 brought the final solution to the risks in bank-investment combinations by completely disallowing the integration of two services. In the current setting, however, investment banks are threatened by growing appeal of commercial and universal banks. For example, the spin-off of Agere Systems from Lucent Technologies which is formerly administered by Goldman Sachs (i.e. an investment bank) is transferred to J.P. Morgan Chase, Citigroup and Morgan Stanley (i.e. universal banks). The main cause of the transfer is the inability of Goldman to provide credit as additional service to investment consultancy. On the other hand, as multi-service banks, the three universal banks offered purchase of .6 Billion of Lucent debts as well as loan of .23 Billion. In this regard, it is concluded that the competitive position of investment banks relies on its ability to sacrifice as much as 30% of its ROE for the purpose of credit capabilities or merge with commercial banks outside US territory.
In dispute of this argument, there are also cases where expertise and skills outweighed credit offerings supporting the continuous market prominence of investment banks. As an illustration, J.P. Morgan Chase and UBS are focused on investment-grade and high yield debt, Citigroup only on high-yield debt issues while Deutsche Bank prioritizes investment-grade debt sector. This shows that universal and investment banks have specific market segments which supported the findings of 1991-2000 analysis of US non-utility and non-financial underwriting clients above. Further, investment banks undermine the debt capacity of commercial banks this service is the simplest investment issue. Most of their clients trust them to address more sophisticated issues such as M&A and initial public offering (IPO) deals. Universal banks also had increased its market share not because of competition but from acquisitions of value-adding banks offering services that inflamed synergies. In the case of Lucent spin-off, qualities of commercial and universal banks are preferred as the company needed interference in IPO and equity support. The linking of spin-off to new funding is triggered by economic downturn and subsequent credit requirements. Commercial and universal bank preference is argued to cease once credit crunch is ended and expertise will matter most in M&A and IPO making credit capabilities only sweetening to key competencies of investment banks.
There are also researches that found overstatements in integration of commercial and investment combinations in post-2000 Glass-Steagall Act. Unlike small firms and individual clients, large corporations do not require one-stop banking rather preferred specialization among service providers to select the best breed. Bank-investment clients are also prone to end-up as riskiest borrowers. Third, the provision of credit grants to clients simply outstrips the service fees that such combinations derive from investment banking services. The new Basel Capital Accord is also a threat to syndicated loans exploited by bank-investment combinations due to restrictions to maintain higher capital requirement for low-rated borrowers to enable matching of risks. Finally, as universal banks have larger underwriting experience than commercial ones, it is recommended that they should increase credit ability and improve underwriting skills to compete with investment banks. For commercial banks, integration to investment banking is recommended to be fully-revisited due to regulation and questionable synergy. For investment banks, it is recommended that they should not shift focus from superior authority in underwriting and advisory skills to credit capabilities because their service still holds the most lucrative areas in financial services industry.
Comparative Risks of Banks, Security Companies and Insurance Firms
Position risk is the combination of market and asset liquidity risk. Market risk could arise if a loss occurs in the on- and off-balance-sheet performance of the entity due to market price volatility. Asset liquidity risk could arise when there is an inability to loosen financial instrument position in a level near its market value due to lack of depth or market interruption of the particular instrument. In general, significant position risk in relation to the capacity of the three institutions can hurt them and even lead to their dissolution. Lists of institutions that experienced the full adverse impact of position risk are Franklin National Bank, Pipper Jaffray, Credit Lyonnais, Allied Irish Bank and numerous institutions that faced losses in trade.
For securities firms, the position risk is more important issue to them as their principal activities involved trading of securities in an open market. For global, active and large banks, security trading attracted them because customer’s substituted capital markets against banks loans. Therefore, position risk is acquired by these banks. For insurance firms, position risk is derived from underwriting risk or the risk that they will default in paying policyholders. Although technical provisions are protected by regulation to prevent non-payment, insurance firms exposed their investment premiums to position risks limiting their additional capacity to execute contractual duties.
Regulators in these three institutions, as mentioned, protect consumers from the substantial risks inherent to the latter. Regulations also serve as protection against planned or unintended exploitation of consumer’s vulnerabilities. Consumers are vulnerable because they pay for benefits that will be received in the future with the handicap of asymmetric information. This caused them to select incompetent, dishonest and fraudulent institutions unconsciously. As a result, regulators use capital requirements to the three institutions to assure that their promises are backed up by minimum level of resources that can be used in case of upcoming default. Apparently, when institutions have inherently higher position risks, they are applied with more sensitive capital requirement provisions to protect depositors, investors and policyholders.
In regulatory definition, systematic risk could arise when there is an abrupt and unanticipated shock can affect economic activities of the whole economy. This is triggered because there is an assumption that shareholders of financial institutions will not put concern on social adversaries of systematic risk on top of their self-interests that reducing capital is a common practice. The three institutions vary the degree of regulation to minimize the economic-wide adversaries of building significant level of systematic risk.
Banks are the primary source of systematic risk as they are central in the payment and resource allocation mechanisms considering their fragile capital structures. They maintain portfolios which have first-come and first-serve short-term deposit liabilities, illiquid loan assets and high degree of debt. As a result, they are also the main institution that is expected to receive vulnerable confidence from clients. Self-fulfilling prophecies are the motivating factor for client decision to withdraw their interests. For example, when no one believes that there is a bank run, withdrawal only occurs when liquidity is needed. However, when everyone believes a bank run is coming, clients will race in liquidating their deposits to prevent adverse effect from bank’s perceived adverse position.
Regulation can prevent an ensuing bank crisis through capital regulation such as the capital can serve as barrier against loss and the capital as incentive-reducing factor for banks to take substantial risks. Further, regulation can be more effective when there is a group-wide view rather entity-to-entity as it prevents multiple gearing to prevent inappropriate increase in equity. The group wide-view to regulation does not apply to securities firms instead to broker-dealer only due to four reasons. Negative news will not create crisis because the assets of the firm is separated from the assets of the clients and there is easy and non-service disrupting transfer of assets to other firms. They carry dated debt instruments that are not affected by self-fulfilling prophecies. They possess more liquid resources and assets traded in daily basis which mitigate the asymmetric issues because transparency is eminent. Lastly, they pass the responsibility for payment systems to banks that they avoid large value payments. As illustration, the bankruptcy of Drexel Burnham Lambert Group in the US is unwind with minimal disruption of services in transferring process, slight and speedy repelling of flight to quality and even end-up with Dow Jones index increases. As a result, systematic risk is less of an issue to securities institutions.
Also, unlike banks, insurance institutions do not place substantial concern to systematic risk. This is because failure of few of these institutions does not create spillover effects to their group, insurance industry and wider financial markets. In effect, entity-to-entity capital regulation is the same as security companies. The liability structure of insurance companies is irrelevant for first-come and first-serve demand liabilities. This does not incur loss of confidence partly because they are not force to sudden liquidation of assets to meet demands of policyholders. Insurance claims have periodic schedules of disbursement (e.g. life insurance plans), can be paid slowly and can be delayed pending investigation (e.g. property and casualty insurance plans). As a result, insurance companies can prevent losses from fire-sale in asset liquidation and exposing their assets in markets that offer undervalued quotes.
CHAPTER 3: HYPOTHESIS
Hypothesis 1: In a developed economy, insurance carriers and banks offers products that are more complementary than competitive where alliance model is based on cross-selling agreement rather than control by ownership. As insurance and banking companies are not substitutes, there are minimal costs and risks that AIA-Hong Kong is facing.
Hypothesis 2: With stricter capital requirement and group-view evaluation to banks, they cannot enter mergers and acquisitions easily where internalization of insurance and investment businesses is an alternative action. Therefore, competing with a global mindset can increase competency of AIA-Hong Kong against threats from bank competition because banks do not have the same incentive as insurance carriers when it comes to global resource network.
Hypothesis 3: For bancassurance to be more competitive than carriers, banks should merge with consolidated agents, their market values should be higher than the deal and they are entering a deal as medium-sized banks. If these conditions are met, AIA must increase aggressiveness in Hong Kong market to compete effectively.
Hypothesis 4: For universal banks (i.e. bank-investment) to be more competitive than carriers, they should provide loan in addition to advisory services, the economy is under credit-crunch, focus are small companies as market, and continuously improving their underwriting capabilities. If these conditions are met, AIA must increase aggressiveness in Hong Kong market to compete effectively.
CHAPTER 4: METHODOLOGY
This chapter provides information on the description of the methods and procedures that were conceptualized and constructed in order to obtain the needed data and information that will be most useful to the study. Details on how the accumulated data were analyzed and interpreted as well as how the conclusion was drawn is discussed in full extent in this section. This provides justification of the means in which the study was accomplished and at the same time helps in giving purpose and strength to the validity and reliability of the collected information that makes this particular research practice truthful and analytic.
Specifically, this research chapter will cover the following discussions: the research design, the conceptual framework, the participants of the study, the methods used in accomplishing the study, the sampling technique utilized, the statistical treatment used, the validity and reliability of the collected data, the research instruments for data collection, execution of the data collection procedures and administration of the research instruments and the logic and systematic data presentation and analysis. The last discussion provides the summary of the steps and actions that were completed during the duration of the data collection period.
Research Design
Triangulation through the utilization of both the qualitative and the quantitative research methods were used for the completion of this research activity. On one hand, qualitative research constitutes a method used to derive detailed oral and written descriptions or accounts of things, objects, cases and situations. ( and , 2006; , 2004; , 1999) This approach applies to the study because this supports the collection of wide-ranging research data on the non-measurable aspects of the study such as the experiences of the different departments in utilizing performance measurement systems to assess their implementation of e-Government initiatives and make improvements to enhance IT-based public service delivery.
On the other hand, quantitative research applies deduction because it develops and tests theories. As such, this type of research approach leads to generalized outcomes. Moreover, quantitative research also involves treatment of quantifiable and measurable data. (, & , 1998) This method also finds application in the current research because it seeks to derive performance measures constituting quantifiable data from gathering the results of the performance measures used by the departments implementing e-Government initiatives. In addition, the study seeks to achieve reliable data to support generalizations and the quantitative method contributes reliable data.
Combining these methods happens through the integration of the quality of the information gathered together with the quantitative characteristics of data available to the researcher to achieve both research validity and credibility with qualitative and quantitative data supporting the analyses and conclusions. (, 1992; & , 1997) Even if the relevant aspects of the research study are characterized and classified as qualitative elements standard measures that enabled quantification of the concepts will meet the qualitative and quantitative information needs of the project. These include the organizational behavior in each selected department as well as the attitudes, opinions, and beliefs of the respondents and participants of the study. Both qualitative data such as descriptions, accounts and perceptions was collected together with results of the performance measures to come-up with wide-ranging or comprehensive data on the utilization of performance measures to assess e-Government initiatives.
The exploratory research design also served as the guiding framework for the execution of the entire research project. Exploratory research normally involves open-ended studies, guided by existing and relevant theory and intended to provide a new body of empirical knowledge from which theories might be postulated (, 2003:, , 2002: & ). As such, the case study research approach provided the appropriate methodology since the study calls for the need to conduct a holistic, in-depth investigation of the topic presented (, & , 1991). This contributed to the knowledge of individual, group, organizational, social, political, and related phenomena being studied (, 2003).
Validity, Reliability and Reflexivity Issues
In triangulating quantitative and qualitative methods, the issues of validity and reliability find link. Validity to the trustworthiness of data or the extent that measures are able to handle constructs intended to be covered. (, 1996; , 2000) In quantitative research, the researcher affects the achievement of constructs through the introduction of variable measures. This degree of involvement of the researcher decreases the level of validity in quantitative research. In qualitative research, the researcher studies a phenomenon while it occurs naturally so that there is a higher level of trustworthiness in the qualitative data collected.
Reliability pertains to consistency or accuracy of data collected that allows repetition. Higher levels of reliability exist when lesser bias intervenes in the data gathering process. In quantitative research, the measures or instruments comprise the primary mode of data collection resulting to lesser researcher bias and greater repeatability. In qualitative research, the researcher constitutes the primary mode of data collection and acts as repository of data so that there is a greater level of bias occurring in the data gathering resulting to lower degree of repeatability. This implies that the core strength of quantitative method is reliability while that of the qualitative method is validity. Since both validity and reliability constitute important factors in this study, utilizing the triangulation approach enables the research to offset the weakness of the quantitative approach with the strength of the qualitative approach and vice versa. This further means that through triangulation, both validity and reliability are ensured in the research.
Reflexivity pertains to the recognition of the role that the researcher plays in deriving meaning from the data gathered in the research process. and (1999) explain that the issue of reflexivity encourages the researcher to “explore the ways in which a researcher’s involvement with a particular study influences, acts upon and informs such research” (). This leads to divergent implications. On one hand, the involvement of the researchers could support accuracy in data collection and analyses such as through an insider or in-depth understanding of issues arising from the research topic. On the other hand, involvement could also unduly influence the results of the study. The research addressed the negative implication of reflexivity by ensuring that interpretation and derivation of meaning are always based and consistent with theoretical and empirical data.
CHAPTER 5: FINDINGS
Planning is decentralized to general managers of each division including strategy formulation and operations. They set their own targets together with other subordinates. They work for months initially determining SWOT in the external environment and capital expenditure required to exploit or mitigate them. Afterwards, the ideology of cost-reduction goals and oftentimes a way of life in the firm is formulated and this gives managers the pro-active view of what activities are done in the coming year to align in its firm culture.
Strategic guidelines in planning and budgeting are followed. First, employee involvement is aimed for managers to get useful information from different sources and at the same time create a mechanism wherein resistance to change could be minimized. Second, competitive position is protected through continuous improvement in the value chain, assessing their resources and capabilities with rivals and product innovation. Finally, prudence in capital expenditure would give the planners rationalized trade-offs between investments (improvement) and accompanying costs (departure to cost-reduction culture).
Crucial to the firm is to achieve the designed results through rigorous planning and tight control. With this, they can shape the future as they have intended while profitability is considered merely a state of mind not a chance. Also, how they determine the results is largely dependent on operational level where long-run performance is deemed to stem. While the firm does not have complex business papers to reflect their plans, simplicity would fill the gap as it will foster discipline to employees driving them to pre-determined objectives and work practicality.
As observed, AIA (Hong Kong) has been able to minimize complexity of planning and to remain objective in installing goals. The most knowledgeable, proximate and concerned people relative to resource and capabilities are the ones who will allocate resources. These results to less effort and time devoted to arrive at reasonable forecast of future results. Whatever the information they would use (cash, accrual or modified accrual) and template or software to be utilized, operating budget emerged through the minds of those who experienced budget shortage/ surpluses and who applied certain contingencies on emergency situations. Thus, only objective matters rather subjective or gut-feel are inputted to determine financial results. With this, determining the reserve budget need not be outsourced to an engineering firm while future revenues/ expenses are easily deciphered from the past year. As a result, there will be optimal resolution to avoid revamping that could arise in special assessments.
However, there are also loopholes in simplicity and cost-reduction scheme of the firm. First, since their major concern is scanning the industry and competitive environment, decentralization may increase research and monitoring costs for detriment of consolidated efficiency. Second, cost-reduction culture and emphasis on short-term gains could impede innovation and value-adding activities that could result in imitable competitive advantage as cost-cutting and price based competition have lower switching costs than value based ones. Lastly, oversimplification of setting annual budget would shift the manager strategies towards practical approach to recognize contingency opportunities/ threats that is risky for the division’s contribution to the whole organization.
Of course, the headquarters (HQ) is there to signal and apprehend the concerned division about symptoms of departing to activities determined in budget planning to arrive at results so these loopholes can be easily resolved. However, it is questionable that they can always decode what is in each manager’s heads. As a result, the picture seen by HQ could be myopic that instead of enhancing the focus of the division to its goals would rather annoy and confused managers. It is not disclosed how strict is the strict monitoring of HQ and what disciplinary actions would be resorted but our concern is a definitive structure that would lessen incidence of failure notification from HQ to division managers. With short-term operational lens applied, increase reliance to financial assets would undermine intangible resources such as human capital, innovation and reputation.
Apparently, the CEO’s belief to natural efficiency across the firm’s divisions has its trade-offs. Without caution, competitive advantage can only be sub-optimal. It can is also observable that some of its planning guidelines are in conflict like being competitive with financial prudence and decentralization initially but party centralization in execution as HQ monitors the implementation of each division. As a result, there is a need to fill these gaps by providing a clearer border line between HQ oversight and managerial flexibility using budgeting techniques from academic sources and best practices.
It can be argued that AIA (Hong Kong) would likely use the line item budget to adhere in its simplicity. However, it does not show what key activities or programs of the firm will undertake that makes the HQ monitoring of division operations more unpredictable since both units do not have the map to guide their actions (divisions) and reactions (HQ). Aggravatingly, performance evaluation would highly depend on the level of periodical expenses since results in the annual budget for a specific activity is not indicated. Uncertainty of numbered results would basically make the budget yardstick futile.
Performance budget can ease the pressure of HQ to invest in monitoring mechanisms to safeguard division’s adherence to their determined budget and results. The system will highlight key activities or those with relatively higher investment and crucial results providing the HQ key areas to look at. This could finally infuse strategic planning to the firm in order for specific steps back-up the objectivity of a certain project. Day-to-day operations oversight will be minimized instead diverting monitoring endeavors to the long-range actions and responses of division managers including their contingency decisions. Also, indirect cost of follow-up by HQ will be prevented like managerial demoralization leading to decrease in productivity due to frequent inquiry of HQ officials when an activity is done (incurring cost) without its presence in the determined annual budget.
As divisions can overcome cost-reduction culture through research supported activities, innovation will not be neglected primarily because of supply-side cognition of making budget. They can also transfer the additional or increased financing of a major activity like product development, against trade-off in minor activity like firm funded parties. Priority areas are highlighted due to existence of target outputs and their costs. As a result, managers can easily evaluate possible manipulation of operational areas financing for firm to bear the value-adding and sustainable feature of strategic planning. In effect, cost-reduction would not limit growth of the firm instead provide it the platform to efficiently use its resources and improve its capabilities in view of its valuable contribution in allowing them to manipulate the flexibility of internal activities in favor of exploiting opportunities from the environment.
Contingency decisions during the operational year of division managers could also be limited and rationalized by the system. The budget ceiling implored in contingency account and its desired results, possibly mitigating the effects of an abrupt competitive wide-scale advertisement, will give the HQ and division managers the objective benchmark in which to base their actions-reactions. Of course, the HQ wants to protect shareholders and long-term stability of the whole organization. On the other hand, divisions intend to show performance that can differentiate them from other division and possibly get a higher budget for the succeeding fiscal year. The system will enable HQ and divisions to lobby their oftentimes conflicting goals of agency relationship in financial terms, thus, preventing them to argue in objective terms in case one request departure to the original budget due to unforeseen events (failure to reach quarterly sales quota due to increase in imported raw material costs).
Further, interviews with the managers of AIA showed that due to the minimal intervention of the government and authorities in corporate transactions, recent consolidations of banks with large insurance agents in higher acquisition/ merger deals. However, these banks are also large that minimize the potential of the combination. With regards to the competitiveness of investment banks, they provide loans and advisory services under the credit-crunch and active economy. However, the managers of AIA (Hong Kong) did not know whether the focus market of investment banks for its insurance services are small companies or are there any efforts to increase their underwriting skills.
CHAPTER 6: DATA ANALYSIS
With this information, hypothesis 1 is reflected in the interviews with the managers. AIA (Hong Kong) resorted to use local planning in preparing its budgets and strategies for the market within its scope and jurisdiction. It can afford to do so because of minimal cost and risk that it would receive using such tactic. The open and well-developed of Hong Kong economy aided AIA to minimize dependence on economies of scale and sharing resources with its global partners, network and headquarters. Even tough there are no data that are presented concerning the presence or absence of alliance model, it is an important finding that insurance and bank companies in the country are complementary. Due to this, AIA (Hong Kong) is more focused on how it will localize its products rather than to maximize its global network of resources.
Hypothesis 2 is not in effect to the findings. AIA (Hong Kong) did not use global strategy to complete in the local market. It did not exploit the incentive to use global network of resources to further diminish the intervention of banks in insurance industry. AIA (Hong Kong) is completing against bank competitors head-to-head according to local resources and local knowledge. Perhaps, the goal of divisional budgeting and strategic planning is to replace sharing of resources from the global portfolio of AIG with the ability of AIA (Hong Kong) to maintain accuracy of cost and revenue forecasts. By setting them in realistic targets, the company can reduce mistakes of overspending and therefore can have the same cost-savings it can derive through economies of scale or using its global resources within the local needs.
Hypothesis 3 is addressed by supplying the information from manager interviews that although banks had recently merged with larger insurance agents under high deals these banks are also large-international companies. As a result, the merger are exposed to legal requirements that may undermine any advantages derive from the combination. Litigation can also disrupt bank reputation as it can create domino and self-prophesizing effect from its clients when the news about its inability to maintain the merger advantages leak. This situation is favorable to the current strategy of AIA (Hong Kong) in which it did not prefer to integrate its planning and allocation of resources with global AIG.
Lastly, hypothesis 4 is in the same position as hypothesis 3 since two conditions are not met. Therefore, AIA (Hong Kong) can continue its local strategy without loosing competitive advantage since universal banks do not have a clear progress in its underwriting skills and they are not focusing in small companies. This imply that the larger and more important clients are giving their trust in the name of AIA (Hong Kong) and other large insurance companies that has focus in providing insurance services.
CHAPTER 7: RECOMMENDATIONS
Strategic Options for AIA (Hong Kong)
Global functional structure is intended to integrate the functional departments of the company in the areas of production, marketing, finance, etc. This structure is lucrative for companies that has products/ services that does not face fierce and numerous competition, has market leadership and able to innovate ahead of competition. These features are very important for the company that is integrated by departmental functions because once competition delivers greater amount of innovation it will benefits of the strategy below its costs. Simply put, the lack of flexibility and local responsiveness in this structure overtakes the economies of scale and functional specialization because the market has a relative choice that can deliver their needs. Therefore, brand image is the most important aspect of this structure as it posts loyalty that can reduce competitive attacks on the company’s leadership.
Global product or divisional structure address the shortcomings of the functional structure especially when global markets are dispersed that require diversified product lines and different technologies. Although undermine economies of scale, its primary advantage is rapid growth in a specific market segment that can involve partly economies of scale especially when market characteristics are similar in more different countries. The strategic business unit (SBU) will concentrate on the needed response to specific markets by having its own functional design. As the design is intended to solve recurring improvements, markets are not only created but also maintained.
Global geographic structure is concerned with regional clustering of markets in different countries where marketing strategies are top priority. The product/ service do not necessarily designed to response to the needs of a particular market rather select a particular country which can absorb or accept their product/ service. The focus is trying to get the market base on strategic selection on where to introduce the product then subsequent marketing campaigns to solicit customer loyalty. Therefore, innovativeness is undermined by market knowledge, which is, determining the first the nature of the strategic problem before making a strategy on largely marketing aspect. As a result, market research and substantial marketing will serve as costs while simplicity in structure without the need of sharing resources and responding to local needs are the potential benefits.
A matrix structure is the combination of the three structures that is described as very complex and hard to implement in reality. In this structure, the functional, responsiveness and geographic characteristics of the earlier structures are integrated to come-up with an optimal strategy. However, this structure can pose managerial and accountability problems since there are to much supervisors in the organizational structure. They are scattered in the global management to administer innovation, responsiveness and geographic issues.
CHAPTER 8: CONCLUSION
The decision to embark in multinational investments is proved to be satisfied by major motivational theories. Our discussion shows that some of them are partial explanatory models and there is a need for critical thinking, theoretical knowledge and case evidence to be able to come up with a more consistent model that best describes corporate motivation. As observed, both resource-based and network theories play considerable roles in influencing multinational companies’ decision to geographically expand operations. This can be the reason behind long-run profit-maximizing goal of the firm as well as adaptive requirements of host countries. Generally, these two decision factors are at the fore in determining strengths and opportunities as well as the weaknesses and threats of a cross border investment.
Due to fast-phased and busy environment people are living, there is a need for a more convenient and easy-to-understand insurance policies that make the role of e-commerce crucial to bank assurance. The use of technology, however, is not fully tapped and banks should have initiative to apply it before customers can appreciate. The success of insurer Zurich and broker transformed the innovative feat of global banks that created Identrus into a promising and profitable banking technology for the future.
In view of the prospects of information technology, the challenge for banks to diversify into insurance provision developed the context strategy. Most insurance companies were found not in the good position to adopt e-commerce and combine it with their profitable personalized and dynamic selling skills. Banks are relatively compatible with the web requirements that place them in the spot to extend insurance service through expansion or alliances and integrating the use of internet for carrying the business. Alliances with insurance companies are said to provide cost and security advantages than banks handling its own insurance service.
When a bank has already allied with a certain insurance company operating under e-commerce strategy, its direction and intent can be measured by the types of insurance it should sell. In Shenzen, there are about 382 kinds of personal insurance products that are related with life, health and accident principals (, 2003). Providing large number of insurance could not be attached to higher profits or market power and prominence. Because of this, crucial factors such as the need of face-to-face communication for life insurance applicants and holders, high liquidity requirement of property/ casualty insurance and the high sensitivity of health insurance holders that emphasize on timely, sufficient and just hospitalization are to be considered.
Lastly, the models, findings, statistics and cases presented in this literature, however promising and ideal, lack supporting studies and researches. In the list, the limitation arises in the blurred extent of security from being hacked in e-commerce, the effect of privacy rights of bank customers whose information are infiltrated by insurance firms and propensity of people or firms using internet to conduct business. Another, the drawback occurs in the lack of evidence on the observed effectiveness of three models under life insurance partnership, extent of risks (on monetary terms) of property and casualty insurance and profitability of health insurance companies in view of government and private institutions’ voluntary support to this public issue. The quest has ended but entails another journey.
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