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for release on delivery
Expected 10:30 A.M. E.D.T.

Statement by
J. Charles Partee
Member, Board of Governors of the Federal Reserve System




before the
Committee on Banking, Housing and Urban Affairs
United States Senate
June 14, 1979

My purpose in appearing before you today is to describe
the recent Board staff study of possible tie-ins between the
granting of credit and the sale of insurance by bank holding
companies and other lenders.

I would like also to discuss some

related issues that have been raised concerning permissible
insurance activities for banking organizations.

The appendix

attached to my statement describes the study methodology in
more detail and attempts to address some of the critical comments
that have been made about 1t.
The Board staff study of tying has received considerable
attention.

It has been used--and abused--by those seeking either

to expand or limit bank and bank holding company insurance
activities.

The debate has at times become quite heated and

both sides have tended to overstate what they interpret the
study results to show.

Those seeking to expand bank and bank

holding company activities argue that the study indicates there
are no problems.

Those seeking to limit these activities assert

that the results are contradictory and meaningless.

Some

commentators have even charged that the study was biased in
order to favor banking organizations.
In view of the current debate and the role that the
Board staff study seems to be playing, Ird like to note for the
record that we are not here to defend the credit insurance industry
or lenders who offer Insurance.

Certainly there are aspects of

their activities that concern me very much.

For example, I am

distressed about the relatively high charges for credit insurance
that seem to persist 1n the face of low payout rates when compared
to other insurance.




-2-

It 1s also not our role to protect the Independent
Insurance agents who have waged a long campaign in both the
courts and state legislatures to limit entry by new competitors
into their business.

I believe that full competition, so long

as it is fair and equitable, is the best way to assure that
consumers will receive good service at the lowest price.
My purpose today is simply to report objectively my
reading of the results of the Board staff study.

By way of

background, the Board in its 1975 Annual Report expressed concern
that some consumer borrowers were being required to purchase
credit life and disability insurance as a condition of obtaining
loans.

Senator Proxmire subsequently voiced this same concern

and requested the Board to undertake this study of the sale of
insurance by banks and bank holding companies in accordance
with the anti-tying provisions of Section 106 of the Bank Holding
Company Act.
The study attempts to accomplish two tasks.

First, it

provides an analytical framework to evaluate whether or not tying
is taking place.

Second, it reports the results of two special

surveys that were conducted.
consumer borrowers.
attitudes toward

One was a survey of individual

It focused on borrower experience and

credit life and disability insurance in

connection with recent loans that were still outstanding.

The

other survey was addressed to a small group of bank holding
companies in order to gather information on their policies,
procedures and organizational patterns in selling insurance.




-3-

Of particular interest was information on their activities in
the property and casualty insurance area.

The sample selection

and all survey questions were coordinated with and approved by
the staff of the Senate Banking Committee.
The survey of consumers focused on those borrowers having
outstanding closed-end credit balances with banks, finance
companies, retailers or credit unions where the original balance
had been $200 or more.
had credit insurance.

Of these, 62 per cent of the borrowers
Retailers and banks had the lowest

penetration rates, with about 40 per cent and 61-1/2 per cent
respectively; finance companies had the highest at 75 per cent.
The supporting evidence from the survey, however, suggested it
was unlikely that these insurance coverage rates reflected
either explicit coercion (which seemed to be virtually nonexistent)
or involuntary tying.

For example, relatively few consumers

felt that Insurance was strongly recommended or required.

Among those

who did, 1t was not possible to determine from the data whether insurance
costs had in all cases been Included in the annual percentage
rate on the loan, as required by law.
Only a small portion of the consumers 1n the survey
viewed credit Insurance as a "bad service."
j» s

Most regarded It

desirable, and more Importantly, felt 1t was priced "about

right" or even "Inexpensive" for what they got, and Indicated
that they would recommend it to others.

Finally, in response

to an open ended question about whether they had ever been
treated unfairly in connection with a credit transaction, about
ftri«?-fourth of the respondents cited instances which they considered




-4-

unfair; none of these cited instances involved
coercion or tying in the sale of insurance.

reports of
This survey

result is consistent with the staff’ search of the Board's
s
complaint files, since no valid complaint of illegal tying could
be found to have been filed by a consumer or business under
Section 106 or otherwise back to at least 1970.
With respect to the survey of bank holding companies,
few if any firm generalizations can be made about the reported
penetration rates because of the character of the responses to
the survey.

The median reported penetration rates on credit-

related property and casualty insurance clustered well below
the 40 per cent rate, whether categorized by type of loan or
by type of credit originating subsidiary.

These penetration

rates are lower than I would expect to see if tying were a
widespread practice, and are consistent with respondents' reported
policies and procedures which our staff does not judge to he
conducive to tying.

Higher penetration rates were reported for

credit life and disability insurance than for property and casualty
insurance, but even these varied widely by lender group, type of
loan and location of company.

Again, the reported patterns of

conduct did not seem consistent with extensive tying.

Most

institutions reported that the insurance solicitation was made
after the loan was approved but before the monthly payment was
determined.
In sum, the results of the study led the Board's staff
to conclude that explicit contractual tying was virtually non­
existent and that implicit tying did not appear to be a widespread




-5-

problem.

My reading of the study convinces me that these con­

clusions are appropriate.

I think it is important also to

emphasize that these are general conclusions.

They do not

imply that no abuses have taken place, but simply that problems
are not widespread.
Because of the relationship between the tying concerns
and a number of pending legislative proposals, you also asked for
the Board's views of several additional issues.

These include

the appropriateness of banks and bank holding companies selling credit
life and health or property and casualty insurance, the public benefits
arising from these activities and the effects of permitting bank
officers acting as insurance agents to direct premium income
to themselves that might otherwise have gone to the bank.
The Board's view continues to be that banking organizations
should be allowed to sell credit-related insurance, including
property and casualty insurance.

We believe that the benefits

of such activity outweigh any adverse effects.

In the first

place, the activity of banks and bank holding companies in
providing this service 1s procompetitive.

This is an industry

where additional competition would seem desirable and
potentially quite productive.

Second, bank sales of insurance

provide a useful and convenient service to the public, Including
sales at locations poorly served by others.

Finally, on the basis of

equity, it does not seem to us that banking organizations should be
singled out as prohibited sellers among financial institutions and non­
regulated lenders.




Prohibiting jkhe activity for banking organizations

-6-

would inconvenience at least some of the public--namely, those
borrowers who would prefer to purchase their credit-related
insurance from the lender and who would be forced by the
prohibition to look elsewhere for the service.
The public benefits from banking organization involvement
in the credit property and casualty insurance field rest entirely
on the premise that better service and enhanced public convenience
represent a valuable attribute.

This is especially so since the

insurance industry is immune from antitrust statutes.

Furthermore,

little retail price competition exists because rate ceilings are set
by state regulatory organizations and it is the underwriters who set
the insurance rates actually charged.

In the case of credit life

and disability insurance, I would note that holding company
applicants often agree to hold premiums below state ceilings as a
precondition to Board approval of their applications.
Finally, an area where the link between insurance activities
and lending is of concern to the banking agencies involves situations
where banking officials, during their working hours, use the
facilities of the bank to sell Insurance as agents acting on their
own account.

The effect is to divert insurance premium income

that would have accrued to the banking organization had the officer
been acting as an agent for the bank or holding company.

On the

other hand, such premium income can be viewed as an alternative form
of compensation for the bank officer, supplementing what otherwise
would be an unduly low rate of pay.
have differing policies toward

At present the banking agencies

this practice.

These differences

need to be resolved, and we will be working to do so as a matter of
interagency coordination in the period ahead.




-7-

I will be happy to try to answer any questions you
may have, assisted by Mr. Robert A. Eisenbeis, the Board's
Research Division Officer who was principally charged with
overseeing the tie-in study.




# # # # # # # # # # # # # #

Appendix

The purpose of this appendix is to respond to the major criticisms
that have been directed at the Board staff study of tie-ins between the
granting of credit and sale of insurance.
the misinterpretations that have arisen.

The aim is to clarify some of
In particular, four areas

are addressed:
1.
2.

Alternative sources of consumer credit.

3.

The omission of certain studies.

4.
1.

The methodological framework of the staff study.

The assertions that the conclusions are not supported
by the evidence.

The methodological framework of the staff study.
Conceptual differences over the nature and structure of the rela­

tionship between the granting of credit and sale of insurance are at the
root of the tying controversy.

Lenders and those in the credit insurance

industry tend to argue that because of the relatively low cost and essential
social value of insurance, a large number of credit extensions with joint
insurance sales are to be expected, and these joint sales are entirely
voluntary.

To the extent that coercion takes place, it is only in a few

isolated instances.

Parties on the other side of the issue assert that,

because of the monopoly power of financial organizations, the structure of
the sale of insurance in connection with the granting of credit is, by
its very nature, inherently coercive.

Therefore, they contend that all

joint sales are by definition coercive, and they employ sales penetration
rates as the index of coercion*




-A2In reviewing the tying controversy, the Board staff concluded
that both of these views of tying were overly simplistic.

Moreover, these

views were not deemed particularly helpful in generating behavioral hypotheses
that could be examined through surveys.

Therefore the staff sought to

characterize the various types of tying and to identify the conditions
under which they might exist.
A review of the relevant economics literature makes it clear
that different kinds of tying may exist depending upon the types of
pressures exerted on the customer by the supplier.
are explicit contractual tying arrangements.

At the one extreme

Here the seller, through

the exercise of monopoly power, is able to coerce the customer to contract
formally to tie the purchase of one good— in this case insurance--to
the purchase of another— credit.
tying.

The Board staff labeled this "explicit"

At the other extreme, a joint purchase can be made that is purely

voluntary, and no pressure to tie is exerted by the supplier or is
perceived by the purchaser.

Such purchases may in fact result from an

economically rational decision by the consumer based upon both convenience
and the relative cost of the goods or services.
Between these two extremes a continuum of pressures could
exist to achieve joint sales.

These could range from situations where

there is strong "implicit" pressure to tie by the supplier to the
mere perception on the part of the consumer that it might be advantageous
to make the purchase.

The degree to which these pressures can be

exerted successfully and the extent to which they are coercive depends
importantly upon the market power of the seller.




If consumers have

few options for credit, then it is relatively easy to force the purchase
of insurance.

In contrast, where there are many options for credit, economic

theory suggests that only a few customers can be pressured into buying
insurance from the lender.

Even here abuses can take place.

Lack of

information and full disclosure could make some customers more susceptible
to high pressure sales tactics to make joint purchases.

We would not,

however, characterize such practices as tying but rather as "unfair
and deceptive1 sales techniques.
1
In summary, then, a precondition for joint sales potentially to
constitute a tying problem is the existence of some degree of monopoly
power.

This may lead to supplier conduct employing either explicit

or some degree of implicit pressures on the customer to agree to a tied
sale.

However, developing methods and techniques to measure the

relationships between market power and the pressures that might be
exerted on individual customers so as to identify where on the continuum
of potential tied sales they may lie is a formidable research task.
To deal with this problem, the staff identified a series of
indirect types of hypotheses about which evidence could be generated.
They might— when taken together— provide some clues to aid in deciding
when particular joint sales could represent a potential tying problem.
For example, if tying were a widespread practice, it surely would be
perceived and reflected in consumer attitudes toward credit-related
insurance.

First, the perception of pressures to tie would be great.

Second, a high proportion of borrowers might view the service as
unnecessary, undesirable, and relatively expensive for what they received




-A4even though they purchased the service.

In this instance consumers would

perceive being forced into purchasing a service at nonmarket rates and
terms, or else there would be no point for the supplier to exert
coercive pressures.

Third, if a significant number of borrowers felt

coerced, it would generate widespread consumer resentment that would
in many cases result in formal complaints.
At the same time, if bank holding companies (or any other
organizations) were engaging in tying practices, their procedures for
selling insurance and granting of credit would likely be structured to
facilitate tying.

One would expect to find close coordination between

insurance sales and lending, both in terms of the solicitation for
insurance and the timing of the credit decision.

Organizationally,

there could be patterns in the way agents are compensated for insurance
sales.

If coercive sales were promoted, incentive compensation to

induce greater sales penetration could be more prevalent.
Finally, high penetration rates would likely result from aggressive
tying policies.

It should be noted, however, that high sales penetration

rates are not, in themselves, evidence of tying behavior, despite the
arguments of those who believe tying is a significant problem.

High

penetration rates are also consistent with a high incidence of voluntary
joint purchases; they become an important indicator of involuntary
tying only when accompanied by other evidence of coercive sales
practices and consumer perceptions of required joint purchases.

By

the same token, the existence of aggressive salemanship is also not
unambiguous evidence, by itself, of tying behavior.




-A5Those who criticize the staff study methodology essentially deny
that any of the consumer reactions hypothesized as being related to tying
are likely to be indicators of tying behavior.

Thus one is left with the

curious result that even though * borrower has been presumatly coerced,
this will generate no resentment toward the product.

It may be even

desired and thought to be fairly priced.— ^ Nor will the consumer be
motivated to file a complaint.

In other words, there is almost no

evidence' that would provide an indication that tying is taking place
rather than a voluntary joint purchase.
2.

Alternative sources of consumer credit.

As already noted, substantial monopoly power in the credit
market is critical to being able to coerce consumers to purchase credit
insurance.

Those who believe that banking organizations engage in tying

behavior point to the unique position that banks play in providing a
package of deposit and credit services to consumers.
While this view of the uniqueness of commercial banks may have
been true at one time, it is now clear that the more traditional distinctions
are eroding rapidly.

Banking organizations are being brought increasingly into

greater and greater competition with other financial and nonfinancial
lenders in providing consumer credit services.

It is now the case that

consumers have a broad range of alternative sources of credit.

The

attached table, for example, tabulates for the Board staff study the
proportion of borrowers who obtained credit from retailers, banks finance
companies and credit unions by type of loan.

In total, banks had

T7 One commentator "does argue that resentment may be directed instead
toward the supplier. We note that in response to a broad, open-ended
question on whether they had ever been treated unfairly in a credit
transaction, about 25 percent of the respondents (622) cited 947 instances
they considered unfair; none mentioned coersion or tying in the sale of
insurance.




-A6Loans in excess of.$200
(percent)*

Lender

Total

New
Used
Addition and
Car_______ Car_________ Repair

Durables

Personal

Banks

51.2

53.2

64.5

66.7

33.0

45.2

Finance
Companies

14.1

13.4

11.1

5.6

14.8

20.4

Credit
Unions

21.2

28.0

17.9

16.7

14.3

21.7

Retailers

13.4

5.3

6.5

11.1

37.9

12.7

Total

99.9

99.9

100.0

100.1

100.0

100.0

*The total may not seem to 100 percent due to rounding




-A7about 50 percent of the consumer credit market, with the shares for
individual loan categories ranging from a high of 66.7 percent to a
low of 33.0 percent.

Furthermore, in most consumer credit markets,

especially in urban and suburban areas, a number of banking and other
organizations supply consumer financial services.
3.

The ommission of certain studies.

Commentators on the Board staff study state that certain studies
were omitted from consideration that provided evidence of tying behavior.
These included:
A.

Complaints filed by consumers to the FTC outlined in the
the 1974 Annual Report of the Commission to the Federal
Reserve Board.

B.

A 1969 Board Staff report to Senator Proxmire which
surveyed Federal Reserve Banks.

With respect to the FTC report, the one documented complaint
about a bank it contained was not regarded as valid by the appropriate
bank regulatory agency.

Furthermore, the FTC staff itself stated that

"...the actual incident may have been an isolated misunderstanding between
the lender and borrower."

Beyond this, no analysis or other information

was cited that pertained to banks and bank holding companies, which were
the primary focus of the Board staff study.
The Federal Reserve staff report was a survey of Reserve Banks—
not commercial banks— for their opinions concerning bank, practices in
the sale of credit life insurance.

The staff report stated, "Most of

the Federal Reserve Banks reported that no specific situations had come




-A8to their attention involving questionable practices in the sale of credit
life insurance by banks, their officers or affiliated organizations in
connection with loans by the banks."

The report contained no analyses nor

did it report any data.
4.

Conclusions not supported by the evidence.

Those who believe that the study conclusions are not supported
by the data tend to focus on the interpretation of essentially two types
of numbers:

(a) the reported penetration rates and (b) the proportion

of customers who felt that insurance was "required" or "strongly
recommended."
With respect to the penetration rates, it is argued that the
numbers reported are biased downwards, since they are lower than those
reported to the FTC by a few individual firms.

Hence, these rates are

said to understate the extent to which coercion is taking place.
The Board staff did not, however, use these penetration rates
as indices of coercion but merely as indicators of whether they were high
enough to warrant going further with an attempt to determine if tying
was taking place.

In describing the penetration rates, the staff concluded

that they were not so high as to be suggestive of the possibility of
widespread contractual tying, but they were sufficiently high to carry on
with the investigation for the existence implicit tying.

Eventually, they

were only one element in the overall conclusion.
The interpretation of the extent to which consumer perceptions
of the pressures exerted on them represent coercion is admittedly subjective.
The critics of the Board staff study believe that the proportion of




-A9customers who reported that they felt the purchase of insurance was either
"required" or "strongly recommended" should be interpreted as direct
evidence of coercion.— ^

There are several reasons, however, why the staff

chose to be much more cautious.

First of all, it is not illegal to require

that insurance be purchased so long as the costs are disclosed in the APR.
What is illegal, is to require that insurance be purchased through the
particular creditor.

Unfortunately, standard survey methods do not easily

allow separation of those who were "legally" required to purchase insurance
from those who were not. Second, there is other evidence to suggest that
"strongly recommended" response was just as consistent with the existence
of salesmanship as with other interpretations.

For example, almost 30

2/
percent of the consumers did not purchase insurance.—

This indicates

that there were an important group of people who felt no deciding pressure
3/
to purchase insurance.—
Moreover, over 75 percent of the respondents
did not get the impression that insurance was either required or strongly
recommended.

This, coupled with the responses on consumer attitudes

toward the product itself led the staff to conclude that implicit tying
was not a widespread problem.

The Board staff conclusions were based

upon a weighing of the totality of the evidence from both surveys
rather than on a narrow interpretation of a single number.
1/ It is noted that a consumer's perception that insurance is required
may or may not be correct.
2/ The proportion without insurance by class of creditor was retailer (46%)
bank (32%), finance company (16%) and credit union (20%).
3/ Furthermore, to exclude these customers from the base when evaluating,
the extent of pressure brought on consumers seems to the staff to be
inappropriate.