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Lateral thinking key to product success Back  
Product innovation in financial services means combining hitherto separate offerings, says Simon Glancy.
Throughout retail financial services, companies now have to strive harder to differentiate themselves in a highly competitive marketplace. Customer loyalty is starting to decline reflecting the greater choice of providers and awareness of alternatives. At the same time customers’ reliance on financial services providers has never been greater as they seek options to invest for retirement, buy property and increase their spending power through credit and debit cards and personal loans.

Providers are recognising the need to take a more ‘holistic’ approach to product development, combining hitherto separate products and in doing so creating value for customers in terms of greater price competitiveness and product flexibility. Product and channel innovation of this kind aims to encourage them to move from competing suppliers while making it far more difficult for customers to easily switch suppliers again at a later stage.

Over the past decade bancassurance has attempted to integrate the sales and marketing channels of the banking and insurance operations of the major financial services players in Ireland: AIB Bank, Bank of Ireland and Irish Life & Permanent.

New product areas are also being opened up by progressive reforms in the social welfare and healthcare systems. Foremost amongst these are personal pensions (which is growing rapidly to supplement the state pension), private medical insurance and long-term care (the financing of residential and nursing care for the elderly). So far long-term care has not got off the ground in the absence of fiscal incentives in contrast to the recently announced PRSA (Personal Retirement Savings Account). Ireland’s strong economic performance is also having an impact on product development creating demand for equity release products in a rising property market and tax efficient investment vehicles to channel personal savings. The ‘grey’ market, those of retirement age or nearing it, represents a key growth market because of the significant appreciation of their property assets.

Developments in technology are undoubtedly crucial in facilitating innovation allowing firms opportunities to gather the sort of strategically important information to generate these new customer propositions, target them to specific audiences and quickly evaluate their success. Likewise new entrants like Bank of Scotland have forced the traditional industry incumbents to rethink their pricing and marketing strategies in core businesses like mortgages and savings.

Who is leading the innovation process?
The companies who have recently been involved in product and service innovation have not necessarily been the traditional industry leaders. In fact the reluctance of the two major banking groups to whole heartedly commit to developing new internet products and services to date has been surprising considering the pace of developments elsewhere in Europe. However Bank of Ireland was the first provider to move into the equity release market earlier this year.

In some cases innovation has been driven out of necessity such as First Active for example. There was recognition of the need to bring new life to a tired customer proposition and arrest a decline in market share. It also reflects a concerted attempt to listen to customers taking precedence over sales channels.

Some recent examples include:
• Bank of Ireland’s LifeLoan, launched in February this year, was the first equity release product to be sold in Ireland and is aimed at people who are 65 or older who stand to gain the most from house price increases. It tapped into growing recognition by these house owners of using their home as a funding vehicle for pensions, retirement income and long term care costs in a spiralling housing market.
• First Active’s debt consolidation product Utopia is clearly influenced by the success of Virgin’s pioneering One account in the UK. Launched in April of this year it allows First Active customers to combine financing their mortgage repayments with other personal borrowings, usually a personal loan and credit card, to create a revolving loan facility. This loan enables customers to make large loan repayments at far more competitive lending rates than buying standalone products like personal loans or credit cards.
• OnePlan, Irish Permanent’s equity release loan, also aims to attract elderly borrowers who have low or no mortgages. Some of its product features are similar to Utopia with borrowers allowed to access 75 per cent of the equity of their property and the borrower owns the property until death etc. The new OnePlan equity release loan also functions as a debt consolidation product allowing the funds to be used for any purpose such as a personal loan or investments in home improvements, education fees, wedding expenses and refinancing of short term credit or loans.

Future developments
Some common features are likely to characterise new product offerings:

• Focus on leveraging the unrealised value of bricks and mortar assets
• Competitive pricing in return for greater customer commitment
• Increased flexibility (transferability, service options, combining guaranteed and variable investment returns)
• Greater tax efficiency (product design driven by government incentives affecting retirement savings and long term care provision).

While the internet has made a significant impact on product and service development elsewhere in Europe, especially countries like Spain, the leading Irish banks have been reluctant to proactively develop Internet propositions for fear of channel conflict and cannibalisation of their customer base.

The Irish mortgage market has been the subject of criticism in the recent past for being less innovative than the UK where there is greater product choice. Certainly the challenges to first time borrowers in arranging and paying off mortgage loans will require changes to the existing range of product options.

So far the market’s response for first time borrowers has been to extend mortgage repayment terms to 30 years, offer short-term deferral of mortgage payments and allow borrowers to vary their monthly repayment rates depending on their financial circumstances. More imaginative approaches are clearly required if the mortgage market is to continue to grow at a time of escalating house prices. In response to this mortgage bonds, which are common elsewhere in Europe such as the Pfandbrief market in Germany representing 20-25 per cent of all mortgages, could be one way forward. This is still a very small market here while France is about to set up a similar market. Mortgage backed securities are also a small market segment in Ireland however securitisation is beginning to take off.

Investment mortgages, where the borrower only pays the interest on the loan, may see a resurgence of popularity in a climate of strong investment returns however for many borrowers gambling on being able to repay the principal in a lump sum at the end of a 20 year term may be too great a risk, hence the fall off in demand for endowment mortgages. Pension and ISA mortgages, which are a feature of the UK market, may develop a market niche here but there success will be dependent on the long term performance of the property market. ICS is one of the few lenders currently operating in this market.

• Equity release products will probably become a key feature of the mortgage market as many more people who purchased property before the current property boom seek to unlock their property assets for retirement income. The value of unreleased equity is substantial and is an important growth opportunity for vendors and source of potential wealth by house owners.

The level of public interest already generated by Bank of Ireland’s Lifeloan in April gives some idea of the latent demand that can be tapped. We will see more options built into offerings to broaden the use with which consumers can use their funds including (in the medium term) long term care and other medical expenses or to provide start-up finance for their children in the housing market. Growth rates in this market over the next 5 years may well benefit from changing consumer attitudes to diluting their home equity so as to provide a significant improvement in their standard of living in retirement.
• Debt consolidation has attracted considerable market interest and is closely tied into innovation in mortgage offerings bearing in mind that the re-mortgaging of the borrower’s property is a central feature of the product’s design providing the necessary collateral. The benefits of aggregating loans to their existing mortgage and being rewarded with lower interest rates make debt consolidation products an attractive proposition so long as lenders can ensure borrowers can handle the extra financial commitments involved.

The potential risk for lenders in embracing this product is the cannibalisation of their existing offerings and margin attrition. Inbuilt flexibility will be crucial in combining products with different repayment terms as extending the repayment term for a motor loan or other type of personal loan to 15-20 years would hardly offer good value.

Pensions and retirement savings: The pensions market has been experiencing strong annual growth rates for the past 5 years and there is no indication that this will slow down. A recent survey by Lansdowne Market Research shows that only 13 per cent of those between 25-34 expected to rely on the state pension as a source of income in retirement. The introduction of the government’s special savings incentive scheme to build up retirement savings will also create a large new group of first time savers who are willing to invest for their retirement. More importantly it will create a savings culture that is far more broadly based than heretofore.

The PRSA (Personal Retirement Savings Account) has resulted in all the financial services providers launching broadly similar products, however this market is likely to evolve and become more sophisticated once first time savers become more adventurous in their investments and commit sums greater than the minimum requirement. ARFs (Approved Retirement Funds), introduced in 1999 for the self-employed and directors of family companies, represent another attempt by government to increase private pension coverage. These offer an alternative to traditional annuities but are a niche market because of the small number of people who qualify.

There is also a substantial pool of experienced equity investors investing either through company schemes, privatisations or managed funds who are receptive to new product offerings offering greater choice and value.

Employees have been granted greater freedom as to where they can invest their company pension scheme contributions including investing contributions outside their own employer’s scheme or topping-up company benefits through AVCs (Additional Voluntary Contributions) to create a supplementary personal pension plan. This represents another growth opportunity for annuity and pension investment products.

Companies have already sought to capitalise on this booming savings market with bonds still a dominant feature of new product introductions especially equity linked bonds like Tracker bonds linked to selected stock portfolios.

This trend is set to continue with the launch of more specialist sector funds, funds combining a mix of fixed and variable returns and a greater choice of domestic and overseas investment opportunities. Irish Life’s SCOPE funds are a case in point. The deregulation of the pension market to allow financial services providers other than life assurers to offer products should also make an impact on future product offerings and goes some way to explaining the recent surge of investment bond launches by the banks. Traditionally life assurers sold annuity products.

Long Term Care (LTC) cover could emerge as an important product in the insurance market although demand in the short term is likely to be modest. Demographic and social factors appear favourable to the introduction of this type of cover with 103,000 elderly people already needed a moderate level of care in 1996 and this figure is forecast to rise by 71 per cent in 2026 to 176,0001. Their offspring are often living away from their parents’ residence or both working full-time. At the same time the costs of nursing care are rising and means testing eliminates a substantial number of people from state assistance.

The Government instituted a review of the future demand for LTC but so far neither of the two private healthcare providers BUPA and VHI offer such cover. Insurers are reluctant to offer cover in the absence of tax incentives by the government and the establishment of a government sponsored scheme similar to that recently introduced for pensions.

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