CHIP AND PIN: COMBATING CREDIT CARD FRAUD. Chip and PIN is the next weapon in combating credit card fraud. As discussed in the Bluerock Review of September 2003, credit card fraud was estimated at £411m in 2002 and to be growing at 30% per annum (source: APACS www.cardwatch.org.uk). Terms like skimming (the act of reading the card's magnetic stripe and then creating a duplicate card) have even joined the Oxford English Dictionary. Chip is the next generation in fraud prevention. This small gold coloured device embedded within the plastic provides a mechanism to store account information and manage security. The chip also provides other features that over time will be developed by various issuers - these could include loyalty scheme balances, current available balance on the credit card and also the electronic purse concept that enables prepay cards. This feature alone brings huge benefits to card schemes such as Visa and MasterCard, enabling them to break into the youth and sub-prime markets which, as the mainstream UK market becomes more saturated, could become the next growth areas. The PIN acts as a secret password and becomes an effective tool in confirming to the retailer, and therefore the acquirers and issuers, that this is the authorised user, i.e. they are who they say they are. Replacing the signature with a PIN removes the need for retail staff to check the signature; removes all doubt of identity and reduces staff fraud in retailers. This system-based decision will also significantly reduce the challenges from customers saying they did not purchase those goods or services - otherwise known as non-repudiation. WHY DOES A CHIP PROVIDE BETTER SECURITY? The data held on the chip is encrypted and therefore more complex to read. There are also various security features, for example, the chip will monitor the number of times an incorrect PIN has been entered, after which the card will disable all further transactions (as the card is 'blocked'). Cards can be unblocked at ATMs, making the 'hole in the wall' a central part of the management of the credit card. The PIN can also be changed at ATMs to make them easier to remember. The scenario of a stolen card with the thief practising your signature before using it in a shop will just simply disappear - they will need to have your PIN to be able to use it. New Point of Sale devices are being rolled-out across Britain's retailers and by the end of 2004 the vast majority of retailers will be upgraded. These new card readers must be able to read chip cards whilst continuing to read magnetic stripes (to support older cards; cards from non-Chip and PIN UK issuers and from foreign customers whose countries have not yet rolled out Chip). The key pad comes in many different formats from hand-held (for use say in restaurants) to fixed to the end of the till. HOW DO WE KNOW IT WORKS? Northampton was the Chip and PIN capital of the UK in 2003. The town ran a three month trial consisting of 200,000 PIN-enabled credit and debit cards and 1,000 retailers, with the findings contained in a report published by the not-for-profit Chip and PIN Programme Management Organisation (www.chipandpin.co.uk/pdf/main_trial_report.pdf). This trial demonstrated that customers, retailers and credit card issuers all support the Chip and PIN initiative. Valuable learnings have also been gathered with regard to disabled users, older users, smaller retailers, etc. The trial has shown which key pad units are better suited in which environment and which customers feel more secure. It is also worth pointing out that several countries in Europe have been using Chip and PIN type technology for some time, with France having used this technology for at least the last ten years. APART FROM REDUCING THEIR FRAUD COSTS WHY ARE CARD ISSUERS DOING THIS? There are two main reasons: 1. Liability shift - All fraud costs currently sit with the card issuer unless proven that a retailer has not followed procedures. Traditionally this has been difficult to prove. Liability shift (effective from 1st January 2005) will move the cost of fraud to the weakest link, whether retailer or issuer. Therefore, if a card issuer is compliant and the retailer is not, any fraud costs will reside with the retailer. 2. Fraud migration - If you are the only issuer without chip and PIN functionality you can bet the fraudster will focus on you as easy pickings. Another effect is that the interchange fees, the fees paid by the retailer to the acquirer/issuer, will reduce for chip transactions, thereby reducing the income that acquirers and issuers receive. This interchange fee is often used to 'pay' for cashback or loyalty scheme benefits. One area of credit card fraud that Chip and PIN alone will not immediately help is 'Card Not Present'. These transactions typically occur over the internet and telephone, and currently account for the biggest growth area in card fraud Roll-out of Chip and PIN is a massive undertaking - credit cards will need to be re-issued (even those currently with a chip). PINs will need to be issued to everyone with delivery timed to coincide with that of the card, (because without the PIN the card is useless). A number of back office processes used by issuers will have to be re-written to accommodate chip and PIN. Retailers will have to roll-out new card reading machines and key pads; staff will need to be trained and a massive communication programme will be required to inform customers both why this is happening and how to use their new cards. I N SUMMARY Chip and PIN is probably the single biggest card initiative ever started, and over the next 12-18 months it will move from being an industry initiative to a consumer reality. THE UK LIFE & PENSIONS INSURANCE MARKET - STATE OF THE NATION Bob Heath, Bluerock Consulting THE LIFE & PENSIONS INSURANCE INDUSTRY Whilst arguably less glamorous than its investment and retail banking cousins, the UK insurance industry is none-the-less an important element of the country's financial services industry. Indeed, the UK has the largest insurance industry in Europe, the third largest in the world and, at 354,000 employees (Association of British Insurers (ABI) website), constitutes fully a third of the jobs in the UK financial services sector. With annual premiums of £97 billion and 214 authorised providers of long-term insurance (principally life insurance and pensions), the Life & Pensions industry is a significant part of this, and it's well-being has a major impact on the UK economy. F o r a n industry that is often thought of as being overly stuffy and hidebound by tradition, the UK Life & Pensions insurance industry has undergone substantial change over the last few years. Some of this change has been forced by new Government regulation; some has arisen from within the industry itself. However, much of this change is being driven by consumers as the Life & Pensions industry finally comes to realise that it cannot continue to ignore the needs of those it serves. INDUSTRY CHALLENGES The UK Life & Pensions industry has had a torrid time in recent years, a large part of which is self-inflicted. Pensions and life assurance miss-selling scandals have directly impacted consumer confidence. This has been compounded by the collapse of once venerable institutions such as Equitable Life, and the closure to new business of established players like NPI and Pearl. This has all happened at a time when investors have seen the value of their holdings fall in line with the markets. However things would appear to be starting to look up for the Life & Pensions industry, not least due to recent rises in the equity markets. Although sales of with profits products remain depressed, greater confidence in equity markets, and in the economy as a whole, has resulted in increased sales of unit-linked funds. New business figures from the ABI show increasing amounts are being invested in regular premium life and pension policies, with the monthly value of new premiums increasing by 3% from £836m in January to £863m in October 2003. This follows a period in 2001-2002 where the trend was quite the reverse. However, everything is not totally rosy in the world of Life & Pensions, and product providers still have a lot of ground to make up with their customers as, according to ABI research, nearly four in ten pension customers distrust the Life & Pensions industry. Some of this distrust is probably well founded, but some of it is a result of factors beyond the immediate control of the industry, such as the closure of many company final salary pension schemes and their replacement by money purchase schemes. Similarly, the Government's seemingly constant meddling with the pensions system, e.g. the removal in 1997 of a pension fund's right - worth £5bn a year - to claim tax relief on the dividends they received from investing in UK shares and the proposed maximum lifetime limit on the value of a pension fund of £1.4m, has created a climate of uncertainty regarding the future of pensions. As a result, many people are now looking to alternative ways of saving for their retirement that are more immune to the vagaries of changing Government policies, e.g. buy-to-let residential property. The upshot of all of this is a looming pensions "crisis" as increasing numbers fail to put money into pension provision. The size of this crisis is hotly debated, with the ABI suggesting that Britons should be boosting their retirement saving by £27 billion a year to ensure their future security. However, as the mouthpiece of the industry, this figure from the ABI is open for dispute, as are the assumptions upon which it is made, for example that the retirement age remains constant. However, what is clear is that the Government is determined to get the British public back into the habit of saving for retirement, although this is not proving to be as easy as first thought. For example, sales of the Government's low-cost stakeholder pension have continued to slide. Figures show that only 113,007 of these pensions were sold in Q3 2003, which is 32% less than sold in the previous quarter, and of these nearly two thirds of the funds invested were transfers from other pre-existing policies. THE FUTURE FOR LIFE & PENSIONS The Sandler report into long-term savings provision proposed the introduction of a suite of new simple, low-cost stakeholder products with capped charges in a bid to open up the market to less affluent and previously marginalized consumers. However, what is clear is that with a 1% cap on charges there is little incentive for stakeholder providers to actively sell these products. Consequently, pension providers are lobbying hard for the cap on charges for the next generation of long-term savings products to be raised substantially, or even scrapped. 2004 appears set to see ongoing tussles between the Life & Pensions industry and legislatures as the latter continue to introduce new regulations. Some of these measures have the potential to benefit both the industry and its customers, although typically causing shortterm upheaval and additional work for the former. The FSA's proposals for depolarisation (CP121 /CP166) are designed to address concerns that the insurance industry operates in a manner detrimental to the consumer and fails to encourage the public to save enough for retirement. It is argued that by scrapping polarisation, which separates financial advisers for packaged products into those who are 'independent', advising on the entire market, or 'tied', acting for a single institution, the consumer will be better served and the overall market for long-term savings products will increase. New financial or prudential regulation will arguably be of less immediate benefit to customers, but should reduce the risk of failure of a large insurer, as well as increasing transparency of the industry as a whole. These regulations concern such things as capital adequacy, reporting, and operational risks and controls. These changes are being driven by the FSA operating within a framework set not just by UK legislation, but also by European Directives and other international agreements such as the Basel accords. Timeframes for implementation of much of this regulation remain to be confirmed, but it is clear that 2004 will be a key year in preparing the ground for their introduction. However, not all new regulation is likely to be accepted without a considerable fight. At the time of writing, probably the most contentious piece of relevant legislation is that proposed by EU Social Affairs Commissioner Anna Diamantopoulou to address "sexual discrimination" by outlawing the use of gender in setting prices for consumers of insurance, a practice common throughout the industry. IN SUMMARY Although the UK Life & Pensions industry faces some real challenges in 2004, the prospect of an equities bear market augers well for the financial health of the sector. Assuming that these markets pick up then it is likely that the blood letting seen in recent years will cease and the industry will start to take advantage of improved growth opportunities. Whilst ever increasing regulatory requirements will undoubtedly add to the burden placed upon the industry, which will certainly lead to much complaint regarding additional overheads, the mediumterm prospects for growth in the UK Life & Pensions industry have not appeared better for a number of years.