This presentation was given on the VALIKO's 25th anniversary seminar at the Finlandia-hall in Helsinki.

1. How to promote innovation in financial
services industry?
Presentation at the Valiko’s 25-years jubileum 4.10.2012
Professor Olli-Pekka Ruuskanen
Insurance Science
School of Management
University of Tampere

2. Olli-Pekka Ruuskanen
Content
1. Introduction
2. Innovation in financial services
3. New challenges
4. Regulation and innovation
5. Conclusion

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Situation today
• Customers demand more choices, increased
transparency in rates and greater convenience.
• Governments demand more transparency and
more adherence to risks
• Competitors are emerging with new business
models and non-traditional delivery methods
(Peverelli
and
De
Feniks
2010)

4. Olli-Pekka Ruuskanen
Future trends
• Demographics
• Big data and telematics
• Social computing
• Mobile web
• Scalability in cloud
• Polarization: Cheapest versus convenience
• Regulation
• Globalization

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89% of insurance CEOs indicate that
their organization will need to implement
substantial change.
IBM Global CEO Survey, 2010

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Functions delivered by financial systems
1. Moving funds across time and space
2. Pooling of funds
3. Managing risk
4. Extracting information
5. Addressing moral hazard and asymmetric
information
6. Facilitating sale through payment system.
Merton (1992)

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”Finance is technology”, Robert Schiller

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Definition
• ”Financial innovation is the act of creating and
popularizing new financial instruments,
technologies, institutions and markets.”
Peter
Tufano,
Harvard
Business
School

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What innovation does in finance (1)
1. Innovations exist to complete incomplete
markets
2. Innovation persists to address inherent agency
concerns and information asymmetries
3. Innovation exists so parties can minimize
transaction, search or marketing costs

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What innovation does in finance (2)
4. Innovation is a response to taxes and
regulation
5. Increasing globalization and risk motivate
innovation
6. Technological shocks stimulate innovation

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INNOVATION = IDEA + COMMERCIALIZATION

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” In the past 25 years the only useful
innovation in finance has been ATM.”
Paul Volcker, Former Chairman of Federal Reserve, 2009

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What makes innovation difficult in
finance?
• Conservativism
• Protecting intellectual property difficult
• Finland is a small market, can’t recoup
investments
• Risk avoidance
• Regulation hinders innovation
• The shadow of the 2007/2008 financial crises

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What makes innovation difficult in
finance? (… continued)
• Maturity of the market
• Limits to insurability
• Lack of demand / financial literacy
• Data limitations
• Ambiguity of risks
• Asymmetric information
• Basis risk

17. We
can
not
differenAate
our
product!

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Evidence from national surveys on
innovation
• Importance – How many firms active
• Intensity – Expenditure on R & D
• Ingenuity – New to firm / new to market

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Case: Insurance and Financial Services
• Variation in reported innovation activities across
countries
• Innovation in financial intermeditation large
• 80 % German insurers claim innovative products
• The share of turnover from new products lower
in financial services
• Skewed towards smaller countries

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How difficult to copy innovations?

21. Innovation in financial services industry

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Types and Degrees of Innovation
Product
Process
Organisa0onal
Service
Incremental
EvoluAonary
DisrupAve/
Radical

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Examples of innovation in banking and
insurance

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Examples
• Mutual funds
• Exchange traded funds
• Catastrophy/mortality bonds
• Alternative Risk Transfer
• Algorithmic trading
• Insurance futures
• Industry loss warranties

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Major innovations in insurance

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Finance is a Service
• Banking
• Insurance
• Knowledge engineering

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Service industries are about solving
consumer problems
• What fundamental problem is the customer
trying to solve?
• What objectives do customers use to evaluate
solutions?
• What barriers limit the solution?
• What solutions do customers consider?
• What opportunities exist for innovative solutions?

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Incremental innovation in insurance
• Policy amandments
• Bundling and unbundling
• Parametric insurance

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Mutation in innovation
• Innovation often intentionally span across different
labels.
• Financial innovation spiral (Person & Warther 1997)
• ”Adoption provides other participants with information
about the profitability of innovation, creating waves of
innovation and S-curve”
• Security created -> slightly modified by competitors
• 1980 – 2001 1,836 security codes in Thomson-
Reuters database.

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In finance counterparty matters
• B 2 C
• B 2 B
• B 2 W
• I 2 R

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Back office problems
• Infrastructure lacks when innovation takes off
• Trade confirmation
• Settlements
• Contractual verification and standardization
• Risk aggregation
• Collateral determination

34. New challenges

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Motivation for innovation?
”There are things we know, that we know.
There are things we know, that we don’t know.
and then there are those things that we don’t know
that we don’t know.”
Colin Powell, 1991

36. Olli-Pekka Ruuskanen
Unstructured versus structured data
• Banking and insurance have used structured
data
• The challenge of unstructured data
• Legacy systems
• Real time underwriting
• Real time credit
• Semantic web

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Real time, ubiqious, personal data
• RFID technologies
• GPS
• GIS
• Digital imagery
• Health informatics
• Genetics
• Privacy?

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Patents in Financial Services
• Business method patents
• State Street v Signature Financial, 1998.
• U.S. Patent Office
• 2010 reduction in scope ”Bilski vs Kappos”-
ruling
• Failure of finance patents to give proper
attribution to prior art
• Few patent litigation cases in U.S. finance
• European Patent Authority

41. Olli-Pekka Ruuskanen
Microfinance and microinsurance
• Microfinance is typically a small loan given to
low-income people without collateral guaranteed
by a group.
• Microinsurance is protection of low-income
people against specific perils in exchange for
regular premium payments proportionate to the
likelihood and cost of the risk involved.
• Cost efficency is key.

42. Olli-Pekka Ruuskanen
My personal favorites
• Proactive transparency
• User assigned reputation scores
• Consumer based buying clubs
• User based underwriting and risk assessment
• Telematics
• Claims tracking systems
• Mass customization
• Supporting data disclosure or low-risk
demonstration

43. Regulation and innovation

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Regulation
”Finance is at its most dangerous when it is
perceived to be safe.”
Andrew Palmer, The Economist

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Frameworks for innovation
• Basel III
• Solvency II
Is there room for innovation?

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Regulation and Innovation (1)
(Lumpkin 2008)
1. Adopt an unbiased stance.
2. Ensure that necessary framework conditions for
markets to function
3. Acknowledge that there is no one policy
measure that can be considered optimal in all
circumstances

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Regulation and Innovation (2)
(Lumpkin 2008)
4. Ensure that the policy instruments needed to
achive incentive-compatible objectives are in
the toolkit.
• Clarify what is meant by maintaining systemic
stability
• Properly address exit problems for large
institutions
• Establish a proper macro-prudential framework
• Establish a proper consumer protection
framework

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Regulation and Innovation (3)
(Lumpkin 2008)
5. Ensure regulators and supervisors have the
requisite skills and expertise
6. Ensure a proper balance between regulation
and governance
7. There should be appropriate monitoring of a
new products, markets and processes
8. Adopt the regulatory system as a necessary to
the market environment it is intended to
regulate

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Tipping point
• Finance lacks ”off” button
• When does a new innovation become
systemically significant?
• When will the flaws in innovation start having far
reaching consequences?

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Regulatory evaluation of financial
innovations
• Target of innovation
• Core purpose of innovation
• True value added or transfer between
participants
• Key assumptions underlying innovation
• Timing of innovation
• Revolutionary or adaptive
• Change in institutional structure or business
models.

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”Some radical innovation may ultimately be
needed to deliver sustainably higher growth”
Darren Pain, Swiss Re

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Conclusions
• Financial services industry needs more
innovation and creativity in the future.
• Technology and data are keys to disruptive
innovation.
• Paradigm shift: from conservative to innovative
culture within organizations.
• Regulation is a constraint. Should be possibility

54. Thank you
e-mail: olli-pekka.ruuskanen@uta.fi
http://fi.linkedin.com/in/ollipekkaruuskanen
twitter: @opruuskanen