Combining Insurance And Financial Services: Reality Check

COMBINING INSURANCE AND FINANCIAL SERVICES: REALITY CHECK

by Carol Hammes

Financial institutions have been in the insurance business for many years, with some states granting savings and loans and banks in small towns the right to have insurance departments and with seven large 'grand-fathered' national bank holding companies allowed to remain in the insurance business after most were shut off. There were more than 4,000 financial institutions in the insurance business before the courts and legislation opened the doors to the rest of them to take the plunge into combining the various types of financial services.

Although most of these initial banks and S&Ls were only selling credit life and annuities, a number of them attempted to make a go of it in the Property/Casualty arena. In fact, back in the 1980s almost half of the members of the IIA of North Dakota were bank agencies. So, the convergence of banks and insurance isn’t new. It’s now become much more widespread and actually almost trendy. It was something that the banks had been fighting long and hard to do and something that most agents’ associations had been dead set against — which made it all the more attractive for banks. Once they got the opportunity to do what they’d wanted, many financial institutions altered their strategic plans (or scrapped them altogether) and set out to find the pot of gold at the end of the insurance rainbow.

For the past decade banks have faced shrinking profit margins from their traditional products and services. Financial institutions have been looking for ways to expand their activities, improve account retention through selling more products, and finding additional income to help cover overhead. Selling insurance as part of a full financial services package seemed to be a logical choice for this expansion. Even 20 years ago banks and insurance agencies were developing ways to try to get around the existing regulations by creating joint marketing entities. The overworked term 'synergy' kept popping up as the excited participants made their plans to work together to sell insurance to the bank’s existing client base. For a number of reasons, most of these joint ventures died within two years. Perhaps the so-called synergy was (and is) more myth than reality.

BANKS IN UNDERWRITING

The merger of Travelers with Citigroup was seen as the premier indication that full financial services would be the wave of the future. Less than four years later Citigroup divested itself of the Travelers Property Casualty Corp, after admitting that they might’ve failed to recognize essential differences between banking and Property/Casualty underwriting. It’s important to note that Citigroup retained the Life and annuity company. The spin-off of the P/C company allows Citigroup to focus on distributing products through other insurers and will allow Travelers to grow by making acquisitions. At least that’s the party line.

In short, Citigroup discovered very quickly after the 1998 merger that underwriting P/C insurance doesn’t yield the same returns as do other financial services. The high volatility of the P/C business simply didn’t fit the mold that Citigroup wanted as part of its overall strategic plan. They needed a minimum of 10%-12% organic growth and, with the dramatic cycles in the insurance business, that type of growth can’t be guaranteed or even expected.

Whether other financial institutions will decide to get into insurance underwriting is unknown. Most of the trade press coverage indicates that they’ll be very cautious, understanding that the risk involved in underwriting is relatively alien to the banking business. Yes, they’ll take a risk to make a loan, but do they want to commit millions in capital to pay claims after a hailstorm, hurricane, fire, or terrorist attack? Although actuarial science is quite sophisticated, reality can be a very different story. The current shaky status of many reinsurance companies should also give bank executives pause for thought in thinking about the P/C business. Our guess is that we won’t be seeing too many financial institutions entering the underwriting side of the business within the next several years.

BANKS IN INSURANCE SALES — JOINT VENTURES

Many financial institutions have decided to get their feet wet before they jump wholeheartedly into insurance sales. They don’t want to make the capital outlay to buy an existing agency, and they lack the expertise to start one from scratch. Many agencies also want to pursue a lower-key relationship with a bank, maintaining their independence while taking advantage of the perceived sales possibilities in a joint venture. Sometimes the motivation is simply to make sure that the bank doesn’t make a deal with a competitor. So, the bank and the agency enter into joint marketing ventures, hoping to sell insurance to bank customers through a variety of sales approaches and hopefully having both sides profit from the alliance.

Most of these arrangements have proven to be less than satisfactory and have been disbanded within two or three years. The average independent agency has a pro forma profit of around 19%-20% before bonuses to owners. When you split the profit with a bank, each side gets less than a 10% return — and that’s after several years of setup costs and initial marketing initiatives that are almost sure to outstrip the return. The best that you can hope for is a break-even status at the end of the third year. If both parties are accruing ownership in the new insurance accounts at 50%, the increase in equity value might be enough to offset the low level of annual return. But most of the time, to make the dollars work out, the marketing program must be set up to increase the commissions written far more rapidly than the average 6%-7% growth rate of the average insurance agency. And the sales and servicing operation for smaller Commercial and Personal Lines business must be structured to produce a much higher profit margin than in a traditional insurance agency operation.

To have a successful joint venture with a bank, you must identify what customers you want to reach and develop a program that provides the most cost-effective way to do it. For medium to large Commercial accounts that bank loan or trust officers might prefer, the traditional approach of using a producer, account manager, CSR and support staff should work — provided, of course, that you get the bank personnel to make those referrals. But for smaller accounts a telemarketing/direct mail approach using only several companies and perhaps company service centers will be the only cost effective way to sell and service the business. The insurance companies should have an 800 number for claims reporting even if they don’t have a service center. There should be complete upload and download capabilities, as well as online quoting and policy issuance. Premium payments (if not direct billed through the insurance company) should be made through automatic account debit.

Handle marketing activities as efficiently as possible on the smaller accounts. Alert bank customers to the availability of insurance products through leaflets in monthly statements, a computer terminal and phone in the bank lobby, requests for quotes on ATMs and on the bank’s Web site. Make follow up calls after each inquiry or expression of interest and at least every six months thereafter. Once a policy is written give the sales reps specific goals to write additional coverages for the accounts within the first 12 months.

Both parties need to understand that, for the joint venture to make money (or at least break even) you won’t be in a position to write insurance for every single bank client. It’s extremely important that all bank personnel understand this fact. The best loan client might not be a good insurance risk. The underwriting process might exclude the bank’s president, who might not understand why the agency can’t write his Auto coverage even though his 16-year-old son has three tickets and has just been given a Corvette. One of the bank’s major clients might have a small Commercial account with high activity that only produces $250 in commission. It would be detrimental to the success of the joint venture to write much (if any) of this business. The insurance agency principals need to be able to demonstrate and explain this reality to the decision-makers at the bank.

BANKS IN INSURANCE SALES: BUYING AGENCIES

Although the landscape is littered with the bleached bones of bank insurance agency acquisitions that have gone awry, banks are still continuing to buy agencies. However, most have learned some harsh lessons from their predecessors that paid three times commissions (or eight times pro forma profit) for insurance agencies, only to realize a year or two later that they weren’t going to make any kind of a return at all — and sold them back at 50 cents on the dollar. Most sophisticated larger buyers of agencies are paying six times pro forma profits for their acquisitions. Some buyers will pay a higher multiple (up to seven times pro forma earnings) if the agency has strategic importance to them. For example, if the agency is the bank’s first insurance acquisition, they might want to use key management personnel to help them develop their 'core' agency.

Some banks might add something additional for the commissions they think they’ll get from selling insurance to their own accounts. However banks that have had any experience with insurance will put this future income on a contingent or bonus/earn out basis. They know that selling insurance to bank customers isn’t as easy as it might seem. The bank’s customer list can provide thousands of leads. But that’s all they are — leads. Most agencies already have a large group of warmer leads because they haven’t rounded out their existing accounts. The average Personal Lines customer buys four insurance policies and the average independent agent only has 1.5 of them. Why would anyone think that agents who haven’t done a good job of rounding out their own business would do a better job of selling insurance to the bank’s customers?

One of the largest bank insurance agencies, owned by BB&T based in North Carolina, has been in the insurance business for nearly 80 years and barely has 5% penetration selling insurance to the bank’s customers. If a bank is buying an insurance agency it shouldn’t count on the commissions that might come from merging the financial services businesses and expanding accounts in the structuring process. If the account expansion happens, great. But structure the deal to pay the agency principals and producers for their participation in this growth. It’s simply not good business practice to count on this growth and include these projections in the initial pricing.

CULTURE CLASH

Selling an agency to a bank can be an alluring option for smaller agencies that are having trouble meeting volume requirements from insurance companies but lack the capital to buy or merge with other firms. It can also be attractive to larger agencies that are having problems finding people or capital to maintain a viable management and ownership perpetuation plan. Unfortunately, selling the agency to a bank isn’t always a marriage made in heaven. Any time that an independent agency is sold the principals have adjustment problems. In many cases, they’ve owned their own firm for 40 years or more — and once you’ve called all the shots it’s hard to work for someone else, much less a bank. The significant differences between the insurance agency environment and the bank culture, with its almost constant meetings and long list of rules, can create an enormous shock. Sometimes serious disagreements can erupt over both small and large decisions and the brilliant marketing plans fall by the wayside while the parties figure out a way to move off dead center.

At the heart of the issue is the fact that many bankers still have a problem with the concept of selling. As a result of the major changes in the banking industry during the past decade, they know they have to learn how to sell their own products, as well as understand the insurance sales process. But they seem to have a hard time embracing the concept. If the CEO of the bank pays only lip service to the 'new sales environment,' this lack of commitment will pervade the entire bank and eventually the acquired insurance agency operation as well. And when it turns out that a good insurance producer starts to make more money than the CEO due to the agreed on commission schedule, the bank executives can get more than a little nervous.

The unique relationship between an independent agency and its suppliers is also hard for bankers to understand. The focus on meeting premium volume commitments while maintaining low loss ratios, sometimes at the expense of writing business for a bank board member, can become a real stumbling block. The potential for jeopardizing the bank’s relationship with some of its primary customers is a real concern, particularly if bank personnel blame the agency for the problem because they don’t clearly understand the underwriting requirements imposed by insurance companies with whom it’s necessary to maintain relationships.

The hard market in Commercial Lines might put additional strains on bank personnel/agency personnel relations because the bank personnel might not fully understand why the account can’t be placed in the standard markets or why the premium is double what it was last year.

Trying to combine financial services makes sense on paper. But it’s been a tough road so far for most that have tried it. Whether it’ll eventually turn out to be the best thing for the banks, the agency principals, their customers, and their employees remains to be proven.