Joining Banks In Insurance: Doing A Smart Deal

DOING A SMART DEAL

by Carol Hammes

On November 12, 1999 the Gramm-Leach-Blily Act, the long-awaited financial services legislation which effectively breaks down the barriers among banks, securities brokers, and insurance companies, was signed into law. This legislation allows such entities to compete in one another's business and will most certainly result in many more mergers and consolidations.

Many experts are speculating that at first banks will be the primary buyers, because they have more capital and perhaps a more pressing need to expand the list of products and services they provide to their customer base. In 1980 banks held 23% of household deposits; now they have less than 13%. They need additional fee income and view selling insurance as a good avenue both for providing something more to existing clients and for helping to increase the client base itself. While banks have experienced a decline of 0.6% in real GDP dollars over the past 10 years, the insurance sector has gone up 3.2%. This makes the acquisition of an insurance company even more attractive to a bank.

At the same time, some of the larger insurance companies have started to form banks and provide mortgages and car loans. They might also go into an acquisition mode now, buying financial institutions that will be in a position to sell the company's insurance products to new and existing bank customers. With policyholder surplus at such high levels, insurers are looking for more premium dollars any way they can get them. Banks offer many opportunities to achieve that growth: ease of automatic premium payments, a way to identify good prospects, a new way to market products, and more opportunities to cross-sell. And although not many observers seem to be willing to put it in print, there's an additional attraction of bank marketing to insurance companies that can be implied from some of their other recent distribution moves. This might be another way to cut the independent agent out of the picture.

What does all of this consolidation activity mean to the average independent agent? After the Barnett decision in 1996, many banks decided they could get into the sales side of the insurance business even if they were still restricted from underwriting. So they began to buy insurance agencies and/or to set up joint marketing programs with local agencies. The flurry of business-combination activity between banks and insurance agencies that began a few years ago hasn't let up, and the passage of Gramm-Leach-Blily probably won't have much of an impact other than to keep the pressure on agents to decide whether they want to jump on the bank bandwagon. Now they not only have to worry about their agent competitors doing a deal with a bank first, but they also have a legitimate concern about what their companies might decide to do, with or without agent participation.

There certainly are plenty of opportunities out there for an agency to join up with a bank. Our guess is that at least 75% of the remaining 35,000 independent agencies have been contacted by a bank recently. Banks have been fighting for more than a quarter of a century to sell insurance, and they're in a hurry to get started. The benefits banks can bring to an insurance agency include capital, a high level of credibility and trust, and a substantial number of active prospects. In return, banks are looking to the agency to add insurance expertise, marketing savvy, and knowledgeable sales and service personnel.

Most banks want to buy an agency so they can have control, but they may settle for a joint venture if the agency can show it can administer itself profitably and effectively. It's often hard for agency principals to resist the allure of thousands of warm prospects. And equally as compelling in some cases is the fear that those opportunities will fall into the hands of the agent down the street if they don't act quickly. These bankers clearly want to be in the insurance business, and if we say 'no' they'll move on to the next, less reluctant agent.

In the face of this pressure, many an agency has set up some sort of business combination with a bank, and hundreds, (if not thousands), have given up all of their ownership interest in the process. For many agencies and for many banks, these have turned out to be bad decisions that have cost a lot of money and diverted resources from potentially more positive pursuits. Not every successful bank can and should be in the insurance business, and not every insurance agency can and should align with a bank.

You have a choice. Carefully analyze your options before jumping in.Talk with other agents that have done joint ventures or sold to banks over the past several years. Find out whether the marketing programs are working the way they'd envisioned. Ask them about their frustrations with the bank bureaucracy and with the inevitable cultural differences between the two industries. Try to get these agents to quantify the amount of time that the agency's management and sales personnel spent trying to 'make it work,' and weigh that against the results. If your agency was to spend the same amount of time on other nonbank-related marketing pursuits, would the results be more favorable and potentially more lucrative for the agency principals?

If people are honest, they'll tell you that even in successful operations, it's been much harder than either side had envisioned. In more than 20 years of consulting, we've helped many banks buy insurance agencies and almost as many to sell them. Along with other consultants who've had similar experiences, we've become conservative and less than optimistic about the chances of a joint venture or a bank-owned agency achieving the ambitious results they'd anticipated. Even the success stories have had rocky periods.

BB&T is often touted as the model to emulate. Located in North Carolina, South Carolina, and Virginia, this bank-owned agency has acquired more than 30 P/C agencies since 1980 and now has more than $50 million in revenues and a pretax profit of around 20%. Lost in the hype, however, is the fact that BB&T has been in the insurance business since 1922 and that even in 1991, after 10 years of paying attention to growing the agency, their $5 million in annual revenues didn't cover fixed expenses. Success clearly didn't come overnight. It takes a lot of trial and error, and while this firm may have found the right formula for it, other banks will have to find their own way.

Each bank and insurance agency is unique, so it stands to reason that each bank agency will also be unique. What works well for one bank agency may not work for others. Finding the right structure and marketing approach will take time, and the road often will be bumpy. This means that there must be a full commitment on the part of bank management to stay the course, not just for one or two years. A number of banks have opted to get out of the insurance business within a relatively short period of time after making the acquisition or setting up the joint marketing plan because the return wasn't want they'd expected. Banks that aren't willing to give it at least three years, with the potential of a pitiful return during that period, shouldn't enter the P/C insurance business.

An agency thinking of doing a deal with a bank should carefully explore the tolerance and commitment levels of bank management as part of their due diligence. On the surface it may not seem necessarily bad to sell the agency for 1.5 times and then be able to buy it back for 0.75 times two years later. But any damage to the client, employee, and company relationships will last much longer than the bank venture did. And the emotional toll it can take on the agency principals can be devastating. A bad deal is simply not worth it.

Because consultants see so many different situations, we can sort through the things that have been successful for agencies and those that haven't. And we can give warnings and suggestions to those who are embarking upon certain strategic or marketing plans. Here are some observations and recommendations regarding bank-agency relationships that have been derived from the experiences of a number of insurance agency management consultants:

Reasonable Expectations. Most of the failures in bank-agency combinations can in part be traced back to differences in expectations. Even if the bank is buying the agency (and maybe more so in that circumstance), it's absolutely crucial to the success of the venture that each side clearly understands the expectations of the other. In general, banks expect a quick and substantial financial return on their investment. Agents expect a high level of marketing activity and sales results for the time spent.

Many bankers believe they can make a killing selling P/C insurance. This is why a number of them have grossly overpaid for insurance agencies during the past several years. Some community bankers don't understand that the premium dollars they expect to generate aren't the agency's income and are shocked to later learn that they'll only get 13%-15% of that large amount. Others naively believe that an agency can set prices and thereby drive all competing agencies out of business.

Before selling to a bank or setting up a joint venture, an agent should teach the bankers the economic realities of the P/C insurance business. They need to know that the average agency generates an 8% pretax profit and that even after pro forma adjustments are made, the potential for more than a 20% profit is only available in a small percentage of agencies. Whether the deal is a joint venture or a merger, after considering acquisition and start-up costs plus initial marketing expenses, turning any kind of a profit in the first few years will be difficult. Bankers live by the bottom line, and when the return isn't there they can become disillusioned very quickly 3/4 often within the first year.

Agents, on the other hand, tend to think the bank has more control over its clients than it actually does. They assume if the loan officer suggests that a client talk to the bank's resident agent, the insurance account will be written then and there. This isn't the case. These businesses and individuals already have insurance. They may be very happy with their current agent. Even if they're willing to listen, it'll take almost as long as it normally does to write the business 3/4 in Commercial Lines, generally three years of hard work.

What the agency will get from the bank is simply a list of leads, albeit some warmer than others. It's really not that much different from receiving leads from an insurance company or other source. The leads still must be worked by professional insurance salespeople. We have a hard time believing that these leads are better than the ones already in the agent's files. The average independent agency still only writes 1.5 policies per Personal Lines customer. Rounding out those existing insurance accounts has to be easier than trying to sell insurance to a new prospect, but many agents lose sight of that fact in setting up their expectations for a marketing association with a bank.

Reasonable Projections. We've lost count of the number of bank-agency marketing plans we've seen that project a 10% penetration for the sale of at least one P/C insurance product to existing bank customers within the first three to five years. In fact, some models provided by organizations in the industry use that figure to 'help' agents decide how much business they could write in conjunction with a bank. BB&T has been in the insurance business for 75 years and has focused on trying to increase that sector for almost 20 years. They currently report writing P/C insurance for 5% of the bank's customers. How can a new venture expect to have a 10% penetration of bank customers when one of the greatest success stories is only doing half of that level after so many years in the business?

Be conservative in making the projections for selling insurance to existing bank customers. Set up your initial estimates and then cut them by 50% before putting the marketing plan in writing. If you do better than the projections ,everyone will be happy. If you don't meet the projections, the whole venture will be in jeopardy. Use higher percentages for new bank customers than you do for existing ones. It will be easier to sell insurance to people obtaining mortgages or other loans at the time they're applying to the bank than it will be later on. But under no circumstances should you ever expect to write P/C insurance for more than 10% of the bank's clients, old or new.

Too Much Opportunity. In the romance stage of looking at a deal, it's easy to get caught up in the excitement of the many joint marketing opportunities that will be available to the combined entity. The initial business/marketing plan will present the creation of various programs for Personal and Commercial lines in both P/C and Life/Health lines. Segments of the bank's clientele will be targeted in different ways: statement stuffers, agents in lobbies, direct-mail campaigns, and so on. Loan officers, trust officers, and often other bank employees will be educated to spot prospects and rewarded by whatever method is deemed to be legal and ethical by compliance personnel. Sometimes the written plans will contain 10 or more pages of all the wonderful things the bank and agency will be able to do together to cross-sell each other's accounts and generate totally new business.

What often happens is that this vast number of opportunities becomes overwhelming and paralysis sets in. Rather than getting on with the business of tapping this treasure trove, many bank-agency management teams spend countless hours in meetings trying to figure our how to 'get going' on all of this. Set priorities, and recognize that you can't do everything at once. Analyze the bank's core business and customer profiles. The initial insurance programs offered must fit both. Where can you get the most visibility and return for the least amount of effort?

For example, many bank-agency ventures have found that one of the best first steps is to set up a program to write the insurance for bank employees on a group basis. If the insurance operation can do a good job for them, they'll be more enthusiastic about recommending it to their clients. Just make sure you can effectively handle any program you introduce. The bank personnel will be naturally suspicious but may give you a chance or two. If you jeopardize their relationship with a client through faulty insurance service, however, you won't get another chance.

Merging the Cultures. Because both banks and insurance agents are in the business of providing financial services, it's assumed that there's a natural synergy between the two. This is a myth. Banks are generally risk-adverse, bureaucratic, financially sound, and not very market driven. Their compensation systems are for the most part attendance-based. The independent agencies that are thinking of doing deals with banks are market driven and accustomed to taking risks. They're entrepreneurial, often have little capital, and have marginal profits. They pay their producers and service personnel based on the overall success of the agency and/or the individual book of business handled.

It's critical to the success of the operation that each side recognizes the differences up front and strives to understand where the other side is coming from. Set up some hypothetical situations and see how you each react. What if several of the agency salespeople end up making more money than the bank president? What if the agency can't write the insurance for a bank client who may be a good loan risk but a bad insurance risk? What happens when a member of the bank's board has a claim that's not covered? What if the agency's first-year profit and/or revenue growth is only half of what had been projected when the acquisition was made? What if agency personnel balk at changing procedures to achieve economies with the bank's back office? In a joint venture situation, who will own the expirations and where will the management control reside? What will the exit strategy be?

Listen to what the other side says or doesn't say on these and other issues. Make sure you've done whatever you can to get all major items on the table prior to signing the papers. Compatibility is essential, but liking the other guys isn't enough. You must develop a level of trust that will transcend the inevitable rough spots that will be encountered. Putting together a successful bank-insurance agency operation is really hard work. Agents must recognize that it will take a substantial time commitment to get the joint marketing systems up and running and to get the bank personnel up to speed on the insurance learning curve. Bankers must recognize that all undertakings can't be measured solely by the initial return on investment. If getting into the insurance business is a key strategy for the bank, then the board and top management must be patient and flexible enough to recognize and accept the major differences between banking and insurance.