Community Bank Insurance Sales: The Outlook

Traditional insurance distribution is creaking and groaning from the increasing pressures it has endured for more than a decade. The sources of these pressures are numerous, and the ultimate result may be dramatic. The nearly 40,000 independent insurance agents and brokers nationwide have been impacted most. Where's the pressure coming from?

For starters, insurance carriers prefer to do business with fewer agents and with higher average premium volume per agent. Let me restate this point because it's crucial to all insurance distributors. Carriers are looking for premium volume. Because most agents produce far less than $10 million in annual premiums, they're finding it increasingly difficult to keep all of their carriers happy. Furthermore, the average agent has experienced top-line growth of less than 5% annually since the mid-1990s. This suggests that growing your way to sufficient premium volume is unlikely.

Additional pressure is being applied by technology. Lower-margin products such as Homeowners, Auto, and Term Life are beginning to migrate toward lower-cost distribution channels, such as call centers and the Internet. Today's telecommunications and Internet technologies provide legitimate alternatives for distributing products that many believe are approaching commodity status. While disintermediation to date is slight, it is occurring and it's certain to increase.

Consumers are providing further pressure. Insurance consumers today are more knowledgeable, sophisticated, and demanding than they were only a few years ago. This is true of both Personal Lines and Commercial Lines consumers. Today's consumers want flexibility, control, and the ability to access their provider when and how they prefer.

Still further pressure is coming from new types of insurance distributors. Banks and other financial institutions, agency aggregators, financial services consolidators, and others have descended on the traditional distribution system in recent years. Though in aggregate these competitors have captured less than 10% of the insurance distribution market, they're making their presence felt and are poised to grow their collective market share to substantially increased levels.

The pressure is significant and increasing. It should come as no surprise that consolidation is rampant and that the number of independent brokers and agents is dropping steadily. However, most of the change is still ahead of us, and it might be more profound than we anticipate.

It's against this backdrop of turbulence that the bank insurance movement is seeking to find its legs. While it's fair to say that the bank insurance industry is just emerging, it's doing so with mixed results.

During 1999, insurance and annuity premiums produced by banks grew approximately 18% to nearly $37 billion. However, while banks have captured a respectable share of credit insurance and annuities, their General Lines market share remains below 5%.

Furthermore, insurance hasn't yet become a significant source of income for most banks. More than 300 banks participated in the '2000 ABI Study of Leading Banks-In-Insurance,' jointly conducted by Reagan Consulting and the Association of Banks-in-Insurance. Of the participants currently distributing insurance products, the average earned only 1% of the bank's 1999 net operating revenue through insurance.

In reality, it takes time to build a book of business in insurance and to grow substantial revenue. Although cross-selling insurance products to bank customers is a valid strategy that's gaining traction, cross-selling penetration occurs slowly.

Despite this dose of reality, the banking industry seems undeterred in its quest to sell insurance, and rightfully so. The argument for banks selling insurance isn't about the direct non-interest income opportunity; it's the strategic need to provide fully integrated financial solutions to customers. Said another way, insurance distribution presents a compelling long-term strategic opportunity for banks, rather than a short-term economic gain.

Will community banks be forced to watch the industry pass them by, relegated to a disadvantageous position? Not necessarily. It's not too late for community banks to close the gap, nor is it a forgone conclusion that larger banks will win in the area of execution.

To be fair, many of the insurance programs even among larger banks are rudimentary, and some are floundering. It's one thing to be in the insurance business, but quite another to be successful at it. There's evidence to suggest that community banks, once in the insurance business, might be better at it than their larger brethren. For example, community banks have achieved higher cross-selling penetration levels than larger banks. Whether this represents better relationships between community banks and their customers or other factors, community banks should take note. It might be that community banks will emerge as the stars of bank insurance. But first, some obstacles must be overcome.

The challenge for community banks and the most likely explanation for their lower participation levels is leverage, or more precisely the lack of it. Let's take an example. What's the predominant entry and growth strategy for banks in the Property/Casualty insurance business? Agency acquisitions. Each year banks become increasingly active in acquiring agencies.

When a bank acquires an insurance agency, it conducts an investment analysis to ensure an acceptable level of return on equity and an acceptable, nondiluted impact on shareholders. If the numbers work, the reason is top-line leverage. The bank will find it has little redundant operation with the agency and, therefore, little opportunity to eliminate expenses. The leverage necessary to make the transaction work must be supplied by the cross-selling opportunity. The problem for community banks is that they have smaller customer bases. Smaller customer bases yield less cross-selling revenue. And less cross-selling revenue means less top-line leverage.

But isn't the solution for smaller banks to simply buy smaller agencies? Though this seems logical, it's a flawed strategy for two reasons.

First, as previously discussed, carriers are emphasizing premium volume. Now is not the time to jump into the market as a low-volume producer. Premium volume equals influence with carriers. Influence with carriers equals greater contingent/bonus income opportunities and greater flexibility in designing products or programs to address the needs of your customer base.

Second, the bank will want a sufficient platform on which to build its insurance operation. As a rule of thumb, even a small community bank will need an agency with annual net revenues approaching $1 million in order to have sufficient infrastructure - production and support staff, technology, carrier contracts, and other items.

For community banks, insufficient leverage compromises their entry and growth strategies. In addition to acquisition challenges, third-party marketers and potential joint venture partners might be underwhelmed by the economic prospects of helping a community bank realize its insurance cross-selling potential.

Though there are challenges, smaller banks need not concede defeat. In fact, it might be time to become bullish on community banks as insurance distributors. The landscape is changing and new alternatives are emerging. These new alternatives, combined with lessons learned from those at the vanguard, dramatically improve the chances for a community bank entering the insurance business. What's the best path to follow? There's no consensus, but there are alternatives worthy of consideration:

• Acquire an independent agency. You might've thought we just eliminated this option, and for small community banks, perhaps we did. But for banks with at least $500 million to $1 billion in assets, it might be worth a look. Banks approaching $1 billion in assets can often make the numbers work and might find an acquisition to be the most attractive strategy.
• Join a consortium. Perhaps the most promising model that has emerged to neutralize the leverage issue is the consortium - as few as a handful or as many as dozens of banks joining forces. This collection of banks will typically establish a separate legal structure, such as a limited liability corporation, through which it'll acquire or partner with agencies to market insurance products. The primary advantage of the consortium is that it gives banks access to, and perhaps shared ownership of, good insurance agencies at a fraction of the capital otherwise required. The cross-selling leverage of the bank is applied to a much smaller capital investment, and returns on equity soar. There are currently several consortiums at various levels of development. Though some consortiums are developed directly by the banks, a third party, such as a state bankers' association, usually facilitates them. Look for the consortium movement to grow explosively at the first reports of success from the trailblazers.
• Consider a joint venture. Although joint ventures between banks and independent agencies have a less-than-impressive track record, they're worthy of consideration for small community banks. Since these ventures usually require minimal investment capital by the bank, the concern over inadequate leverage is minimized. Furthermore, a joint venture frees the bank from constraints relative to agency size. A small bank may join with a large agency, thereby gaining access to all of the advantages of being a high-premium volume producer. However, it's unlikely that a large agency would agree to an exclusive arrangement with a small bank, so be prepared to share.
• Outsource. Finally, several vendors are now offering turnkey agency solutions for banks. In this scenario, the vendor provides access to carriers, as well as providing full servicing and administrative functions. Limited marketing support might be provided, although a bank should expect to be largely on its own for new business production. The bank generally earns a commission on business it produces and has full (or at least partial) ownership of the book of business. Though this remains an unproven business model, it offers promise and is worth watching. As in the consortium model, the outsourcing vendors are relying on the aggregated production of many community banks to better leverage the fixed cost of the infrastructure.

Ultimately the decision to enter the insurance business or to remain on the sidelines is one that each bank must make in light of its own unique circumstances. There are no universally correct entry and growth strategies, only best choices given the needs, expectations, and opportunities of each bank. Community banks are growing restless and increasingly aggressive in their pursuit of better alternatives, and we might soon see a more nearly level playing field. Any bank that views insurance distribution as a strategic necessity and is committed to its success is ahead of the game.