by Jim Campbell, August 2006

National Underwriter

Over the past decade, hundreds of banks have plunged into the insurance brokerage business, creating annual growth in bank-produced insurance premiums of twenty-five percent.  Once in, most have continued to build, producing tens-of-billions of dollars in aggregate bank-insurance premiums.  In fact, in 2005 the banking industry produced insurance (i.e., property/casualty and life health) premiums nearly equal to its annual annuities production.

To even the casual observer, this emergence and growth of bank-insurance is largely attributable to agency acquisitions.  In pursuit of fee income, banks have been aggressive participants in the agency acquisition market.  For most banks that have acquired agencies, their investment has provided an acceptable return while contributing to the bank's revenue diversification objective. 

But lately things have changed.  Agency acquisitions by banks have declined in number over the past several years.  In 2005, the number of completed deals by banks fell to less than half that of its peak reached in 2002, and the declining deal pace has continued through the first half of 2006.

If acquisitions are the life blood for bank-insurance growth, the decline in deals raises this question:  Has bank-insurance reached an early maturity, with only modest growth ahead or will banks regain their appetite for agencies and resume their previous acquisition pace?  To answer this question, let's ask two more:  (1) Why has the pace of bank-agency deals slowed?  And (2) How are banks responding to the challenges of the acquisition market?  The answers to these two key questions suggest the current lull in bank-agency deals is temporary.  Let's take a closer look.

Why Has the Pace of Bank-Agency Deals Slowed?

To begin, let's eliminate one possible answer to the question of why deals have slowed.  Banks have not lost interest in selling insurance products or in acquiring agencies.  Interest remains high, and most banks that have previously acquired an agency expect to acquire more.  Pipelines are filled with active discussions, but fewer deals are being closed.  The true culprits for the slowdown in deals by banks are the three "Cs":  (1) candidates, (2) contingent income and (3) competition. 

Candidates - The field of acquisition candidates has been narrowed in two ways.  First, the robust consolidation of recent years has eliminated the low-hanging fruit.  The agencies that were ready to sell have sold.  Those remaining are generally more committed to independence.  Second, banks have become more discriminating.  The profile of a successful platform agency for a bank has evolved, and banks are now less willing to pursue an agency that doesn't match the profile.

Contingent Income - An additional challenge for banks that attempt to buy agencies is the strong contingent income earned by many agencies in 2005 and 2006.  Increases in contingent income drive increased earnings.  Increased earnings drive increased payouts to agency principals.  With payouts for many agency principals at all-time highs, why should they kill the goose that laid the golden egg?  Bottom line:  as contingent income goes up, the motivation to sell goes down.

Competition- The third challenge for banks is the increased aggression of their primary competition for deals, the public brokers.  Looking for acquisitions to supplement low organic growth, public insurance brokers are in active search mode.  The impact:  rarely does a bank approach an acquisition candidate that has not already been approached by one or more of the public brokers.

How are Banks Responding to the Challenges of the Acquisition Market?

The second key question to consider is the banking industry's response to these challenges.  If banks are still committed to building their insurance capabilities, then surely they won't roll over and quit when the going gets tough.  They haven't.  Most are now using one or some combination of the following tactics to support their agency acquisition strategy:

-Pause and Focus Internally - For some banks, the current challenges of the acquisition marketplace create a needed opportunity to pause temporarily from deals and to focus internally.   Integrating, digesting and enhancing their existing insurance business are the priorities for now.  Their interest in growing their insurance business remains high and they intend to return to acquisitions when they sense that market conditions have improved.

-Pursue Smaller Acquisitions - Some banks have elected to redirect their near-term acquisition efforts toward smaller fold-in agency deals and book-of-business acquisitions.  Their rationale is that each of the challenges stated above is less onerous when pursuing smaller deals.  Candidates are more plentiful, contingent income levels are generally lower and, therefore, less intoxicating to the principals, and competition for smaller transactions is less intense.  These smaller deals often fly beneath the radar of some industry observers and are frequently excluded from lists of completed bank-agency transactions.

-Structure Deals More Creatively - Many banks now approach A-list acquisition candidates with more creative and more aggressive deal structures than previously used.  Industry data suggest some modest inflation in deal pricing by banks in recent years.  A closer look shows that guaranteed pricing has changed little but that maximum potential pricing has increased more significantly.  What these data reveal is that banks are using richer earnouts to enable selling principals to participate in the upside if the agency is successful post-acquisition.  While this approach has been successful, it is generally reserved for larger, high-performing platform agencies.

The answers to the two questions above suggest the recent decline in bank-agency deals is the result of temporary market conditions and not a strategic shift by banks.  In time, these market conditions will change.  Moderation in contingent income will reduce payouts to agency principals and will increase the field of agency candidates.  Market hardening will increase organic growth for public brokers and will reduce their acquisition urgency.  As these market conditions change, expect the number of bank-agency deals to increase.  How much it increases will be determined in large part by community banks.  Smaller community banks have been relatively inactive in the agency acquisition market to date, but are showing signs of becoming more engaged.  If they do, future years may produce higher numbers of bank-agency deals than past years, but with a smaller average deal size. 

Until these acquisition market conditions improve, banks will remain opportunistic buyers.  When a significant opportunity emerges, they will utilize creative structures and move aggressively.  Lacking a significant opportunity, they will focus on their existing insurance business, pursue smaller fold-ins and watch for changes in the acquisition market.