by Jim Campbell, February 2005

National Underwriter

Michael Phelps had raised enormous anticipation heading into the 2004 Olympic Games in Athens.  The superstar swimmer was hoping to break, or at least tie, the record seven gold medals won by Mark Spitz in 1972.  But his dreams ended after only his third race.  Earning only one gold medal in his first three attempts, the opportunity for seven golds was lost.  Ultimately he won a total of eight medals, including six golds, matching the record for the most medals won at a single Games.  But having fallen short of expectation, had he succeeded or failed?  According to one article, "…he may paradoxically be considered as the loser."

Mr. Phelps' achievements in Athens were remarkable.  But as his story reminds us, the line between success and failure is often drawn by expectations.

Beginning in the late-nineties, the banking industry became one of the most aggressive acquirers of insurance agencies.  Over the time since, banks have been second only to insurance brokers in the number of agency acquisitions completed, consistently announcing 50 to 80 deals annually. 

But have these acquisitions been successful?  For most the answer is yes.  But to gain some perspective, let's revisit the expectations that led banks into the agency acquisition fray in the first place.

1.  Increase Shareholder Value

In order to see the light of day within a bank, an investment opportunity must pass two tests.  First, it must be accretive to (i.e., add to) earnings per share (EPS).  And second, it must produce acceptable returns on invested capital (ROIC).  Banks that acquire agencies expect their investments to pass both tests and to grow shareholder value. 

But have these transactions produced the anticipated results?  In most cases, yes.  Agency acquisitions are generally accretive to EPS beginning in the first year, and produce solid (if not eye-popping) returns that usually reach double digits between the third and fifth years. 

For most banks these results are in line with their pre-acquisition expectations.  In fact, the 2004 ABIA Study of Leading Banks in Insurance reports that, of 49 surveyed banks, more than 80% are experiencing financial results that meet or exceed their pre-acquisition projections.  And nearly 90% of these banks plan to continue acquiring agencies.

2.   Grow Non-interest Income

A second expectation for banks that buy agencies is growth of non-interest income.  It has become practically a mantra of the banking industry to grow non-interest income in order to diversify revenue sources and reduce vulnerability to fluctuations in interest rate spreads. 

To this end, banks are pushing deeper into investment brokerage, asset management, mortgage origination, insurance distribution and other fee-based businesses. Property/casualty insurance distribution is especially attractive because its annuity nature provides a more predictable cash flow.  The potential for a steady flow of fee income is irresistible to most banks.  But what about the results?  Have these acquisitions really contributed to the quest for non-interest income? 

The results are mixed.  The ABIA Study found that some bank-owned agencies are producing more than 20% of the bank's non-interest income, while others are producing less than 2%.  Some community banks and small regionals have significantly altered their revenue profile through agency acquisitions. But for larger banks, the contribution to non-interest income can be a mere drop in the bucket.  Either way, the impact is predictable, based on the volume of insurance revenues acquired, so disappointment is rare.

3.   Cross-sell Bank Customers

Banks have long understood this simple fact:  The more products they sell to a customer, the longer they will retain that customer and the more profitable the customer relationship will be.  Therefore, cross-selling for banks is both a defensive strategy (retain revenues) and an offensive strategy (grow revenues).  Banks that acquire agencies expect them to contribute to these strategies.  But do they? 

Consider this.  The average Wells Fargo customer has purchased more than five products from the bank.  The bank's goal is to raise this average to eight.  They understand that increases in the average number of products per customer produce both higher retention rates as well as new revenue.  But don't look for insurance sales to lead the way.  Why? Because the vast majority of customers at Wells, and at virtually every bank, are individuals or small businesses.  Not exactly the sweet spot for most agencies.

Measured as penetration of a bank's total households, or even its total commercial lending base, insurance cross-selling has been abysmal.  In most cases penetration rates are less than 1%.  On the other hand, many bank-owned agencies are producing impressive results selling commercial lines solutions to targeted commercial lending customers.  On average, these cross-sales are adding about two percentage points of annual growth for the agency, and are often contributing 20% or more of annual new production.   Bottom line:  Forget about overall penetration rates and focus instead on sweet spot (i.e., target customer) penetration.

Conclusion

So let's return to our original question.  Have agency acquisitions paid off for banks?  Expectations for investment performance have generally been met or exceeded.  And non-interest income contributions are mixed, but rarely a surprise.   On the strength of these two measures, most agency acquisitions would be deemed a success. 

The wild card issue is expectations for cross-selling.  Those who expected insurance cross-sales to bank customers would strengthen key commercial relationships have been pleased.  As have those who expected cross-selling to leverage the stand-alone growth of the agency.  But those expecting high penetration of the core customer base, resulting in increased overall customer retention rates, have been disappointed.

One conclusion is clear.  The banking industry will remain active in the agency market and will be a growing segment of the insurance distribution system.  By learning from the results of the past seven years we all have the opportunity to better set our expectations for the years ahead.  And it is against these expectations that the future success of bank-insurance will be measured.
 

Jim Campbell is a principal and senior vice president of Reagan Consulting, Inc, where he leads the firm's bank consulting practice.  He may be reached at 404.233.5545 or a jim@reaganconsulting.com.  Reagan Consulting is an Atlanta-based financial and management consulting firm serving the insurance distribution system.