Reagan Consulting

A decade ago, the banking industry was captivated by its prospects in the insurance brokerage business. And rightly so. Years of battling for the opportunity to sell insurance were finally paying dividends. Regulatory barriers were falling and the sky was the limit.

 

To seize this opportunity, banks began aggressively buying insurance agencies. By 2000, banks were the most active acquirers in the market, completing 78 deals, or nearly 40% of all agency deals announced that year. Their appetite for agency acquisitions seemed insatiable with some banks lamenting that there simply weren’t enough available deals to satisfy their demand. Among those leading the way into the promised land of insurance sales were large banks and industry leaders. Expectations soared.

 

Today, however, bank-insurance momentum has slowed. True, the landscape has changed. The capital crisis that has gripped the banking industry over the past couple of years has made agency acquisitions difficult for some banks. However, the beginning of the slow-down pre-dates the full force of the credit crisis and can be traced to a sequence of setbacks that unfolded over the past half-decade. 

 

The first setback for bank-insurance began in 2004 as property and casualty insurance pricing began to soften. As softening prices slowed agency growth and suppressed investment returns, bank boards began to reassess their agency acquisition strategies. Enthusiasm for more deals waned. By 2005, the banking industry’s share of the agency acquisition market had plummeted to 21.1% or roughly half its peak level reached three years earlier.

 

The following year, as banks tried to mount a comeback in the agency acquisition market, they encountered a second setback. The competitive landscape had changed. The public insurance brokers, needing to supplement their woeful organic growth in a persistent soft market, were highly-motivated buyers. In addition, private equity was on the hunt and willing to pay premium prices.  With the increased aggression of the public brokers and private equity groups, banks had lost the pricing advantage they previously held and were finding it more difficult to compete for deals. Many announced they would forego agency acquisitions until the return of a more favorable market.

 

The third setback began to emerge by late-2006 and was in full-bloom by 2007. During this time, banks, including several leaders of the bank-insurance movement, were questioning the results of their efforts in insurance. Although most acquired agencies were performing at least reasonably well, some had failed to contribute meaningfully to the overall performance of the bank. They were deemed “ancillary”, “non-core” or “non-essential”.   Ultimately, some banks divested. Included among them were Bank of America, Union Bank of California, Capital One and Webster Bank, all of which sold insurance agencies that were among the 100 largest in the U.S.

 

Unlike the first two setbacks, which were driven largely by market cycles, this third setback hit at the core of bank-insurance, questioning the potential for insurance sales to make a relevant contribution to the banking industry. The 2008 American Bankers Insurance Association (ABIA) Study of Banks in Insurance found that, for 66.2% of surveyed banks, the primary objective for selling insurance is to “increase non-interest income”. This suggests that, in order to be relevant to the performance of the bank, an insurance agency must make a material contribution to the bank’s non-interest income growth.  Clearly, some banks were determining that, for them, this threshold was unattainable. 

 

But what about other banks? Was this an indictment of bank-insurance generally or was it still possible for other banks to achieve the objective of meaningful non-interest incomes growth through insurance sales? The 2009 Michael White – Prudential Bank Insurance Fee Income Report sheds some light on these questions. Analyzing data from approximately 9,500 commercial banks and 1,000 bank holding companies (BHCs), this report provides the percentage of non-interest income each of these BHCs derived from insurance brokerage fee income, a metric referred to as “non-interest income (NII) concentration”. Following are some key findings from this analysis:

 

·        For the 50 largest U.S. BHCs (let’s refer to these banks as “Group 1”), median insurance brokerage fee income is $9.6 million but median NII concentration is a paltry 1.0%. So, although the median bank in Group 1 is generating nearly $10 million through insurance sales, this income represents only 1% of the bank’s total non-interest income

 

·        For the 50 U.S. BHCs with the highest NII concentration (“Group 2”), the median insurance brokerage fee income is only $4.1 million but the median NII concentration is a robust 36.5%.

 

Although there is no universal threshold for determining relevance, it seems reasonable to assume that the 1.0% contribution to non-interest income achieved by Group 1 would be considered irrelevant by most banks, but that the 36.5% contribution to non-interest income achieved by Group 2 would be considered highly relevant. Yet, the median Group 1 bank is generating more than twice as much insurance brokerage fee income as is the median Group 2 bank. Why is this income so much less relevant to the Group 1 banks? Because the Group 1 banks are much larger. Median assets for the Group 1 banks are $62.4 billion compared to only $0.9 billion for the Group 2 banks. Conclusion: relevance is relative. It’s harder to move the non-interest income needle in a larger bank because the total non-interest income number is so much greater. Consider that although the median Group 1 bank has more than twice the insurance brokerage fee income as does the median Group 2 bank, it has almost 60 times as much total non-interest income. 

 

This inverse relationship between bank size and the ability to make a material contribution to non-interest income growth through insurance distribution will play a critical role in shaping the future of bank-insurance, perhaps most notably in the following two areas:

 

·        Community banks will lead the way. Change in the banking industry often starts at the top and then trickles down. Consistent with this pattern, larger banks were the first out of the gates in pursuing the insurance business. But many have now admitted that, for them, pursuing relevant scale in insurance is futile.  BB&T and Wells Fargo have proved it can be done, but they are the exceptions and not the rule. In fact, only five of the 50 largest U.S. BHCs are on the top 100 list for NII concentration (i.e., percent of NII derived from insurance brokerage fee income). For community banks, however, relevant scale in insurance is generally more attainable. Consider the example of First State Bank in Webster City, Iowa. Having previously acquired more than a dozen small insurance agencies, this $242 million asset bank generated approximately $4.5 million in insurance brokerage fee income last year. Although this may not be enough income to be relevant to some larger banks, Michael White Associates reports it accounted for 37% of First State’s net operating revenue and 76% of its non-interest income.

 

·        Agency acquisitions will drive the growth. As demonstrated by the top 100 BHCs in NII concentration, most of which have acquired at least one insurance agency, the surest path to relevant scale in insurance is through acquisitions. Although cross-selling is an important part of the insurance strategy for most banks, it is more practically a means for strengthening existing bank customer relationships than for building scale. In addition, individual life and health insurance will be an important element of most bank-insurance strategies but will not do the heavy lifting of building scale. Why? Because individual life and health commission income is generally non-recurring and must be re-produced annually. Conversely, property and casualty (and group benefits) insurance commissions provide a renewable source of non-interest income, with retention rates often in excess of 90%. Look for community banks to increasingly pursue acquisitions of property and casualty insurance agencies to establish insurance platforms and to build scale. 

 

The recent slow-down in bank insurance momentum has resulted from a combination of factors but reflects in part the fact that some of the nation’s larger banks have decreased their focus in insurance. But the potential for insurance distribution to be a relevant contributor to smaller banks (primarily those with assets of less than $5 billion) is proved by the more than 100 such banks currently earning 10% or more of their non-interest income through insurance sales.

 

Many banks have seen some erosion in their non-interest income over the past two years. Community banks are no exception and can ill-afford to lose ground on this front as they generally have fewer well-developed non-interest income sources than do larger banks. It is the community banks, therefore, that have both the greatest need for the additional non-interest income that insurance distribution can provide and the greatest opportunity to achieve relevant scale. Although larger banks led the surge into insurance distribution over a decade ago, it is the community banks that will lead the next wave and that will ultimately benefit most from bank-insurance.           

 

 

Jim Campbell is a principal and senior vice president of Reagan Consulting, Inc. where he leads the firm’s banking industry practice. He can be reached at www.reaganconsulting.com or at (404) 233-5545. Additional information about Reagan Consulting is available at www.reaganconsulting.com.