Citigroup Failure Undermines Synergy Claims

The Citigroup merger did light a fire under efforts on Capitol Hill to tear down the walls separating the banking, insurance and securities sectors erected in the wake of the stock market crash of 1929. The nearly 20-year-old lobbying slugfest came to end in the waning days of the last century with the enactment of the Gramm-Leach-Bliley Act.

The merger also propelled Mr. Weill to the pantheon of "Wall Street Men Who Mattered," particularly after he engineered the ouster of his co-chair two years later. Mr. Weills reluctant removal from the day-to-day operations of the enterprise two years ago in the aftermath of investment banking research scandals paved the way for the final dismantling of his vision.

The first block fell in December 2001 when it was announced that Travelers Property & Casualty would be spun-off to become a public company.

At the time, Standard & Poors noted that p-c operations yield little opportunity for synergies with banks. In addition, a report from A.M. Best Company asserted back then that "the changing risk environment that has exposed numerous lines of business to catastrophic risk once thought confined to natural occurrences" would discourage future convergence of p-c operations with broader financial services.

Analysts joined Travelers P&C CEO Robert Lipp in asserting the spin-off would position the unit well in the aftermath of the post-Sept. 11 hard market for the anticipated future p-c industry consolidation. They proved quite prescient two years later when St. Pauls, under the leadership of CEO Jay Fishman, acquired the company he once chaired under the Citigroup umbrella.

MetLifes demutualization in 2000 put it in the perfect position to strike the final blow to the alleged financial sector deal of the decade when it moved four years later to shade its Snoopy with the nice red Travelers umbrella.

The benefits for both parties were obvious. MetLife assumed the number one position in individual life sales along with new distribution of foreign outlets it did not possess. And for Mr. Weills successor, Charles Prince, it was an opportunity to take capital from the slow-growth insurance underwriting operations for deployment in ventures where high-teens growth rates are the norm, and also put his stamp on the company he had led for more than a year.

The 2003 acquisition by Bank One of Zurich Life represented the only other sizable post-GLB bank-insurer deal. That, of course, begs the question of what happened to the New Paradigm of 1998?

The short answer, according to S&P analyst Tanya Azarchs, is the divergent profit picture of banking and insurance. "Owning the manufacturing of insurance hinders banks sales efforts by restricting their product offering and by being very capital intensive," she said. "It is difficult for insurers to get their earnings on that capital above the 12 percent level, and growth slows."

Such figures compare poorly with U.S. bank returns on equity of about 20 percent and serve to dilute the group return on equity, Ms. Azarchs asserted. The fact that the p-c and life operations accounted for only 8 percent and 6 percent of Citigroups earnings, respectively, according to rating agencies, served to underscore Ms. Azarchs assertion.

Fitch Ratings analyst Doug Meyer said the MetLife-Travelers merger was also notable for the admission that the life insurance business, like its p-c brethren, failed to provide the growth synergies envisioned in 1998. "The cross-sell of life insurance to retail customers virtually confounds all banks," Mr. Meyer said.

UBS analyst Andrew Kligerman does not see many bank-insurer mega deals in the foreseeable future. "Although select bank/insurer transactions have arguably succeeded, these transactions have involved small companies," he said, citing the HBOS-Clerica Medical deal.

In addition to the Citicorp-Travelers failure, disappointments include Credit Suisse-Winterthur, Allianz-Dresdner and Lloyds-TSB/Scottish Widows, noted Mr. Kligerman. "Whatever the reason for these outcomes, the pattern has not been lost on other global financial institutions that might have attempted the same thing," he said.

Other impediments to future bank-insurance deals, according to Mr. Kligerman, include the Basel II capital regime that eliminates double leverage. This set of capital adequacy standards was approved during a meeting last year in Basel, Switzerland, of central bank governors and regulators from the major industrialized nations.

Under the new rules, banks with wholly-owned insurance subsidiaries will have to deduct the equity invested in the insurance company to the tune of 50 percent from Tier 1 capital and 50 percent from Tier 2 capital. "This will obviate the use of double leverage with financial groupspreviously a key and sometimes explicit motivator of bank-insurance deals," Mr. Kligerman said.

In addition, banks lower capital requirements in comparison to insurers will always result in an expectation of ROE dilution, Mr. Kligerman explained.

The Citigroup dissolution does not necessarily sound the death knell for "bancassurance," as the combination is widely known in Europe, where such amalgamations have been far more successfulit just means it will have a distinctly American flavor, observers say.

Ms. Azarchs said the bancassurance model has been much more successful in Europe in those instances where there has been an integrated approach to selling bank and insurance products. "The bancassurance model may also work better in Europe because European clients are more accustomed to purchasing a broader array of financial management products, including investments and insurance, at their banks," she said.

The problem with making the model work in the context of financial conglomerates is the fact that U.S. banking and insurance operations are for the most part run as separate entities, Ms. Azarchs explained. "The differences in cultural and financial norms may ultimately mean that the bancassurance model will have to be different on either side of the Atlantic," she added.

Mr. Kligerman contended that marketing agreements (sometimes accompanied by strategic minority equity holdings) as well as joint ventures will be the path to success. "Given these precedents, banks and insurance companies today often question the wisdom of paying goodwill and going through the sometimes painful integration process involved in an acquisition when a marketing agreement or joint venture can be more effective," he said.

Ms. Azarchs said that in the United States, the model that has worked best involves banks buying insurance agencies. BB&T Corp, Wells Fargo and Wachovia are among the major banks that have built up significant brokerage businesses. BB&T derives about 11 percent of its revenues from such activities, while the much larger Wells Fargo derives about 4 percent from a similar-sized operation.

"U.S. clients like to go to brokers so that they can be offered a range of products from competing insurers and can pick and choose among them," Ms. Azarchs said. "This is an open architectural model that works similarly to the way in which brokers sell mutual funds manufactured by a variety of asset managers. The client feels best served by having a choice, and so the brokers are forced to provide it."

Flag: Merger Autopsy

Head: What Killed The Citigroup Merger?

The 1998 Travelers-Citibank merger was widely seen as the first of many mega-mergers to come that would capitalize on expected synergies between the insurance and banking industries. Among the factors that undermined such dreams and led to Citigroups breakup:

The merger exposed vast cultural differences between the insurance and banking industries.

The two industries learned that there are more profitable ways to reap whatever synergies there might exist between the two disciplines, short of an outright acquisition or mergersuch as a joint marketing agreement.

The exposure of numerous insurance lines to catastrophic risk beyond just natural disasters made the business too volatile for the more conservative tastes of bankers.

Owning the maker of insurance hindered bank sales efforts by restricting their product offerings.

Banks were frustrated by the lower returns on equity and slower growth produced by their insurance operations.

Widely anticipated cross-selling opportunities failed to materialize.

Banks found it was more productive to buy into the distribution system, acquiring brokerages, rather than bringing insurance companies in-house.

Caption for Vault Art:

Citibank expected a big synergy dividend when it merged with Travelers in 1998, but the deal failed to pay off, leading to the spin-off and eventual sales of the banks insurance operations.

Reproduced from National Underwriter Edition, March 10, 2005. Copyright 2005 by The National Underwriter Company in the serial publication. All rights reserved.Copyright in this article as an independent work may be held by the author.