Banks Keep Gobbling Up P-C Agencies

o Will insurance sales be economically relevant to banks?

o If so, how is this economic relevance achieved?

o Which banks will benefit the most?

Emerging evidence suggests the economic impact of insurance sales will be significant for many banks, and already is for some. But let's take a closer look. A study of the 100 largest U.S. banks provides some answers to each of these questions.

Of the motivations for banks to sell insurance, the greatest is revenue diversification, as insurance commissions offer banks a source of highly-sought-after non-interest income–or NII.

Better yet, insurance commissions provide renewable NII, as retained accounts produce commissions and fees year-after-year. Therefore, the first test of economic relevance is contribution to NII.

Here's the evidence:

o Among the 100 largest U.S. banks, 11 now earn more than 10 percent of their NII through traditional insurance brokerage–and this excludes sales of annuities, credit insurance, title insurance and some individual life/health products.

o More noteworthy, the median insurance brokerage revenue for these 11 banks is $45 million, and contributes nearly 21 percent of total NII.

o Among these banks, contributions to NII range from 10 percent to a whopping 32 percent.

o Another test of economic relevance is contribution to the bank's earnings per share, or EPS. Assuming a 15 percent net income margin, the median EPS contribution of insurance brokerage for these 11 banks is $0.08. The range is $0.03 to $0.19 per share.

With these contributions, we can safely conclude that these 11 banks find selling insurance to be economically relevant. How did they cross the relevance threshold?

Few will be surprised to learn that all 11 banks built their insurance brokerage business through acquisition.

The old debate over alternative strategies (whether to buy, build or align) has yielded to the following conclusion–banks that are serious about developing a property-casualty and group health insurance brokerage business should acquire.

What may be surprising is the thoughtful and deliberate way in which these banks have gone about doing just that.

All 11 banks have completed a series of acquisitions over several years. In short, they are methodical, serial acquirers of agencies. They are executing disciplined strategies for identifying and pursuing agencies that match their acquisition profile.

Another consistent characteristic of these banks is tenure in the insurance business. Most were, if not at the vanguard, at least early adaptors of bank-insurance. Ten of these 11 banks completed their first agency acquisition by 2000 and have been building their brokerage business for more than five years.

Are all banks able to build an economically significant insurance brokerage business?

Thus far, bank size has been a factor. The assets of the 11 banks range from less than $10 billion to greater than $100 billion–with a median of only $17 billion. The median assets rank is 61st–well below the midpoint on the Top 100 list.

If we divide the top 100 banks into thirds according to assets, we get the top third (banks ranked first to 33rd), the middle third (ranked 34th to 67th) and the bottom third (ranked 68th to 100th). Only one of the 11 is in the top third. Six are in the middle third and four are in the bottom third.

The bottom line is that our 11 are mostly regional banks rather than larger money center banks.

Although some of the largest banks (Wells Fargo and Wachovia, for example) are significant and well-known insurance brokers, they are not yet on the list of those that earn 10 percent of NII through insurance sales. Their size makes the 10 percent threshold challenging, though not unattainable.

An analysis of the top 100 banks helps clarify both the macro-impact and the micro-impact of bank-insurance market development. It reminds us of the changes of the past decade, and it offers clues about the future.

At least one in 10 of these 100 largest banks (and one in six on the lower two-thirds of the list) has achieved economic relevance in insurance brokerage. Each has done so by methodically acquiring and integrating agencies over a period of years–usually more than five.

For each, contributions to NII are significant, and the value delivered to shareholders is strong. Expect these regional banks to continue to develop their brokerage businesses–through both organic growth and acquisitions–and expect some of those regional banks still on the insurance sidelines to reconsider.

Community banks, though smaller and generally well below the top 100 list in assets, should take note. These banks are the most dependent upon the interest margin, and most in need of further diversification into sources of non-interest income. Yet their participation in bank-insurance continues to lag well behind that of larger banks.

Some community banks have tried unsuccessfully to sell insurance through a joint venture or other alliance. Others have shied away for various reasons.

Their lack of familiarity with the insurance business, concerns over scale or critical mass requirements, and stories of struggles by other banks are the primary reasons for reluctance. However, the successes among the top 100 banks will erode some of these concerns.

Look for a wave of community banks to enter the insurance brokerage business over the next three years–many intending to execute the same strategy of persistent, disciplined agency acquisitions that the regional banks have followed.