Attractive new addition: some banks are finding that acquiring agencies is the most profitable and least risky way to break into the insurance business. (Property/Casualty).

After passage of the landmark Gramm-Leach-Bliley Financial Services Modernization Act in 1999, industry watchers expected banks to plunge into the insurance business big time. While a recent survey showed that nearly one-quarter of banks are now selling insurance, and about as many more plan to do so within the next two years, banks are simply not biting when it comes to the outright purchase of insurance companies.

Judging from industry news, however, commercial banks have found it much more appealing to acquire insurance agencies instead.

"Where you have insurance companies merging with banks, the invasion of bank capital by the insurance company in the event of massive losses, particularly after 9/11, is frightening to banks," said Harmon S. Spolan, chairman of the financial-services department of Cozen O'Connor, Philadelphia. "And a bank's requirement to maintain certain capital ratios might be impacted by the insurance company's liabilities."

Rather than pursuing mergers with insurers, banks have been very interested in designing a business model that reduces the importance of the so-called interest-rate spread--what banks pay to depositors for holding their money compared with what banks charge borrowers for loans, said Spolan, who served for 22 years as president of Jefferson Bank in Philadelphia.

"If banks depend upon interest-rate spreads, the unpredictability and volatility of these spreads make for very difficult planning," he said. "Banks hate to get into that sort of volatility."

What they've done instead is look at fee-based income rather than interest-rate spread income, Spolan said. Agency commissions provide this income source. Naturally, insurance agencies are subject to the cyclical nature of the insurance market. In a soft market, rates and commissions go down, and when the market is tight, rates and commissions rise. "But you're still talking about commission income that is fee-based and immune to the volatility of the interest-rate spread," he said.

A prime illustration of this is Commerce Bank in Cherry Hill, N.J., a frontrunner in the Mid-Atlantic market in the acquisition of insurance agencies. Commerce entered this business about five years ago with the simultaneous purchase of three agencies in southern New Jersey.

"The basic strategy of the bank was to build fee-income sources to help the bottom-line growth, along with the basic banking business," said Ed Kiessling, president and chief operating officer of the bank's insurance subsidiary, Commerce National Insurance Services. In a few short years, Commerce has engineered 14 agency acquisitions from Delaware to New York, he said.

Wachovia Bank, another active buyer on this front, has a different plan. Its acquisition strategy is fueled by the desire to have its clients--individuals, companies and corporations--view the firm as their financial-services provider, said David Holton, president of Wachovia Insurance Services, Winston-Salem, N.C.

To do so, Wachovia needs to have "a robust and comprehensive insurance offering, because insurance is such an integral part in the whole scheme of the financial-services industry," Holton said. "You have to be strong in it." And commercial property/casualty represents a major part of corporate expenditures, he noted.

Wachovia has nearly $250 billion in assets, and its insurance operations are still small in comparison. So this early in its game plan, the cross-selling factor as a percentage of total business is very limited. "But we're working on it, and we're very pleased with the results," Holton said.

Opportunities to Cross-Sell

In a bank-agency deal, the possibility of cross-selling is one of the big lures for both sides.

First, the agency has access to a massive number of new customers on both the consumer and commercial sides, which is a boon for the cross-selling of products, Spolan said. This factor happens to appeal to banks as well, because they gain access to the customers of the insurance agencies and can pitch them loans and other kinds of deposit services, he said.

Having a reservoir of prospective clients is doubly attractive to agencies, because it allows them to "tap into the trusted relationships that banks have with their clients," Holton of Wachovia said. The same goes for banks--while they gain a new distribution channel for their products, they also can trade on consumer loyalty to the agencies.

It's likely that a local independent agent will have customers with a profile very similar to those of the local bank, noted Jerry Vigneron, a former independent insurance agent who is managing director of North Bridge Advisors Inc., a Concord, Mass., consulting firm that helps banks acquire and manage independent agencies. He was the architect for two transactions involving Stoneham Savings Bank, Concord, Mass. In 1999, Stoneham Savings was one of the first community banks in the Boston area to take advantage of a 1998 state law that allowed banks to enter the insurance business.

"Some people would argue that that's not where the fastest-growing area of banking or maybe even insurance distribution is. But these are solid, loyal customers," Vigneron said. "What makes sense is that businesses with that kind of customer base should get together and strengthen their organization. It makes sense to me that a local insurance operation and a local bank would get together and work to leverage their franchise into something bigger and stronger."

With this arrangement, the bank and the agency would be able to cross-sell "quite powerfully" to each other's customers, he said. People who have a mortgage, car loan and home-equity loan with the local bank could conveniently purchase other financial products through the same organization.

North Bridge has been active primarily in the Northeast and Middle Atlantic states, working almost exclusively for banks seeking to acquire insurance agencies. "There are great opportunities for a bank to enter the insurance business, and right now, the most sensible place to be is in distribution through an agency," Vigneron said.

Once he recognized that banks generally lacked a core competency in insurance agency operations, he focused on being the insurance expert that banks can turn to when they're evaluating an agency, as well as trying to price and structure a deal, Vigneron said. He has owned, operated and purchased a number of agencies throughout his career. And when he sold his last agency, he sold it to a bank.

Gaining Liquidity

This points out yet another advantage for agencies that sell to banks: The agency principals can gain liquidity in their asset mix. Privately held agencies have principals who can't liquidate their interests in the business unless they sell, Spolan said.

"This way, if they get publicly traded bank stock in exchange for their interest in the agency, they liquefy their net worth, and they have a piece of paper they can sell in the open market when they decide they need money, or retire, or plan an estate," Spolan said.

In his line of work, Vigneron has found that some banks don't always know what to look for in purchasing an agency--they just want to be in the insurance business, he said. There are three ways banks can plunge into this arena. One is by way of a start-up, but that means beginning without customers or agency contracts. Another is through a partnership or joint-venture arrangement, with the bank providing back-room operations to gain access to a local agency's customer base.

"These partnering concepts have a lot of enthusiasm in the beginning, but don't really produce great results, because if a bank wants to be in the insurance business, it needs to have both feet in the business," Vigneron said.

And the way to do that, he added, is through acquisition. "If a bank wants to be in the business, they need to make an equity investment--and it doesn't necessarily always mean a 100% acquisition," he aid. "The bank needs to be an owner of the insurance agency."

A bank in the buying mode should look for a "vibrant agency that's probably not for sale," Vigneron said. "They need to find an agency that has strong management, where the principals are going to be part of the ongoing operation for a period of years, because banks generally don't have anybody in their operation who knows how to run an insurance agency."

All too often, however, banks have made the mistake of purchasing agencies whose principals are about to retire. That plan can work for another agency, which understands the business and already has an infrastructure with producers and agency contracts. But a bank needs to acquire a platform and a leader willing to stay long enough for the bank to "really get its arms around the business, understand it and maybe begin to develop management from within the bank that can eventually be responsible for the agency operation, at least from an oversight point of view," Vigneron said.

Vigneron thinks the biggest competition for his bank clients in this market comes from regional firms or strong local agencies. In some cases, national companies will compete for some of the larger agency brokerage firms. But he likes to point out to successful agency principals who hope to work for at least 10 more years that if they sell to a bank, they can have their cake and eat it, too. While a sale to regional brokers will make them part of a larger insurance organization, "they're usually someplace well down the totem pole," Vigneron said, "and that regional organization really doesn't need them. It may want them when they structure a deal, but ultimately what they want is their customer list." But when a bank buys the agency, it wants the principals to continue running it, he said.

Another consideration: When one agency acquires another, there often is a structured pay-up, with the selling agent dependent upon how well the acquirer does in managing the acquisition so the seller can be paid. "The landscape is littered with agents who came back from Florida or some other nice place, because they didn't get paid and they had to try to collect their asset and rebuild it," Vigneron said. "This is not such an issue with a bank. Banks have something that no agency has--a vault that's filled with money. So for an agency that's got the right profile, that's considering being acquired or looking at various options for the future, clearly a bank should be high on their list if not No. 1."

Bob Anderson, president of The Berkshire Group, Sudbury, Mass, has 22 years of experience in valuing insurance agencies. His firm brokers agencies and assists banks in locating and acquiring them. The banks he deals with want agencies with a minimum of $1 million in revenue, Anderson said. Another requirement is good management, "preferably young management," he said.

Anderson doesn't flinch at the idea of courting an agency if the owner is, say, 65 years old, provided he or she has a young management team. "That's still a pretty good situation, because you buy the agency, you retire the older guy, and then the young guys rise up and run the agency," he said.

Now or Never

But Anderson is puzzled by the way some banks view the insurance-agency market. He recently found a "beautiful agency literally across the street from the bank." No matter how he tried, he couldn't get this bank interested in buying the agency. Bank officials kept saying they had other priorities for their investments and they'd get around to acquiring an insurance agency in a couple of years when that rose higher in their priority list, Anderson said. "I tried to explain to them that it was an opportunistic time--you either bought it now or somebody else was going to come along and take the agency and it wasn't going to be there," he said. "But they just didn't want to talk about it."

That agency is in the process of being purchased by another organization, Anderson added. "There are a lot of agencies out there, but there aren't a lot of really good agencies, and this was a good agency," he said. "It was a shame to see the bank pass on it."

In contrast, he has another bank client that is very eager to buy an agency, but Anderson's firm hasn't been able to find one for this customer at any price. That's because there are fewer and fewer successful agencies to be had in a competitive market where banks and other agencies are vying for the best.

"It's becoming very rapidly a business of scale--you've got to be big to be a competitor in this business," Anderson said. "When you get outside of the major metropolitan areas and deal with banks in some of the small, more rural towns, it's hard to find a $1 million agency. There may be one in the bank's marketing area, and if you approach that agency and they say 'No,' you're pretty much stuck."

An obvious alternative--finding two or three small agencies and combining them--is difficult to make work. "Banks have been pretty well conditioned these days to want $1 million worth of commission income, knowing that they need a minimum of $1 million to get into the business," Anderson said.

Buying two or three small agencies may add up to that magic $1 million figure, but it still comes down to having three small agencies. "You've got location problems, because they're in three different areas," Anderson said. "There are three different staffs, probably three different computer systems. They think small and don't think like a bigger agency thinks, and they don't produce business like bigger agencies produce business."

For the short term, Spolan said, he doesn't expect to see many agency acquisitions by banks because of the uncertainty that exists throughout the economy. "Long term, however, I have no doubt that the trend will continue," he said. "The banks that have been active in acquiring insurance agencies have been very happy with the acquisitions."

Studying the Market

Many banks that don't yet own agencies remain interested in acquiring them, but they are wary of making the same mistakes as some in the first wave of acquirers, Vigneron said. "These banks want to study this more and are willing to engage an expert," he said. "Initially, a lot of banks would turn to their bank auditors, who might have been very knowledgeable auditors and regulatory experts, but were never inside an insurance agency in their life. So they really didn't have the required background to do a sophisticated analysis of what they should be looking for in an agency and how to evaluate it."

The banks that are waiting in the wings want to know why some acquisitions were not successful. In Vigneron's view, too little thought, planning, research and evaluation went into those transactions. "I put most of the blame on the lack of sophistication on the banks' parts and really understanding what they were getting involved with," he said. "But I think some of that's gone away."

Anderson likens what's happening now in the insurance agency marketplace to the classic strategy called flanking--when a manufacturer develops a new product, gains more space on the store shelf, and competitors quickly copy the move. If the new product takes off, all the companies are then in a position to profit from it. With banks and insurance agencies, those banks that jumped into the market quickly and grabbed up successful agencies were positioned so that if the insurance business took off, they would profit.

"Lo and behold, the insurance business has become extraordinarily profitable of late because of the hardening of the commercial market," Anderson said, noting that most banks that own insurance agencies are doing well. "The others are sitting out there, not able to capitalize on this and are beginning to say they should have insurance agencies," he said. "But in many cases, it may be too late."

RELATED ARTICLE: Commerce Bank Seeks Agencies With Strong Management

Already one of the top acquirers of insurance agencies in the Mid-Atlantic market, Commerce Bank in Cherry Hill, N.J., is looking to spread its agency reach both north and south. Commerce's long-term objective is to stretch its banking network from Boston to Washington, D.C., and the bank's agency acquisitions will follow its footprint, said Ed Kiessling, president and chief operating officer of its insurance subsidiary Commerce National Insurance Services.

In sizing up possible acquisitions, Commerce scouts some key characteristics. First, if the bank is venturing into a new geographic area, it looks for what's called a foundation agency--one that has a certain economy of scale that the bank can build on, Kiessling said. These agencies "have a broad spectrum of business, from personal lines through middle market and perhaps even large accounts," he said.

Commerce is very interested in the strength of an agency's management team. In a new territory, those people will be the ones to promote the culture that the bank wants to build, hire producers or make local agency acquisitions.

Some of the bank's acquisitions also conform to its strategy of building expertise in different niche areas. "These tend to be smaller agencies, but ones with very high levels of expertise in an area where they may be dominant or one of the dominant players," Kiessling said. One example: Commerce has purchased a life sciences insurance agency in New Jersey, a state that boasts several major research companies.

But the bank is leery of buying agencies embroiled in succession issues. "That can be a little bit tricky," Kiessling said, adding that if management plans to leave after the sale, the accounts and some key people might go out the door, too. "When we buy, we will sign the agency principals on for extended contracts, because when you're buying a company like that, you're not just buying a stream of revenue--that stream of revenue is the people who are there and have been there," he said.

In fact, Commerce looks for agencies with principals who want to stay in the business and have decided that the best way to grow that business is to become part of a larger organization. "We just want people who want to take the next step," Kiessling said.

In some cases, agency producers or principals in their 30s and 40s find that their success also has brought more administrative duties. They want to get back to being producers and get some liquidity out of what they have built. Selling to Commerce offers the opportunity to get out of the office more and to act as the agency administrator, Kiessling said. "That's a motivation for them, and it's a motivation for us, because we can supply those kinds of services that will keep them free from the minutia," he said.

These days, the bank is as interested as ever in purchasing insurance agencies, and it continues to look for the best opportunities, Kiessling said. But with increased competition, prices have gone up considerably, and Commerce has slowed its acquisition activity. "We're very careful," Kiessling said. "We're only going to do deals that make sense for the long term, so we're pretty disciplined about that."

Agency Culture Is Important to Wachovia Bank

Wachovia Bank, in its quest to become a complete financial-services provider for its clients, has acquired 11 insurance agencies, including Davis-Baldwin Inc., Tampa, Fla., which was the largest privately held agency in Florida; Hamilton Dorsey Alston Co. in Atlanta, the largest privately held agency in that city; and the Tribus Cos. in New Jersey.

In shopping for agencies, Wachovia looks for a strategic fit in the culture of the company, said David Holton, president of Wachovia Insurance Services, Winston-Salem, N.C. "We spend a fair amount of time talking with the principals of the agency, learning how they've grown their company, what their philosophy has been," he said. "We like to know about the producers and how long they've been with them. We like to know how they take care of their producers in terms of salary-bonus plans. All of that goes to the heart of how they view their employees and their customers, which helps us determine if they have the same cultural fit that we have as we bring them into the banking model."

Once an agency comes on board, Wachovia focuses on integration, spending a great deal of time introducing the agency to its banking partners. "There is a formal rollout program, a formal assignment program of brokers to the different departments inside the company, so that bankers know who their agent contact is inside of the organization," Holton said. "We believe that is an excellent way to get the integration going."

Wachovia leap-frogged ahead in reaching its goal by merging with First Union Corp. in September 2001. The two banks didn't know it at first, but they shared a similar strategy in their drive to buy insurance agencies.

"It's almost as if we had the same play book and didn't realize it," Holton said. First Union purchased its first large agency in September 2000, and Wachovia did the same in November 2000. "Both of us were actively in the market, not knowing the other was," he said. "We were in Florida, and they were in New Jersey."

Before the merger was announced, Wachovia purchased another large agency in Georgia, and First Union scooped up five or six small or midsize agencies in the New Jersey marketplace. So when officials of the two companies came together and finally were allowed by law to share what they were doing with their business plans and insurance, they found they had the same vision, Holton said.

"We continue to acquire since the merger," he said. In early August, Wachovia Corp. announced it had reached a definitive agreement to acquire Cameron M. Harris & Co., a Charlotte, N.C.-based insurance broker that specializes in commercial and personal risk management and employee benefits. With $27 million in revenues, the Harris brokerage is the largest privately held insurance broker based in the Carolinas and ranks among the top 50 largest brokers in the United States, Wachovia said. The bank also is eyeing large agencies with operations outside its footprint, because these agencies are working with larger commercial accounts that can fit into its national corporate presence, Holton said.