Choosing Partners.

Some insurers are using strategic alliances as a quick and profitable alternative to mergers and acquisitions.

When Safeco wanted to add machinery-breakdown coverage to its standard business owners policies last year, it didn't buy the leader in the field--Hartford Steam Boiler. It formed a strategic alliance with the company instead. "Buying brings complications, such as regulatory and logistics issues," said Kevin Link, director of property underwriting, Safeco business insurance.

That sentiment is echoed by other insurers that have chosen the strategic-alliance route over mergers and acquisitions. "Mergers are disruptive, and strategic alliances are creative. I'd rather grow at 20% per year with an alliance than buying a company and dealing with a merger," said David Zwiener, president of Hartford Financial Services Group's property/casualty division.

Insurers also are looking to alliances to meet business customers' needs, to react to the global marketplace and to offer products to customer segments, such as baby boomers. "Where I think the world is going to move is in strategic relationships, a web of different relationships of businesses where you can get what you need in a relationship without having to build it yourself and make all the mistakes," said Martin Feinstein, chief executive officer, chairman and president of Farmers Insurance, Los Angeles.

Merger Activity Down

Mergers still are a popular business move, even though there were 29% fewer mergers in the first nine months of 2000 compared with the same period in 1999, according to SNL Securities, a provider of information on real estate, banking, insurance and nonbank financial-services industries. The number and value of mergers had been growing until 2000, according to a Conning & Co. report.

An industry analyst observed that over the past few years, insurers have experienced some rocky mergers. "Insurers' experiences with mergers have been poor; they haven't done what was expected, which was to generate operating efficiencies. Look at St. Paul/USF&G and Chubb and Executive Risk," said Todd Bault, an equity analyst with Sanford C. Bernstein & Co. St. Paul eliminated 2,600 jobs when it merged with USF&G, a move the company characterized as "the downside to the acquisition." At the time of the merger, industry observers noted that the merger slowed St. Paul's writing of new business and the union seemed harder to digest than anticipated.

Zwiener agreed that very few mergers and acquisitions result in a successful integration of businesses. "They are trying to buy scale. It's cheaper and faster than growing, and they are also courting the stock markets, hoping their stock goes up," he said. On the other hand, Zwiener said alliances bring together two separate businesses and create value for both operations. "Each company has its own distinct capabilities in a strategic alliance; the magic is finding a company that complements your own," he said.

In general, Wall Street is critical of large mergers, Bault said, unless a company acquires a small, specialty book of business. But in a strategic alliance, the Street is mainly judging which partner has the stronger position. Each member of an alliance should be careful not to train the other member so well that its management knows the business and no longer needs the partner, he said.

Old Allies

Strategic alliances are nothing new to State Farm and Hartford. State Farm, the No. 1 personal lines insurer, has forged alliances with banks to offer auto loans to its policyholders. But after almost half a century of teaming with banks, State Farm decided it had learned enough about the business, and it rolled out State Farm Bank in 1999. Company agents in 11 states now can assist consumers with savings, car loans, home mortgages and home-equity loans. And State Farm has found another need growing out of its personal lines coverages that reach one of every four households in the United States, according to company estimates.

Last summer, State Farm decided to offer individual medical insurance products to its customers through its network of 16,000 exclusive agents. Viewing the individual medical insurance coverage as a "logical extension of the needs of our customers," Mike Tipsord, a State Farm vice president and assistant treasurer, said that for the first time in the company's history it decided to sell insurance underwritten by another company.

State Farm decided against building the product itself, because "the company always determines the best way to bring the best product and service to our customers," Tipsord said. "If we can't do it, we turn to external parties." The company considered regulatory issues, expertise, product offerings and time-to-market before forging its strategic alliance with Fortis, the 37th-largest life/health group, ranked by net premiums written, according to A.M. Best Co. Although Fortis has similar partnerships with other companies, none is as large as the one with State Farm, said Fortis Health spokesman Rob Guilbert. "This will get us into a whole market that we don't have access to," Guilbert said. The arrangement allows Fortis to expand its distribution; it currently sells its products through independent agents and career agents. State Farm is offering product-awareness training to spread the word to agents about the health product. Tipsord said the alliance is "successful" and State Farm will continue rolling it out this year. In the meantime, the personal lines leader is working on another strategic alliance with Aon Corp. to sell commercial-specialty insurance products.

Under the agreement, Aon has formed Prairie State Administrative Services Inc., which will provide underwriting and administrative services on behalf of State Farm. Prairie State will design, underwrite and administer the products, and State Farm will sell them through its network of agents. The products will include professional liability, employment-practices liability, directors-and-officers liability for small businesses and nonprofit organizations and errors-and-omissions liability for service providers, including technology service businesses such as Web developers and information technology consultants. Additional products will be rolled out in the future.

Like State Farm, Hartford Financial Services is a veteran of strategic alliances with ongoing deals with AARP and Zurich U.S. "Strategic alliances have been part of the Hartford's culture for two decades. We learned a lot from the AARP alliance, and it gave us the impetus to move aggressively in future strategic alliances," Zwiener said.

Hartford offers auto and homeowners coverage to AARP members. Its latest alliance is with USAA, the company known for serving military families. Hartford, ranked No. 3 in commercial multiple peril in 1999 by the A.M. Best Co., views USAA's 400,000 members who own small businesses as potential customers. It's willing to sell its products and mine USAA's data to expand business. The alliance also is fueled by Hartford's online marketing machine that's designed for agents to be able to sell, bind and service policies online.

Equity analyst Bault classifies Hartford as the stronger of the alliance's partners. "Hartford has a good reputation in small-business products," Bault said. "Its strategy of selling the products through personal lines is a good one. It's another way to sell a product they are good at underwriting."

The Hartford, Conn.-based insurer also has access to service centers for claims handling. About 75% of Hartford's small-business coverage is coming in from agents online, Zwiener said. Under the agreement, USAA will sell the commercial coverage and market it to its members. Hartford has formed dedicated teams to underwrite policies and service policies--including claims processing and billing--for the alliance. USAA will target small-business policyholders--such as museums, publishers, professional organizations and small manufacturers--and offer coverage that includes business liability, commercial auto, equipment breakdown and workers' compensation.

Farmers Insurance Group's foray into strategic alliances was borne from its company philosophy of being a solutions provider to its policyholders. The third-largest personal lines insurer aims to cover its customers from the cradle to the grave.

What was missing from Farmers' mix of life and property/casualty products was long-term-care insurance, which is growing in popularity. Long-term-care insurance offers coverage for policyholders who cannot perform certain acts of daily living, such as bathing, eating or getting dressed. From 1998 to 1999 the growth of long-term-care products rose 11%, or about a half-million policies sold, although increasing market penetration is an ongoing challenge to insurers, according to the American Council of Life Insurers. Farmers' marketing department identified a consumer trend of an aging population of baby boomers who are living longer and wanted to bring products to these consumers, said C. Paul Patsis, president of Farmers Life. But first, Farmers mulled a "buy-or-build strategy."

"We looked at our core competencies and knew we had to move into new worlds. In long-term care, we didn't have a clue. We were babes in the woods," Patsis said.

Patsis described the due diligence his company undertook to find a long-term-care provider as "a lot like a merger." Initially, Farmers looked at criteria like selection of products, reputation and experience in the business. "That got us to the top five," Patsis said. The next level of criteria dealt with cultural compatibility, issues concerning Farmers desire to private label the product and the nitty-gritty details of system interfacing. Farmers wanted to rebrand the long-term-care product based on information from studies that showed the strong reputation of the Farmers brand. Farmers decided to build an alliance with CNA, which has its long-term-care products underwritten by Continental Assurance, which is ranked No. 31 among individual long-term-care providers by A.M. Best. "We chose CNA because they had the same values, no issues about private labeling and offer great customer service," Patsis said. So after what he termed "a slow start in 1999," the product took off in 2000, showing a 400% growth ra te from 1999 to 2000. "We're in this alliance for the long term; our customers need this type of product," he said.

Pooling Resources

In the alliance between Safeco and Hartford Steam Boiler, Safeco was looking for a partner as a product development resource. The Seattle-based insurer wanted to add comprehensive equipment-breakdown coverage to its commercial insurance policies in all of its operating states. But the company didn't have the range of products or inspectors to do the job. "We needed access to inspectors, and Hartford Steam Boiler has the staff resources. For instance, in some states they have multiple inspectors to our one," Link said. The addition of the inspection staff was critical to growing that part of the business, which rolled out at the end of 2000, because equipment inspections are required by state law. In 2001, Safeco expects to expand its boiler and machinery coverage from 40 to 47 states. "We write more coverage now that we have the support staff, and we also plan to develop improved expanded coverage this year," Link said.

Safeco didn't experience any challenges in creating the alliance, but made sure it had a solid plan and kept the lines of communication open to Hartford Steam Boiler. But as State Farm's Tipsord pointed out, anytime multiple platforms are brought together, it can be a challenge. Hartford's Zwiener said with mergers and acquisitions the purchasing company is in a command and control mode, but with alliances companies have to make a commitment of personnel resources and maintain open communication to make it work. "The No. 1 priority is to appoint a full-time individual to make it work. Both companies need the right set of expectations and should be in it for the long term," he said.

Farmers Life's Patsis said an alliance is similar to a merger because both companies must adjust to another culture and adopt a communication process that works. And then there are technology issues with which to contend. "We had to get two systems to communicate with each other and various components saying, 'We don't want to modify our system.' We learned to work around that," Patsis said.

Zwiener said there is always an incentive to merge, and Hartford isn't excluding any in the future. "Strategic alliances are more creative," he said. "I would like to start one or two a year and let them grow. They create a ton of value."

Travelers/Winterthur International Still in Step

Two years ago, Travelers Insurance and Winterthur International created a global strategic relationship with the goal of providing property/casualty insurance solutions, risk management and claims services internationally.

The alliance--headed by George Keller, president and chief executive officer of Winterthur International America, and John Stites, Travelers vice president, national accounts--is called Travelers/Winterthur International and has offices in Chicago, Los Angeles and New York and conducts business in Atlanta and Dallas. Both companies are parts of mega-corporations--Winterthur is a part of Credit Suisse Group, and Travelers Insurance is a member of Citigroup. Keller and Stites were interviewed shortly after the alliance was born and pinned the birth of the company on the need to be global to succeed in the future.

This strategic alliance, like other similar partnerships, was created because it was too expensive and too time consuming for Travelers to build an international network and for Winterthur to build an extensive U.S. infrastructure for high-frequency primary casualty and workers compensation lines. So in 1999, the companies joined together to build a venture that now has a presence in more than 27 countries and exclusive partnerships in 28 additional countries. Stites spoke with Best's Review about the goals and lessons learned during the life of the alliance.

Q: After two years, how has it been going?

It's been going very well. We launched Travelers/Winterthur International in the depths of the soft market in early 1999, and that certainly presented some challenges--not at attracting business, but in attracting business at profitable prices. 2000 was a bit of a transition year in terms of the marketplace and pricing trends. We are optimistic based on results that we produced, and the relationship between the two companies is quite strong. Operationally we have hit every goal, such as policy issuance outside of the United States and the flow of premium funds into customers' captives that we established when we put forth the venture in 1999.

Q: Have you expanded your business via this global strategic relationship?

Year-end 1999 we had 26 programs written with gross premiums of $38 million, and not quite year-end 2000, just under 50 programs and $50 million in gross premiums written. Financially, in relationship to original targets, we are on track. One of the benefits of the alliance is we developed business in certain areas that we didn't expect. I think an alliance properly done does provide for a number of surprises. As an example, we have a rather significant relationship with Winterthur now in the boiler and machinery area. They had a need for technical and reinsurance support, and we are providing a good deal of that. It wasn't included in our original insurance plan.

Q: How has getting the two companies to work together panned out?

It still is a challenge, but we're relatively successful with it. We have co-located staff, and when we first set up the business we decided we would have a Travelers account executive and a Winterthur International account executive basically co-manage a given submission. We actually discovered that though it's a good idea, what you really need is one responsible individual to outline the priorities and what's needed and work across both organizations. We've learned a few things about working together, but having teams in the same office buildings in New York, Chicago and Los Angeles has been very, very helpful. From a challenge point of view, one of the things we learned is that national account broker relationships in the United States are frequently with individuals without responsibility for international placements. Now, Winterthur has some of those relationships, but we've had to develop new ones as well. It sometimes makes it challenging to put together a global proposal when you have multiple broker s or different brokers within an organization managing the domestic and international parts.

Q: Do you still consider this relationship long term?

Yes, very much so. I don't think we would have been successful in attracting the business that we have if we weren't committed to this long term. We have a contract that assures that, but we also have had enough mutual benefit from the alliance to view it as long term. One of the mutual benefits is the ability to offer something to, a Winterthur customer in the United States, what we call reverse-flow opportunities. We've also done some domestic-only deals with them sharing capacity and/or service capabilities; that's been important. I think we've, proven that we understand each other pretty well, and we think it will continue to spur new opportunities going forward.

Q: How much does being a part of financial behemoths Citigroup and Credit Suisse come into play in your relationship?

First and foremost, our target is to work the U.S. multinationals and their non-U.S. needs; secondarily, non-U.S. multinationals. Credit Suisse and other areas within the Winterthur Group organization have a significant customer base, and we have done some reverse-flow business for their organization. Within Citigroup's global corporate bank we frequently work on bank customers' property/casualty needs, and Winterthur has been a part of some of the solutions for those customers. So, both organizations are cognizant of significant customer relationships and needs.