Wedding Day Jitters.

Banks should look beyond the barriers of joining with insurers and focus on the long-term prospects.

Since the passage of Gramm-Leach-Bliley Financial Services Modernization Act, much has been written on the subject of banks' interest or lack of interest in acquiring life insurers. For most banks, the thought of acquiring a property/casualty company appears to be a nonstarter.

And most observers have found few compelling reasons for banks to lead life insurers to the altar. In fact, most have focused on the now familiar barriers to such unions. The litany of deal breakers includes insurers' relatively lower returns on equity and assets; their complex, labor-intensive and costly back offices; their inefficient, high-cost and independent distribution channels; their less creative use of technology to enhance customer value and streamline internal processes; and the fact that their profits are increasingly being pinched by the rampant push to treat insurance products as commodities.

Focus on the Numbers

These operational challenges are reasonably well understood after years of industry soul searching, and, admittedly, they will make insurers less attractive to banks. In the short run, as the life industry continues to address these areas, potential acquirers will have to assess the long-term strategic value of a life company acquisition within the existing operational context.

Some near-term improvements are certainly possible, even likely. But given the general lack of functional synergies between banks and insurers, don't expect bank-insurer marriages to produce any dazzling near-term operational improvements within the acquired insurer--like those related to fundamental changes in business models or the use of technology.

But what about the numbers? Do operating returns, earnings growth and shareholder returns really suggest that most deals will be bad ones?

It's true that recent returns on equity of the top life companies, which are at the high point of the last 20 years, are up to 14% to 15%. Recent bank returns, also now at cyclical highs, are routinely 18% to 20% or more. Without fundamental structural change, there is little doubt that a bank's acquisition of a typical insurer will dilute its returns on equity, even without a significant pricing premium.

But how important is that to the stock market's valuation of the combined entity? Numerous studies show the link between return on equity and price/book multiples, so an acquirer should, at a minimum, expect downward market pressure as one result of an insurance deal--pressure that the long-term strategic value of the combination would need to overcome. But the markets have never been good at balancing long-term values against short-term performance, so look for at least moderate price discounting following a bank-insurer deal.

Compare Earnings Per Share

Growth in earnings per share is a different matter, however, as are the shareholder returns achieved by insurers and banks. A recent analysis of the top domestic insurers and banks (excluding the large global commercial banks), shows that over the past five years, insurers' earnings-per-share growth was equal to, or even slightly better than, banks' growth in earnings per share. Similarly, Standard & Poor's stock-pricing data show that the insurance composite stock index has outperformed the bank composite stock index over both the three- and 10-year periods ended Dec. 31, 1999. (See "Banks vs. Insurers" at left.)

In today's market, high returns on equity are no guarantee of strong stock market valuations, as banks are finding out to their chagrin. That reality, along with financial measures like earnings-per-share growth and shareholder returns, suggests that acquiring insurers might not be such a bad idea after all.

So, despite the conventional wisdom, it looks like banks won't be able to quickly dismiss the notion of buying an insurer. Instead, they'll have to make their decisions based on the relative merits of the strategic business options available to them, just as they would in considering any other type of acquisition. All in all, not a bad way to begin a marriage.

Bob Stein is national director of financial services at Ernst & Young LLP, New York.

Banks vs Insurers
Compound annual shareholder returns for
three- and 10-year periods ending Dec.
31, 1999.
          Banks  Insurers
 3 Years   6.7%   14.0%
10 Years  13.1%   14.5%
Source: Standard & Poor's Industry
Composite Indices
Note: Table made from bar graph