Industry Watch – Insurance Operations in the New World Order of Financial Services

One of the most robust dealmaking industries of the past decade, the insurance sector racked up 279 deals (valued at $5 million or more each) totaling more than $28 billion in 1999 as companies bulked up – or in many cases slimmed down – in order to gain strategic or market-niche advantages. Insurers feel the same pressures as other consolidating industries – the need for growth, the ability to serve a multinational client base, and the desire to gain an edge in an increasingly competitive and volatile environment – but the demise of the 1933 Glass-Steagall Act last November has opened up a host of new match-making possibilities for financial services firms. Yet, insurers and other financial institutions thus far have had a ho-hum reaction to their new growth options, and industry experts are not surprised. The disintegration of Glass-Steagall removes the partitions between financially oriented businesses, which had been operating nicely in their own markets and within their own boundaries for some time. Suddenly, the number of possible rivals, or partners, a company has – depending on how each player looks at it – has grown dramatically. After 66 years of running their businesses separately, nurturing different corporate cultures, and perfecting their particular methods of selling their products to customers, experts in the industry say it’s no wonder that insurers, banks, securities firms, and other financial entities aren’t rushing into one another’s arms. With dealmaking opportunities abounding in their own industries, companies still have many roads to growth open to them in familiar territories. Some insurers are realizing that they now have the capability to service more policies, in part because of information systems improvements they made to solve Y2K problems, says Roger Lawson, president of the Alliance of American Insurers. It’s natural for them to explore those avenues toward growth before turning their attention to prospects that may be harder to achieve. It’s only a matter of time before companies start making their moves, says Joe Teplitz, partner of the financial services merger and integration group at Arthur Andersen. He refers to the past few months as a “sigh of relief” period for both banks and insurers after Y2K. His colleague, Beth Briglia, a knowledge manager in the group, thinks that insurance companies are taking their time to figure out how they will play in the new market, such as whether to be a niche player or a large company that can service all aspects of the market – like a Citigroup – and meet all needs of a consumer’s “life cycle.” Patrick Baird, EVP and COO of Aegon USA Inc., remarks, “I expect that in the next 12 to 18 months some banks will make moves on insurers. I think that they think the wave of the future is to have everything under one umbrella, and integrated as much as possible.” He says that he knows firsthand of several banks that are on the prowl for major insurance properties but doesn’t know of any insurance companies that are looking at banks. “In our case, we’ve been pretty clear for at least five years that we would rather date a bank than marry one, and that we do not think that buying a major equity position in a bank is the right thing to do, so we will not be one of those that will be looking,” he asserts. He believes there more business opportunities for insurance companies that forge alliances with multiple banks than those that wed themselves to one bank. “Given other opportunities, I just don’t think that the returns are that attractive. There are still going to be a number of years of consolidation in the insurance industry. That we know how to do. That’s worked pretty well for us.” Generally, Baird believes that activity among financial services companies will be all over the board. “I think some companies will actually want ownership while others will think that alliances are a better way to go because you can have more alliances than you can have equity ownerships.” Lawson, agrees, noting that many people in the industry are wondering why they should buy a company when they can enter into a joint venture or a marketing agreement. Michael McClintock, managing director and head of U.S. financial institutions at CIBC World Markets, agrees. “People are much more comfortable merging in their own industry before they expand beyond,” he says. “Not everybody in banking is fully up to speed with how the insurance industry works. I think they are trying to take care of their own issues first and then they will start getting involved in the insurance industry through alliances and joint ventures.” Briglia points out that in debating the issue it’s best to distinguish between life insurance and property and casualty insurance because she thinks that their reactions to the New World Order of the financial services industry are quite different. There might be more natural synergies between a bank and a life insurer with annuity operations in the marketing and distribution of those products than there are between a bank and a property and casualty insurer, she notes. Yet, some industry participants argue that the personal lines businesses, such as auto insurance, also might be attractive targets for banks because some banking firms are already involved in those markets, she says. The experts agree that most likely, banks and securities firms would begin their foray into the insurance industry by targeting companies that sell similar types of products to what banks and brokerage houses currently sell. They expect to see more m&a activity in the life insurance segment of the business than in the property/casualty or the health insurance area, since the rates of return for property/casualty operations are quite low relative to the rates of return for many other industries. Many companies think they can do better by continuing to consolidate within their own industries, says Baird. “Plus, there is considerable risk in the insurance business right now because of the regulatory environment, and the plaintiff’s lawyers have certainly selected us as an industry in the last five years to go after,” he comments. Conversely, it’s too early in the game to tell whether property and casualty companies will target banks in order to raise their rate of return, though Lawson notes, “A number of insurance companies that got thrift charters over the last year and a half, and whether or not that type of banking business will turn out to be as profitable as a commercial banking remains to be seen.” It seems that any successful cross-sector transaction would have to be closely modeled after the Citicorp/Travelers union that forged Citigroup, notes Baird. But even in that merger of two well-established companies, integration has been painful. Throughout his many years of experience in m&a, Teplitz says that he’s never seen a merger in which the two parties didn’t think that they had vastly different cultures. “Even two firms that the market would view as similar are daunted by the culture issues involved in a merger, let alone companies from different industries.” Another obstacle in integrating diverse financial services operations, Briglia notes, would be working with the different distribution channels of insurance companies. Many insurance companies, she says, use very traditional agent/broker relationships. Therefore, a critical challenge from an integration perspective would be making sure that those relationships are optimized, and not threatened. Nonetheless, Briglia thinks that the agency/broker networks that many insurers have would be very alluring to banks because the networks would provide them with access to more diverse geographic markets. “I suspect that any motivation behind a post Glass-Steagall acquisition would be to gain a greater share of your customers’ financial purchases.” Teplitz believes that insurers would love to get their hands on some of the data that banks have, since they have detailed information about consumer behavior and spending and savings habits, whereas insurance companies, specifically property and casualty insurers, mostly know just the kind of car a person drives or the kind of home being insured. He thinks that a partnership or merger with a bank would be a tremendous asset for insurers in marketing products to its existing customer base. Pointing to the example of American Express, Lawrence Stern, a knowledge manager for the insurance industry at Arthur Andersen, says he believes that the diversified financial services company has been quite successful in marketing an array of financial products to the customers of its varied businesses. “They can insure your car or sell you life insurance, through their life insurance unit,” he remarks. “They’ve had some success on the life insurance side, although they’re struggling on the property/casualty side. So, that’s an area where I think banks would be hoping to benefit from in the longer term. Who wouldn’t want to have Prudential’s 20 million customer base?” “We still don’t have any information that the customer prefers one-stop shopping,'” Baird cautions. “For the most part, there are some insurance products that are more commodity-like and therefore could be sold through a bank, but to a large degree, insurance still needs to be sold by a professional. We’ve always been allowed to have professionals inside other financial institutions trying to sell our products but it’s never been very successful.” Years ago Sears offered a broad range of financial services to customers through its Dean Witter unit, but the operation ultimately fizzled. Yet, Teplitz speculates that the venture failed more because of financial reasons than it did for its “value proposition.” “It wasn’t a bad idea, but in any of these ventures, execution is the key. Good use of data-mining and pin-pointing target markets is still a relatively recent concept.” Lawson warns that uncertainty looms over whole privacy issue on sharing customers’ confidential data with corporate affiliates and other companies in order to cross-market products and services. The Gramm-Leach-Bliley Act, better known as the Financial Services Modernization Act of 1999, which repealed Glass-Steagall addressed the issue, he notes, and made it clear that companies can use information themselves or with a business partner. However, there was an invitation in the legislation for individual states to set further restrictions on information-sharing among various parties, and many companies are waiting to see what kind of stance the states will take. If companies will be restricted in their ability to cross-market, Lawson notes, some of the more appealing advantages of cross-sector financial services partnerships would diminish. For consumers, one of the major benefits of allowing varied financial services companies to merge would be the customers’ ability to get insurance, securities, and loans from a single source. Since the company already would know each customer’s financial history, it would be able to make more rapid decisions on loan applications and other requests. While it’s convenient for consumers to be able to purchase all their financial products from a single source, some of the experts say, there also are considerable threats to one-stop financial shopping. “For instance, from an insurance company’s standpoint, there’s increased competition now. With the repeal of Glass-Steagall, you’ll see a lot more nontraditional competition cropping up that insurers never had to face before,” says Stern. Agreeing with Stern, Teplitz adds that he recently attended a meeting with executives of a large financial institution and discussed who its competitors are. “Their reaction was, Five years ago we could have given you a very detailed list. Now we don’t have a clue because there’s probably going to be a major competitor that shows up within the next year that doesn’t even exist yet.’ While they’ve been getting through Y2K, there’s been a whole new market that’s been growing in the meantime. I think that the companies that are going to be successful are going to be the ones that follow a model that may not exist yet.”