Despite banks’ apparent fervor to enter new financial services arenas, such as brokerage products and insurance, they have dropped the ball and now must scramble to avoid getting left permanently behind, according to a report released last week by the Bank Administration Institute and the Boston Consulting Group. The report adds, however, that a quick reversal of the current trend could send bank retail revenues skyrocketing.

The report, Putting It Together: Convergence Strategies For Banking, Insurance and Investments, issues the industry a stern warning, citing woeful statistics of its rapidly falling "share of wallet." It proceeds to offer specific advice to turn the bleak situation around, including quickly increasing banks’ commitment to insurance and other mass market products.

The study asserts that the European system of bancassurance, in which banks have fully integrated insurance and investment products with traditional retail banking, should be used as a model by American bankers. The report cites statistics of the 50% share of the life and pension market in France held by banks, and the 30% share in Spain. By comparison, U.S. banks have 1% of the market. The European banks’ costs are 50%-70% lower than independent insurance agencies in Europe, and the branch sales system sells three to five times as many insurance policies as the conventional sales system, the report said.

John Garabedian, a vice president at the Boston Consulting Group who oversaw the study, said banks have fallen down and let business go to other more aggressive financial service firms by only making "halfhearted" commitments to the new markets.

"Banks need to make a commitment to improving the consumer insurance experience and leveraging elements of their existing administrative, marketing and distribution infrastructure to provide these products at a lower cost and with wider margins. By using their own networks efficiently, banks have the potential to double their profit per customer," Garabedian said.

The study cited statistics showing banks’ share of the retail financial services wallet has slid to 34% in the late 1990s from 50% in 1981, and that banks are paying even more to garner new customers, the majority of whom do not turn out to be profitable. The study counters that woeful picture with the assertion that banks are "well positioned" to reverse the trend by getting into the mass market with insurance and investment products.

Like their more successful European counterparts, U.S. banks are more suited to the sale of insurance than traditional insurance agents, the report says, because of their existing administrative infrastructures and customer base, trusted brand and a lower-cost sales force. The report asserts that if banks made a major commitment to insurance and "a more narrowly targeted commitment to investments," retail revenues could jump by almost 50%.

Other strategies the report touts include selling more aggressively to women and members of Generation X, who have traditionally been under-tapped by traditional insurers and financial advisors. Also, the report advises bankers to market more aggressively cash management products that bundle checking accounts with investment products and offer limited investment guidance to first time and young investors, to maintain market share.

Banks selling insurance are running into a problem with what should be a slam dunk: selling homeowners’ insurance to customers who have just taken out a mortgage. Solving the quandary is one of the main goals for the industry, sources said.

The problem arises when a bank turns to its insurance carrier to underwrite a policy and the underwriter cannot write any more policies for a particular area. Similar to a quota system, insurers do not want more than a certain amount of coverage in specific geographical areas, because significant coverage could mean financial ruin in the case of a natural disaster. The industry learned this lesson back in the early 1990s after Hurricane Andrew ripped through South Florida, causing hundreds of millions of dollars worth of damage.

To ask an insurer to write more policies in an area than it deems inappropriate, a bank would have to be able to balance the insurer’s exposure in danger-prone areas by bringing more production in non-danger areas. Today, the party who is protecting the primary insurer, the reinsurer, charges the insurer more than it would be worth to take on the extra business. Because the primary insurer has committed to the secondary insurer to fix the concentration of losses, the primary insurer must pay a hefty fee to go over the limit. So, in this situation, the bank’s insurance agency must find another underwriter to write the policy–and it may also be at capacity for that area.

Sources said now the only thing to do is work to appease insurance carriers by bringing more business in other areas. But that has not proved easy.

"That is the one thing banks hope to be able to do, especially ones that operate in many states. They can help insurance companies keep their ratio limits in line to help balance out coverage in less attractive areas. I haven’t seen many cases where they can make that work. It’s very early in these programs and they haven’t generated performance to show how much volume they’ll be able to generate. It’s hard to convince (insurance carriers) you can bring value," said bank consultant Frank Caccione, of the Mitchell Madison Group.

Jeff Huff, manager in sales for property and casualty for one of the bank-in-insurance industry leaders, BB&T, said the problem of insurance companies struggling to make the homeowners’ insurance line profitable is a tricky one. If a bank’s insurance unit has enough contractual relationships with enough carriers, he said, a policy can usually be found; it’s just that it will not be at a sellable price in the market. This is because some giant carriers that distribute only to their own agents, such as State Farm or Allstate, will probably have lower prices. But, at the same time, Huff said, "The bigger the bank and the more spread they have, the harder it is to have the right company for all the opportunities that it would have to provide insurance. Most banks are having some heartburn over this. How do you be all things to all people, but do it efficiently with as few carriers as possible? This is getting a lot of tension now as the industry consolidates."

He said BB&T has tackled the problem by trying to work with all of its carriers to understand their strategies, weaknesses and strengths. "We try to direct business to companies’ strengths as best we can. We hope they’ll look favorably on us and allow us to carry the banner into new territories for them. You just feel your way through the thing," he said.

A group of insurers has moved the ball forward on the important issue of onshore securitization of catastrophic risk, which banks may soon be interested in as investments. But important hurdles remain to be negotiated.

The new instrument may also help banks hedge risk stemming from concentrations of loans that could be adversely affected by a hurricane or other natural disaster.

While approving a draft of a model act designed to allow insurance companies to securitize their risk within the United States, the NAIC Working Group on Securitization stalled on further efforts to bring the concept into reality.

The life insurance industry and other institutions are looking at investing in such arrangements as soon as property and casualty companies get state regulatory approval to do so.

The exposure draft of the model, approved last week at the NAIC’s spring meeting in Washington, D.C., calls for assets to be carried at fair value. It will also require fully active cells and funded dollar-for-dollar transactions within the protective cells, and will ban derivative-based deals–for now.

Jeffrey Alton, chief accountant for CNA Insurance Company, said that under the proposal, insurers will have to file a plan of operation with each insurance department. "It should be very clear to a regulator what exposures preside in those cells." Alton said he did not support the concept that the protected cell should have a separate risk based on a capital charge of 10% that stems from concerns of potential tax liabilities.

CNA has pushed the hardest for quick approval of the catastrophe model so it will be in place by the next hurricane season.

Questions continue to arise over whether the assets contained in the protective cells will be enough to sustain the liabilities. Mike McCarter, vice president of accounting for American International Group, isn’t worried. "These are high quality securities," he said.

He said that within the month, he hoped to be able to hook customers up to the bank’s brokerage unit, Midwest Capital Management, Inc., so they can execute trades on-line. A little bit of that is making sure Gold Banc "gets in front of the money," he said, adding that banks should get more aggressive in the securities area. "We have been letting investment strategy go to Wall Street as opposed to letting that money go to the market through the bank." The securities unit finished 1998 with 27% of net interest income for the bank up from 16% in 1997. Gullion said the bank’s goal for the brokerage unit is to be in the 30% range within a year. Part of the expansion of the firm, bought in March 1998 for $4.25 million, will come from the ongoing project of putting investment centers in each of the 28 locations.

The company also provides wholesale services to banks throughout the Midwest. Gullion said that, typically, Gold Banc wants its service companies, which include The Trust Company and Gold Banc Insurance Agency, to shoot for a 20% return on revenue. "We are looking for not just 8-10% growth a year, but 30%–not just in terms of earnings-per-share growth, but income. That is a factor of improving efficiencies and income streams and growing the company in terms of acquisitions," he said.

The insurance agency, while centralized, is a work in progress, as management evaluates how best to deliver the product in the future. The goal is to have an agent in 75% of the branches. The company sells property and casualty, life and health insurance. Gullion said the bank is not interested in getting involved in bond underwriting, professional insurance, or any areas "requiring a high degree of expertise."

The company is at work on a business plan for The Trust Company, acquired at the end of last year. The idea is to bring the service to all banks by mid-year, with officers in the larger branches full-time and videoconferencing to the smaller branches. Now, the firm has full-time trust officers at two banks, insurance agents at five banks, and investment retail brokers at four banks.

Gullion said the bank is always looking for new acquisitions, the criteria being number one or two market share and strong leadership by bankers who believe in the community banking model.

The acquisition of multiple insurance agencies, pioneered by the likes of Norwest and BB&T, is on the cusp of spreading widely among banks as they become more comfortable with their first acquisitions. Now they’re seeking to expand that line of business, not just cross sell products to bank customers.

Union Bank in Ottawa, Ill., for example, is getting comfortable with the integration of the insurance agency it bought last year, and is now looking around to buy another.

Scott Grigsby, president and CEO of Union Bank, said the October purchase of the Mercier Agency was actually two agencies in one. Just before Union’s acquisition of privately-held Mercier, Mercier had acquired the Bryan Agency. The agency has been rechristened Union Financial Services, and has both insurance and brokerage services.

"We are looking at expanding," said Grigsby. "We’re in quite a few markets right now throughout Illinois and we think that acquiring different books of business in those markets might be an advantage." He added that the $625-million-asset bank took a year-and-a-half to two years to buy an agency because it took that long to find one it really wanted.

"You don’t just buy one insurance agency and be satisfied you’re in the insurance business. You grow it and get economies of scale. Get the initial base and build on that," said John Pottridge, who heads up his own bank consulting firm in Alexandria, Va. Pottridge has one bank client which is nearing the close of a deal to buy its fourth agency.

Pottridge said that the new movement is to buy the first agency and let it continue to run without immediately handing over the bank’s biggest asset: its customer base. The key to making the insurance business really work and meet profitability expectations is in developing a strategic plan to acquire insurance agencies over time in a way that makes sense for the bank, he said. The agencies should be chosen on the basis of what kind of insurance business the agency has and how well that blends in with or adds to the bank’s customer base. Another consideration is the location in the bank’s market. As the agencies are chosen and acquired, an integrated and fully developed sales and marketing plan must be implemented. Part of the plan is to have provisions for how the bank’s customer base will be used for the entire insurance organization as it develops. Too often, a bank will buy its first agency, and turn over the entire customer base to the single agency, which probably will not have the entire range of products the bank aims to offer, and that can be a mistake.

Pottridge explained that the downfall of many banks which bought an agency, and were disappointed when it did not prove to be the cash cow they envisioned, was a lack of coordination. Customers with auto loans were pitched auto insurance. Later, if they bought a house, they were pitched mortgage insurance. Pottridge said they should have been approached with a package of products that could be offered from the entire insurance organization, which might have been the merged entity of several agencies. "You can’t seesaw your bank customers. You’ll confuse them," he said.

Ken Reynolds, executive director of the Association of Banks in Insurance (ABI), agreed, saying Pottridge is "forecasting the next wave." But he cautioned bankers to make sure they had their first acquisition under their belt. "I would agree it makes sense once you’ve created the first successful model, figure out how to integrate it into your program. As your base of business supports additional agencies, it makes sense to expand," he said.

Norwest, the granddaddy of insurance-agency-owning banks, has been in the business of expanding for so long it has grandfathered abilities many other banks don’t. But an official at the Minneapolis-based bank recently merged with Wells Fargo said no matter how big you get, the strategy is the same: get a new insurance agency to get into a new market.

"A community we don’t have a presence in–a quick way to get in, better than a de novo, is to buy a good agency, well-run with top-notch talent. Otherwise, we’re not interested," said Charlie Hendrickson, executive vice president of Norwest Insurance Inc., soon to be called Wells Fargo Insurance.

In the debate over who should pay more to bail out the decade-old thrift debacle, recently revived by the American Bankers Association, America’s Community Bankers is fighting back.

ACB, which represents thrifts, is lobbying Congress heavily to stick to the original payment schedule for the Bank Insurance Fund and the Savings Association Insurance Fund. The issue was decided in 1996 when a deal was cut to have each industry pay a certain amount into the funds to cover the cost of the bailout. Those amounts o 6.25 basis points for thrifts and 1.25 basis points for banks–are weighted more heavily on the thrift side now, but amount to more money being paid by the bankers because that industry is larger.

Starting in 2010, each industry would pay 2.3 basis points, an increase for the bankers and a decrease for thrifts. Part of the deal was that the thrift and bank charters would be melded into one when the payments were equalized. The ABA cried foul recently when it learned that there is a possibility that may not happen, because new financial modernization legislation would not eliminate the unitary thrift charter.

The ACB’s message last week was that the 1996 solution was the correct one and it would be a futile "reopening of wounds" to rejigger the deal now. In a document entitled "FICO Obligation: The Real Story," obtained by Financial Modernization Report, the group outlined why it believes the deal did not "squeeze" banks and why it should stay in force. The document said ending the requirement that SAIF members pay higher premiums than BIF members would "risk heightening the premium disparity it averted in 1996" and "pull the rug from under the typical SAIF-insured institution that has paid at least 33 times more in premiums to the FDIC since 1996 than an equivalently sized BIF-insured institution."

Mike Krimminger is a Senior Policy Analyst with the Federal Deposit Insurance Corporation. The views expressed in this article are solely those of the author and should not be construed as representing the policies or views of the FDIC or other governmental entities. Part one of two. The second portion will run next week. A clear understanding of legal and contractual rights if your counterparty defaults on a derivative contract and becomes insolvent is critical to effective risk management, creditor strategies, and market responses in today’s turbulent financial environment. The importance of clear rules is illustrated by the questions surrounding the recent near collapse of Long Term Capital Management and the roiling of Asian and Latin American markets. Currently, while American rules for financial market bankruptcies are sound, there are variations between the bankruptcy laws for banks and non-banks and ambiguities in how those laws apply to some newer transactions. Clarifying and updating those laws is an important step to maintain American leadership in the financial markets.

The President’s Working Group on Financial Markets, chaired by Treasury Secretary Robert Rubin, and with representatives of the Treasury Department, the Federal Reserve, the Office of the Comptroller of the Currency, the Commodities Future Trading Commission, the Securities and Exchange Commission, the Federal Reserve Bank of New York, and the FDIC has crafted statutory proposals that update and harmonize insolvency laws while reducing the risk of a system-wide disruption in the financial markets.

One year ago, Rubin submitted the proposals to Congress, where they won general agreement from the industry and key committees. A version of the Working Group’s proposal was included in the Financial Contract Netting Improvement Act of 1998, which was introduced by Rep. James Leach. Sen. Charles Grassley introduced similar legislation in the Senate. Although Congress adjourned before final action on the legislation could be completed, it is expected that the legislation will be reintroduced shortly. Discussion drafts of the bill are circulating on Capitol Hill now.

When Bank One started what turned out to be a year-long quest to be the first bank to move into the private mortgage insurance market under a new method of risk sharing, the obstacles did not come from the Office of the Comptroller of the Currency, they came from the states. Now that Bank One’s Private Mortgage Insurance Co., Inc. has been in business for a month after 6 blessing from Maine’s insurance regulator, the focus has shifted to the growth potential for the unit.

The OCC had approved other banks’ applications for reinsuring mortgage risk using the excess of loss method. By that method, the reinsurer gets a percentage of the premium from the primary insurer, usually around 20%, and the reinsurer will pay claims above a certain percentage, called the claims frequency rate, which is around 8% now.

But the quota share method, applied for by Bank One’s insurance subsidiary, is exactly the opposite. It is a pro rata sharing of both the premium and all the expenses of an insurance policy. The percentage can be split between the reinsurer and the primary insurer any way, but Bank One Insurance Group wanted to have a 50%-50% arrangement with the original insurer, also known as the fronting company.

Chuck Bennett, Bank One Insurance Group’s chief financial officer, said after just one month, it’s impossible to pinpoint how well the venture is doing, but that it is expected to be profitable in the first year. Bank One National Bank has contributed $8 million in capital to the business and hopes to see $2 million in revenue at the end of this year. Bennett said in addition to a section of the 125-employee Bank One Insurance Group that is focused on reinsurance accounting and risk, the bank is utilizing the resources of the fronting companies, and has hired an outside management firm in Vermont, American Risk Management, to help with coordination with the Maine department of insurance, and to keep Bank One "aware of the environment," Bennett said.

"It’s starting out small," he said, explaining that the private mortgage insurance division probably will account for around 3% of the $150- million-asset insurance company’s total business this year, although that percentage is expected to rise.

With quota share, although the reinsurer gets a smaller targeted margin than using excess of loss, it also gets a higher percentage of the premiums, and losses are a little more predictable. Plus, most important to Bank One, "It’s more of a true risk share," Bennett said. "It puts you in the same position the initial underwriter is in." Otherwise, he said, "You’re not true partners with your fronting company. They’re only concerned up to their risk level, but not after."

Bennett said the bank aims to have the private mortgage insurance division become a true profit center for the bank. "It tends to add to our control of the insurance products that are sold to our customers," he said. "It allows us to reach better conclusions for our customers."

While the OCC approved the application, several states gave Bank One the cold shoulder, citing the bank’s inexperience in the area, the mere fact that it was a bank and not an insurer, and worries about safety and soundness. Bank One officials believe the refusals came after successful lobbying by various insurance trade groups fearful of competition from the banking giant.

Vermont approved the quota share scheme, but said Bank One could only take 25% of the risk. Vermont is home to many mortgage insurance companies, which Bank One believes lobbied successfully to limit the amount of risk the new PMI company could take.

But even Maine, eager to become the home of a new kind of business, was not going to write Bank One a blank check. It set restrictions Bank One must live with while enjoying a 50%-50% split, including a 20 to 1 ratio of risk, more stringent than the industry standard of 25 to 1, and a capital requirement of $6 million. Although most states only require annual reporting for operations relatively small in size, as Bank One’s is now, Maine called for quarterly reports.

Bennett said the limit from Maine seemed strict given Bank One’s history of reinsuring other products, including unemployment and various life insurance products. He said on most products Bank One takes more than 75% of the risk, and unemployment insurance, for example, the bank reinsures at 100%.

Bank One’s venture in Maine is a partnership with two major insurers: United Guaranty and PMI. In Bank One’s arrangement, the consumer pays the premium, the original insurer books and processes the policy, then Bank One enters the picture and buys 50% of the risk from the insurer. Bank One pays the original insurer a processing fee of about 20%, Bennett said. If a claim occurs, the two companies split it down the middle.

The Milwaukee-based Bank One Insurance Group in total generates between $1.5 billion and $2 billion in insurance sales with a pretax profit of around $325

million.