Insurance companies, banks and brokerage firms are actively competing for new business on each other's turf. But financial services convergence in a true sense is progressing at a tortoise-like pace: slow and cautious.When Citicorp acquired Travelers in 1998-forming Citigroup, one of the world's largest financial services institutions-many analysts hailed the union of the insurance and banking entities as the beginning of a revolution in the financial services industry.

And, when the Gramm-Leach-Bliley (GLB) Act was signed into law by President Clinton in November of 1999-removing regulatory barriers to financial services convergence-analysts became even more gleeful. Banks, insurers and brokerage firms would now rush to cross sector boundaries, they predicted, and an era of unprecedented financial mergers and acquisitions would ensue.

Not surprisingly, analysts' predictions about financial services convergence-like their ratings for Enron stock-have turned out to be distorted. Financial services firms are definitely moving onto each other's turf-to increase revenues and capture more of their customers' "wallet share." But most are proceeding at a cautious pace-much more like the tortoise than the hare in Aesop's famous tale.

In fact, insurance-related M&A activity actually has declined in 1999, 2000 and 2001, according to Conning & Co. (see chart, page 35).

"There's been some disappointment around convergence," say Ken Porello, leader of the North American Insurance Practice at New York-based Deloitte Consulting (see "The Last Word," page 48). "There was the feeling that convergence was going to be a revolutionary change, and we don't have a revolution on our hands. It's moving slowly." Nonetheless, it will be no less fundamental in its long-term impact, he says.

Doomed to fail?

Perhaps most disconcerting to the pundits who expected an era of mega-mergers was New York-based Citigroup Inc.'s decision late last year to exit the P&C business. The spinoff of Travelers Property and Casualty Corp. was announced a mere two years after Gramm-Leach-Bliley passed, which left many wondering: Did the divestiture signal the inevitable failure of banking and insurance convergence?

Not at all, according to industry observers. The spin-off was a logical financial decision for Citigroup, not a strategic one, says DeLoitte's Porello. Travelers' performance was strong under the Citigroup umbrella, he says. But returns on equity in the P&C business have been significantly lower than returns in banking. In addition, the P&C market is hardening now-a favorable market for a company to dispose of P&C assets.

Citigroup's decision to sell Travelers should not be thought of as a disavowel of convergence, Conning & Co. concurs in a recent report, titled "Mergers & Acquisitions and Public Equity Offering: 2002 Edition." But the spin-off of Travelers, along with the General Electric Co.'s possible divestiture of its Employers Reinsurance Corp. unit, may be an indication that the P&C business won't figure prominently in convergence-at least not for large conglomerates with aggressive growth targets.

So far, the life insurance business is much more attractive than P&C. Not one property/casualty transaction was among the 10 largest last year, but eight of the 10 largest transactions were in the life sector, notes Jack Gohsler, senior vice president at Conning & Co, Hartford, Conn.

Interestingly, Citigroup is retaining Travelers' life and annuity business, which the firm obviously sees as a better fit than the more volatile P&C business, according to Conning. There's a logical fit between banking and life insurance, Gohsler says, because the two sectors have similar products and cultures, and a focus on wealth accumulation. In addition, demographics are favorable for life insurance and annuities, he adds.

"The U.S. population is aging . . . and it's becoming clear that Americans are going to have more responsibility for funding their own retirements and long-term care," Gohsler says.

The outlook for the life sector is so favorable that even traditional P&C insurers are expanding into that market. For example, last year, American International Group, acquired life insurer American General Corp. for $23.2 billion-the largest insurance-related transaction of 2001.

A bright spot

The risky nature of the P&C business has led some of the largest property/casualty insurers-especially those with a solid distribution network, a strong brand, and a large customer base-to branch into other sectors of financial services. "Many companies that are primarily regarded as P&C realize that by widening their product offerings, they can increase their top line and stabilize their bottom line," Gohsler says.

State Farm Mutual Automobile Insurance Co. and Allstate Insurance Co., for instance, both began offering mutual funds and banking products in the last two years. Although the banking and mutual fund operations of State Farm and Allstate currently represent a small portion of each carriers' revenues, "these companies are very serious about broadening their footprint with their customers," Deloitte's Porello says.

So far, broadening their footprint is improving the balance sheet for both companies. The results in State Farm's banking and mutual fund operations "were definitely a bright spot in our financial picture last year," says Frasier Engerman, a spokesperson for the Bloomington, Ill.-based carrier, which suffered a $5 billion after-tax net loss in 2001.

Positive Performance

State Farm Bank, which received its charter in late 1998 and opened in mid-1999, held $2.3 billion in total assets as of March 31 this year, up from $1.2 billion reported in January. Ten new State Farm mutual funds-managed by State Farm Investment Management Corp.-became available to customers in March 2001. (The company has offered mutual funds to its employees and agents since 1968.) As of March 31, 2002, the new funds had accumulated $100 million in total assets under management.

Allstate Insurance Co.'s financial business, which is focusing on providing Middle America with financial products for retirement, also saw positive results. The Northbrook, Ill.-based carrier launched Allstate Bank at the end of last year, and the company offers 74 mutual fund families, including AIM Funds, Fidelity Advisors Funds and Putnam Funds.

Similar to State Farm's bank and mutual funds, Allstate's financial unit is a positive performer in the company's portfolio. Allstate's property-liability business reported an estimated $367 million in net income for the first quarter of this year, down from $459 million for the same period last year. Allstate Financial, on the other hand, reported $91 million in net income for the first quarter this year, up from $69 million for the first quarter of 2001.

Relationship Issue

Carriers such as State Farm and Allstate-with prominent local agents-may be successful in cross-selling bank products and mutual funds to their customers, particularly in small towns where a local bank may have been acquired by a larger bank, says Faith Trapp, managing director of the global insurance industry for Plano, Texas-based EDS.

"Those are local relationships," she says, "and many banks have lost that relationship with the customer."

Consumer surveys conducted by Synergistics Research Corp., an Atlanta-based research firm, reveals that consumers prefer to buy insurance from a traditional insurance agent rather than a bank, says William McCracken, Synergistics' CEO. Consumers recognize that buying insurance through their bank might be less expensive and more convenient, he says, "but they look to a traditional agency for things like relationship, knowledge and experience, which are weightier in the consumer's mind."

Overall, however, insurance companies are at a disadvantage in building a converged business model, EDS's Trapp believes. "How many times do we go to our insurance contracts in a year?" she asks. "You have a much more frequent relationship with the bank than you do with an insurer." As a result, "if you're looking at where the consumer is more likely to find a one-stop shop, in my opinion, it's more likely to be with a bank or brokerage house."

Many banks are betting on that logic. Large institutions, such as San Francisco-based Wells Fargo & Co. and Wachovia Corp., Charlotte, N.C., are aggressively expanding into the insurance arena.

In March 2001, Wells Fargo announced it was purchasing ACO Brokerage Holdings Corp.-the parent company of national property/casualty agency Acordia Inc.

At that time, Wells Fargo CEO Dick Kovacevich said the acquisition would help the company achieve its goal of having its insurance, trust and brokerage businesses contribute 25% of its income.

So far, the acquisition is paying off. Wells Fargo reported insurance revenues of $263 million during the first three months of 2002, up 123% from the previous year.

"It's interesting that we're not seeing mergers of banks and insurance companies, but we are seeing convergence in terms of banks and insurance companies competing for the same customer demand," Deloitte's Porello says.

In fact, banks have not been gobbling up insurance companies; instead, they have been acquiring insurance agencies. An acquired agency is the dominant distribution platform for banks currently marketing both commercial and personal property/casualty products, according to a study by the American Bankers Insurance Association (ABIA), Washington, D.C. Of the 366 institutions participating in ABIA's study, 70% were currently marketing general insurance lines or annuities (see chart, page 37).

Focus On Distribution

Indeed, financial services convergence appears to be causing insurers and banks to take on separate roles as manufacturers and distributors. "If you look at it, banks don't really need to take on the underwriting risk of a property/casualty insurer," EDS's Trapp notes. "They can get that by buying up distribution." As for insurers, "I see most of them becoming more focused on being excellent product manufacturers."

Insurers will continue to devise ways of keeping their customers' funds in their own group-such as opening or acquiring a bank, Trapp says. Metropolitan Life Insurance Co. purchased Grand Bank, Kingston, N.J., in early 2001 and renamed it MetLife Bank, for example. As MetLife policies mature, customers can move their funds into an interest-bearing account within the MetLife family.

By and large, however, most insurance companies will focus on how they can move their products out into bank distribution, and how they can make it easier for banks and other distributors to do business with them, she adds. "The ones that figure out how to do that well will survive."

Insurers may survive by answering the distribution question, but the industry is missing the larger implications-and possibilities-of convergence, according to Deloitte's Porello. "We don't seem to be picking up our heads and thinking a little more broadly about how we might get value out of leveraging the combined abilities of banking and insurance organizations," he says.

Questions To Ask

Some of the questions he poses include: Can the risk management competencies in insurance be leveraged by a bank? Can the capabilities of investment management in the banking sector be leveraged by an insurance institution? Are there ways to combine aspects of insurance products and debt products to create instruments that might provide some differentiating value for consumers?

For example, mortgages with life insurance characteristics and tax advantages have been developed, Porello says. "But (these products) haven't gotten traction in the marketplace. What could the industry accomplish if it put its product designers together and really thought creatively about the different attributes of different products and how they might be used in new and innovative ways?" he asks.

The industry must ask those questions. But even if it does, consumers will ultimately decide the fate of innovative hybrid financial products, one-stop shopping and convergence.

As for one-stop shopping, research reveals that consumers are skeptical about "putting all their eggs in one basket," and they may not welcome a marketing barrage by agents, brokers or bank representatives all pitching financial products to them (see chart, page 37).

"There was probably more hype about consumers wanting one-stop financial services in the past than is reality today," EDS's Trapp admits.

Most consumers are still looking for best-of-breed products and specialization, Synergistics' McCracken says. Consumers want to know, "who can give me the best product, best service, best knowledge and the best price," he says. "And typically that's the specialists, not generalists who do a little of everything."

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