Literature Review

Despite the adoption of the Gramm-Leach-Bliley Act (also called Financial Services Modernization Act) in November 1999, there have been few strategic attempts in consolidating financial and insurance businesses and some of them (i.e. the Citigroup / Travelers or the General Electric / Employers Re. mergers) have failed. This, despite the fact that some of the research papers cited in the attached literature review do identify diversifications gains from potential consolidation of banking and insurance firms.

However, the inability of banks and insurance companies to merge effectively has not stopped the convergence process from a product offering standpoint. The Insurance Information Institute routinely publishes a chart of financial and insurance products available through major financial services companies from all sectors (financials, securities, P/C insurance, and life insurance).

The chart demonstrates that all major financial services companies offer a diversified range of financial and insurance services. This suggests that, although some issues like consumer privacy provisions, data consolidations and other technological differences between both industries need to be ironed out, the convergence process is on its way.

Refereed Papers

Carrow Kenneth A. and Heron R. "Capital market reactions to the passage of the Financial Services Modernization Act of 1999". The Quarterly Review of Economics and Finance 42 (2002): 465-485.

The authors investigate how the passage of the Financial Services Modernization Act of 1999 (FMA) affected stock prices of banks, thrifts, finance companies and insurance companies. The study looks at stock excess returns across sectors and company size. The idea is that the passage of the FMA opens doors for potential mergers and consolidations across banking, financial and insurance sectors, translating into abnormal positive returns for businesses that are the likely candidate for mergers and consolidation.

The results of the study suggest that the largest returns to the FMA passage were realized by large investment banks and insurance companies. The stock prices of banks, both small and large, seemed to be unaffected by the new legislation while thrifts, finance companies and foreign banks lost value.

Carrow Kenneth A. "Citicorp-Travelers Group merger: Challenging barriers between banking and insurance". Journal of Banking and Finance 25 (2001): 1553-1571.

This paper is conceptually similar to the one cited above, in that the author investigates whether the announcement of a merger between Citicorp and Travelers abnormally impacted stock prices of financial and insurance companies. Analysis of abnormal returns surrounding the merger show that life insurance companies and large banks experienced significant stock price increases, while the returns of stocks of smaller banks, health insurers, and property/casualty insurers remain relatively unchanged.

Estrella, Arturo. "Mixing and matching: Prospective financial sector mergers and market valuation", Journal of Banking and Finance 25 (2001): 2367-2392.

This paper analyses which types of mergers are likely to be most productive for banks and other financial firms in the United States. The author acknowledges that the extent to which different business activities are fundamentally distinct induces a tradeoff between diversification gains and loss of efficiency.

The research considers life insurance, property/casualty insurance, securities, and commercial firms as potential matches for firms and concludes that potential diversification gains arise from almost all combinations involving banking and insurance. The paper stands out because it shows, unlike other earlier research, that property and casualty insurance companies offer larger diversification gains to banks than life insurance companies.

Johnston, Jarrod and Madura J. "Valuing the potential transformation of banks into financial service conglomerates: Evidence from the Citigroup merger". The Financial review 35 (2000): 17-36.

The authors first summarize previous literature that examined motives for combining bank and other financial services. Diversification benefits and product complementarities (i.e. mortgage and mortgage insurance, auto financing and auto insurance) seem to be the prime motives. However, some earlier research also suggests that there are few linkages between bank services ands underwriting services in terms of customers, outlets, or other characteristics that generate efficiencies. Given the sources of potential gains, it appears that life insurance companies with their limited underwriting risk and wide variety of other products offered to individual customers would be more attractive targets for banks than other types of insurance companies.

Based on these observations, the authors propose to test whether commercial banks, insurance companies, and brokerage firms were favorably affected by the Citigroup/Travelers merger for impending consolidation of financial services firms. They measure the valuation effects resulting from the merger announcement among those commercial banks and financial services firms most likely to be affected and conclude that commercial banks, insurance companies, and brokerage firms have all experienced positive and significant valuation effects upon the announcement of the Citigroup merger. However, the authors find that the valuation effects are more favorable for brokerage firms than for commercial banks and for insurance companies.

Finally, the authors perform a cross-sectional analysis which concludes that the largest banks and the largest brokerage firms experience more favorable valuation than the smaller banks or smaller brokerage firms. Size does not seem to be significant for insurance companies.

Industry Publications

Armstrong, Ed and Buse, P. (1996). "You’ve got the green light, what’s it worth?" ABA Banking Journal, Vol. 88, Sept., 13-18.

The article projects that banks would add 5-10 percent to their after tax profits if "they aggressively pursue their insurance opportunity." The author develops a pro forma statement for banks selling 12 different insurance items.

Boros, Joan E. (2002). "Are Convergence Products Happening?" National Underwriter, Life & Health/Financial Services Ed., May 27, 2002.

The author states that "convergence" depends on its definition. She offers very useful definitions for convergence:

1. Merger of banks and insurers, heretofore independent, into a financial supermarket with endless cross-selling potential
2. A combination of insurance and capital markets products moving into a union and uniformity, or separate markets performing the same functions. This could also be labeled as securitization of insurance risk and or "insurancization" of financial risk.

Crystal, Mary (1997). "That was then, this is tomorrow." Bank Marketing, Vol. 30, 1, Dec.97/Jan.98, 28-52.

This panel discussion on bank marketing suggests more direct interaction with customers by direct mail or personal contact. Doing it pro-actively and by alternative methods: call centers, PC-banking, internet banking and supermarket banking. Using branding and other retail marketing skills. Bankers have tried to cut down on personal contact and may have alienated their customers.

Gjertsen, Lee Ann (2002). "Insurance Agents' Thrift Seeks OK to Widen Reach." The American Banker, May 13, 2002.

Insurance agents of New Jersey, Connecticut and Massachusetts founded an association as ‘Independent Insurance Agents and Brokers’ and have applied for a charter for an association savings bank. The bank products are to be sold by the independent insurance agents that own their own agencies. The bank is to be named InsurBanc.

Gorski, Lorraine (2002a). "The New Producers." Best’s Review, May 2002, p.45-48.

The article describes how insurers can use the banks' customer base to reach new customers. Banks have the trust of their customers and that would be a good distribution channel for life insurance, especially in the midlevel or mass market.

Banks could represent 3-4 different insurers therefore the insurance products need to be competitive (for the customer and the representative) and specific for bank employee selling. Furthermore, stable relationships are necessary and the product needs to be branded and well advertised.

Underwriting will stay with the insurers but selling may go both ways by insurance agents or bank employees.

Gorski, Lorraine (2002b). "Banking on Policy Holders". Best’s Review, July 2002, p.44-47.

Insurers have founded banks to offer banking products. One hundred and thirty five applications were made between Jan.1, 1997 and May 31, 2001. Insurance banks have an uphill battle to convince their customers to establish a bank account because it is hard to determine when and why an insurance customer needs a bank account.

On the other hand, it is easier for a bank that provides a loan to sense when insurance is necessary. Since most people already have a bank account, customer as well as agents have to be motivated to deal with another financial institution or to switch. In addition these new institutions often have no brick and mortar establishment but rather rely on Internet applications and Internet interactions.

Establishing banks enable insurers to get into the trust business and offer a sophisticated retirement package and to be able to cross-sell insurance products to their customers and to earn fee income. Although this can be done through partnerships, some insurers want to do it alone and thus to avoid finding later on unpleasant surprises. They count on their name recognitions and the availability of their agents (State Farm, Allstate).

Increasing brand awareness, direct mailing, providing up-to-date interest rates should help to lure customers. Most insurance firms have hired experienced bankers to create and manage these banks.

Hogan, John D (2001). "Financial Services Reform: The Gramm-Leach-Bliley Act and its implications for insurance", Journal of Financial Service Professionals, January 2001, pp. 33-38.

In this paper, the author contends that the impact of the GLB Act on the insurance industry is unclear. It had been widely assumed that the banking industry would quickly expand into non-banking activities, as synergies could be expected from the large bank customer information base and frequent contacts with customers. However, this quick response has not taken place, partly because of perception of risk in the insurance business.

The author also cites a research study by The Federal Reserve Bank of Atlanta that suggests that bank holding companies will add insurance products to their lines of business for sound reasons such as:

1. Small increment costs involved
2. The presence of existing customer relationships
3. Revenue diversification
4. Absence of interest rate risk in insurance compared with loans
5. Banks' web-based marketing capability.

McDaniel, David (1995): "Agents' worst nightmare: Banks are gaining the edge to sell insurance in a big way". Best’s Review [Property/Casualty], Vol. 96, 2, June, 28-33.

The article explains that insurance agents are afraid of banks cutting into their business as they have in Europe where banks are far more efficient than agents. The article lays out how to make the proposed legislation ineffective, by warning of unsubstantiated tie-ins and bank coercion, proposing 10-day waiting periods, state legislation, and tough fire walls.

Milligan, John (1996). "Banking like it used to be". US Banker, Vol. 106, Nov. p.61-65.

First Long Island Bank prospers because it serves a small niche of small privately owned companies and upscale consumers that it coddles by being available both in person/ phone and online.

Pasini, Roy (1997). "Alliances Lawson cites three issues critical to future". Underwriters’ Report, 92nd year, #19, 5/8/97.

The author states that the insurance industry can defend itself against the invasion by banks through better customer service and greater use of technological efficiencies.

Weber, Irene (2002). "No Sale". Best’s Review, May 2002, p. 50-51.

Weber reports that, since the GLB Act of 1999, a few banks have acquired insurance firms and then Citigroup split up again. She provides the following reasons for non-convergence:

• Regulation: financial and bank holding companies are federally regulated, insurance firms are state regulated. GLB requires U.S. jurisdiction to adopt uniform or reciprocal agent and broker licensing laws by November 2002. Reciprocity has apparently been approved by most states. But new insurance products need to have state approval before they are allowed to be marketed, which is a slow process. Will there be federal chartering of insurance firms in the future?
• Technology: banks are able to offer interactive online services, while insurance products apparently don’t lend themselves to it. Also otherwise insurance are slower to adopt new technology.
• Financial reasons: Return on equity for insurers was for 2000 only 7.42 percent while banks made 12.2 percent. Probably Citigroup spun off Traveler’s because it did not make double digit growth, a norm for Citibank.

Banks have two goals in mind:

• Revenue diversification
• Product diversification for their customers

Agencies can provide for both those needs without additional underwriting risks for the banks. Banks increasingly bought insurance agencies well before GLB; they increased from 9 in 1996 to 62 in 2000, but decreased to 43 in 2001. There are some big banks which have pursued that strategy for a long time, BB&T completed 56 agency acquisitions since 1989 and has the 11th largest insurance agency network, Wells Fargo, the bank with the largest insurance agency network plans to make 25 percent of its income through insurance, trust, and brokerage business.

Newspaper Articles

Aquino, Norman P. and Junia C. "Thrift Firms Join Foreign Firms' Lobby for Cross-Selling Venture". Financial Times 7/3/02.

This article describes a recent example of convergence in the Philippines. The U.S. embassy is lobbying for New York Life to sell its insurance through Philippines banks. European insurance firms are also interested in it. Philippines' thrifts are accusing the Central bank of not including them. The Philippe Central bank is interested that banks show that the insurance products are not guaranteed by the PDIC.

Bowman, Lisa. Financial Times, 3/20/02.

Bancassurance in the U.K. is not taking off as expected. Firms are not making use of the data available and the products are not streamlined for bank sales. Consumers apparently prefer professional advice from insurance agents, while banks have a bad reputation for poor service. The author recommends that banks should take on more rich clients.

Instead they stay with second tier customers, thus should employ second tier agents which would provide off the shelve advice but that has not been created. This approach would also be more cost efficient. The new model is that bancassurers acquire pure insurers. Examples given.

Gibson Henry. Financial Times, 5/31/02.

This journalist highly supported the Dresdner – Allianz merger. The new institution is called Allianz Group. The logic behind this giant merger is that the German government is in favor of German citizens to pursue private and company pensions which it will support with tax incentives and coercion. The pension industry is supposed to grow by 15 percent annually. The article suggests that that the familiarity and easy branch access of Dresdner would better service this population.

Lipin, Steven and Frank, S. (1998). "One stop shopping is the reason for deal. The big umbrella: Travelers/Citigroup merger." The Wall Street Journal, 4/7/98.

The authors wonder whether the merger will bring about the promised synergies, and whether consumers really want all their services from one provider. Can they cross-sell their brands?

Walker, Marcus (2002). "Germany's Commerzbank Is Still in No Man's Land." The Wall Street Journal, 7/12/02.

This article on the state of the Commerzbank mentions that tightly focused banks with strong market shares, such as U.K. retail banks, have made money. Diversified universal banks with no dominant market share such as Commerzbank or Frankfurt rival Dresdner Bank AG have slipped to losses in some quarters, raising doubts about their long term viability.