Banks fighting in Washington for the right to sell insurance are in grave danger - they might get exactly what they want.

Winning in Washington will be irrelevant if banks can't capitalize on the victory. Sadly, that outcome seems increasingly possible.

In recent columns, we have described the sizable revenues and income available to the successful bank distributor of insurance products - about $300 in revenue and $150 in pretax income per median-income household.

To date, however, most U.S. banks that have entered the business are not realizing this potential. Many have begun to question the strategies that are being followed, concerned that profitability and growth will continue to elude them with or without significant reform of insurance regulations.

First, we need to dispel the notion that banks are precluded from competing in insurance distribution because of regulatory restrictions. While the regulations are Byzantine, and constantly appear to change, the facts are:

*State bank insurance laws allow nearly every state bank to sell credit insurance and accident and health. Furthermore, 27 states allow state banks to act as general insurance agents, or allow some product sales, short of full general agency. Only 12 states completely prohibit banking/agency affiliation, and many of these have proposals in the legislature to reexamine restrictions.

*The National Banking Act, section 92 allows banks in towns with populations less than 5,000 to engage in general insurance agency activities. This year the federal appeals court interpreted the rule to mean selling is permissible statewide.

*The Bank Holding Company Act, which explicitly limited the authority of the Federal Reserve to approve bank insurance activities, has "grandfathered" exceptions for 16 of the largest national banks. At least one is allowed not only to sell, but also to underwrite most insurance products.

*In NationsBank v. Valic, the high court ruled that annuities are investment rather than insurance products, and thus can be sold by banks.

So while hardly a day goes by without an article appearing on why banks must never be permitted to participate in insurance, or why they must immediately be given broad authority, the fact is that the legal and regulatory skirmish is becoming largely irrelevant. The battle has moved to the marketplace.

Many banks have begun to appreciate the desirability of building an insurance distribution capability, both to remain relevant to their retail customers and to realize greater revenues per household. Most have pursued some variation on three core strategies described here:

*Purchase an independent insurance agency.

*Establish a joint venture with an agency and cross-sell through each other's customer lists.

*Build insurance distribution capabilities within the bank, using platform professionals or insurance specialists in the branch.

These three approaches have generated much press, but few bankers are satisfied with the resulting sales.

One bright spot has been sales of variable annuities, often through third-party marketers. Unfortunately, although sales are brisk, income performance is not outstanding.

The reason is that profit margins in variable annuities are extremely thin relative to those potentially available from life, property and casualty, and individual health sales.

What prevents banks from penetrating these more desirable market sectors?

The problem, in a nutshell, is that banks appear to have accepted the agency as the model for distribution. As a result, many have perhaps too hastily purchased an insurance agency, established a joint venture with one, or tried to recreate the agency model in the branch.

Some are now beginning to discover the reason that insurance companies are turning to banks as sources of alternative distribution, and the agencies are fighting so hard to keep them out: Agencies have serious shortcomings.

First, there is the staggering personnel turnover - 35% per year and often more. New agents are recruited with hopes of riches, then find that selling individual insurance is a difficult, fatiguing occupation. As a result, they leave or become only part-time salespeople.

Combine this high turnover with rather generous commission rates for agencies and one gets a massive cost problem. On average, year after year, distribution alone consumes 4% of individual insurance company assets. By comparison, the total noninterest expense for banks is about 3% to 4% of assets.

Simply put: Affiliating high-cost agencies with banks does not, at present, create new economic value.

But perhaps more important than either the cost or the personnel issue is the need for banks to begin to integrate insurance products into the core banking business, rather than isolating them in a separate agency.

A key reason for the inefficiency of the agencies is that they lack the information and the information-processing capability needed to rationalize the selling process. While independent agents develop leads on customer prospects, the investment needed to create good leads is prohibitive. And agents, while exceptional at sales, do not typically possess the marketing capabilities necessary to acquire and retain customers. These are the ability to:

*Segment the market.

*Gather information on customer needs and purchase behavior.

*Do market research and test marketing.

*Mine data bases.

*Do product functionality analysis.

Independent agencies lack the size and data access to build such capabilities. By contrast, banks are big enough, in possession of much of the relevant information (some of it proprietary), and in the process of building the infrastructure and the models needed to integrate, sift, and pre-analyze the required data.

Such an integration of insurance and banking products implies a fundamentally different model of distribution, one that might or might not involve specialized sales agents. An integrated distribution model has significant implications for strategy, organization, business processes, systems, and people.

Interestingly, many European banks, even those without unusually sophisticated information resources, have managed to do a lot better than U.S. institutions that have allied with or purchased independent agencies.

In fact, some have found it possible to utilize market-image and product-breadth advantages to in effect reshape the financial services market in their respective countries, growing to dominate the insurance distribution business and establishing inroads into underwriting and investment management.

For example, in 1986 U.K. banks held a 3% share of insurance distribution. By 1993 they held 22%. In Spain, the bank share increased from 3% to 14% during the same period; in Italy, from 0% to 26%; in the Netherlands, from 13% to 23%. In France, where banks began penetrating the insurance business before those in other countries, the bank share of insurance distribution has grown to 51%.

Admittedly, banks in these nations enjoy a less "separatist" environment. However, the reason for success is linked to what banks do, rather than to what the regulators do not do.

The European model is called "banc assurance." What is it? Why has it been successful abroad? And, most important, can U.S. institutions replicate it with the same success here? The next article in this series focuses on these questions.

Mr. Kaytes is a managing vice president at First Manhattan Consulting Group, New York.

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