Plug 'n Play?

By John R. Engen

State Farm's push to sell bank products through its insurance distribution system depends on motivated agents.

Edward Manahan's two-room office in a Bloomington, Ill. strip mall certainly doesn't look like a bank. There's no teller line or lobby, and the only clue that Manahan even offers banking products comes from stacks of pamphlets on a window ledge.

But the long-time State Farm Insurance Cos. agent does have one thing that might worry Bank One Corp. and other banks in the area: strong customer relationships.

When one of Manahan's 3,100 clients buys a house or a car, has a death in the family, or encounters some other life-changing financial event, he is called as a matter of course because of the insurance connection.

Now that Manahan is equipped to sell an array of deposit and lending products, those customer relationships translate into a competitive threat to banks. Already, about 500 of his clients have purchased at least one banking product.

As part of an agent force 17,000-strong, Manahan represents a bold experiment in the delivery of retail financial services. Eschewing plans to build bank-like branches, Bloomington-based State Farm is betting that its insurance agents can sell banking products from their existing offices. The potential seems enormous. Those agents serve 27 million households in 48 states under a brand name that's well known across the country.

Already, State Farm Bank has amassed more than $3.5 billion in bank assets and $2.8 billion in deposits. "Banking," says Edward Rust, Jr., State Farm's chairman and chief executive, "is a natural, logical extension of what we offer."

The years ahead will test Rust's theory about insurance and banking being a natural fit. To date, only 1% of State Farm customers has purchased banking products; most are unaware that the insurer is even in the banking business. Convincing the rest to turn to an insurer for certificates of deposit, money-market accounts and mortgages will require a significant marketing outreach.

And none of this will work without the enthusiastic cooperation of State Farm's agents, who are technically independent contractors rather than company employees. Although the company has already put most of those agents through a special training program, its incentive system is still heavily weighted in favor of insurance products, underscoring how State Farm executives face some delicate tradeoffs.

The appeal of State Farm's banking products rests on attractive pricing, so paying the agents too large of a sales incentive would negate State Farm Bank's advantage as a low-cost producer. And seriously distracting agents from their core job of selling insurance would be harmful to the company overall.

For the record, State Farm portrays banking as a long-term project and seems in no hurry to become a nationally significant player anytime soon. Rust says he views the banking operation mostly "as a means of building customer retention," and says State Farm Bank will be judged on its ability to turn a profit (which it hasn't yet), while increasing share-of-wallet among the insurer's established customer base. Banking may, in fact, never amount to more than a niche operation at State Farm.

On the other hand, this could be an opening shot in a long-term struggle to make financial services "convergence" more of a reality by showing that insurers can play on the banking industry's turf — just as banks are learning to sell insurance products.

Banking Play

To be sure, State Farm is far from the only insurer to jump into the banking business. After the landmark Gramm-Leach-Bliley Act in 1999 opened the door for insurance companies to market bank products (and vice versa), a number of insurers obtained thrift charters, including Allstate Corp., MetLife, Inc., and USAA Inc. San Antonio-based USAA, which markets to military personnel, is the biggest player so far based on assets, but State Farm is considered a top contender because of its market heft.

The company was founded in 1922 by George Mecherle, an Illinois farmer who was frustrated that lower-risk rural drivers had to pay the same auto insurance premiums as their big-city cousins. State Farm has since blossomed into the nation's largest property and casualty insurer, with 80,000 employees servicing some 72 million policies.

The decision to seek a thrift charter, granted in 1999 after a contentious two-year review process, was rooted partly in the company's experience in marketing auto loans to its insurance customers. State Farm noticed that these loans, underwritten by partner banks, generated higher customer retention and cross-sell levels, as well as incremental fee income, says Stan Ommen, State Farm Bank's chief executive officer.

While State Farm's initial plans called for modest growth, some bankers quickly sounded the alarm. John McCoy, then-CEO of Bank One, warned at BAI's Retail Delivery Conference in 1998 that if the insurer could sell just one product per-office, per-month, it could generate more than 200,000 new accounts a year.

In fact, McCoy appears to have underestimated the potential. After two and a half years, State Farm Bank now boasts more than 500,000 accounts, and is opening new ones at a rate of 1,500 a day, according to Ommen. "State Farm is redefining itself from a mere insurance company into a financial services company, and doing it very successfully," says Carmen Effron, president of C.F. Effron Co. LLC, a consulting firm that works with both banks and insurers.

The growth so far rests on a relatively low-cost distribution system, which allows State Farm to offer attractive rates on its banking products — an additional 50 basis points over most competitors on CDs, for example. While there have been layouts for marketing, administration and centralized loan processing capabilities, it has cost little to add bank products to agents' product menu, or market them over the Internet. And those agents are already in place with an office network that spans the country.

While some insurer-owned thrifts offer a full range of banking services, State Farm has chosen to focus on a few basic consumer products: CDs, money-market checking accounts, residential mortgages, credit cards, consumer loans and auto loans. The latter is a natural sale, since the agents are often involved in arranging for insurance at the time a car is purchased.

Today, the company has $1.2 billion in auto and other consumer loans, about $900 million in mortgage loans and a $200 million credit card portfolio. Deposits include about 31,000 checking accounts, with total balances of $45.4 million, and $650 million in some 22,000 money-market accounts. But the vast majority of deposits, more than $2 billion worth, comes from CDs, which underscores how dependent State Farm Bank is on rate-driven customers pulling funds out of the slumping stock market.

"State Farm was fortunate, because the company launched the bank at a time when people were looking for diversification and good rates," says Jim Rensel, president of Q-Group, a Tempe, Ariz. market research firm.

Balancing Act

While State Farm Bank's debut may have been propitiously timed, the long-term viability of its delivery model is not guaranteed.

A certain segment of customers will always be rate-driven. But what about those who base their choice of a banking provider on factors such as convenience and security? Even some big online financial services companies, such as E-Trade Group Inc., have reluctantly concluded that they must have some branch offices to compete effectively for mass-market customers.

David Prus, who worked with KeyCorp before joining State Farm Bank as a marketing director two years ago, concedes many customers are "challenged" to perceive State Farm as something more than an insurer. "When they hear 'State Farm Bank,' the first question they ask is, 'How do I conduct my transactions? Where is the branch office?' "

Manahan has witnessed this type of confusion firsthand. He tells of a customer with a sizable sum in a money-market account who recently called his office to purchase a cashier's check. "I had to say, 'I'm sorry, we can't do that here; you have to call the bank.' " Manahan recalls the customer "wasn't very happy" about that.

Despite such difficulties, State Farm executives say they have no plans to build branches. Ommen reckons that enough people are willing to trade branch proximity for a combination of attractive rates and one-stop shopping (95% of bank customers also own State Farm insurance). He also argues that State Farm's easily-accessed Web site, its willingness
to reimburse ATM charges imposed by other banks, and the presence of a trusted agent nearby should satisfy most customers for now. But he does concede this structure will likely discourage customers from placing their primary transactional banking accounts with State Farm.

Instead, State Farm is trying to get its agents to sell CDs and mortgages as "add-on" products. And the agents may be well positioned to do that, considering that the company enjoys a reputation in the insurance industry for a strong sales culture. In addition to auto insurance, State Farm agents have a good record selling life insurance — clearly a product that is "sold, not bought" — along with mutual funds, variable annuities and other investment offerings.

But the agents already make a good living selling insurance products, so why should they exert themselves to push banking products? Right now, there's not a lot of money in it. State Farm Bank pays agents $25 for a deposit account, and up to $250 for initiating a successful mortgage origination. Those are small numbers by insurance standards, and Ommen admits that some agents are unhappy with this compensation plan.

Manahan, for example, recently opened two $1 million CDs for a client, but was paid no more than if the deposit had been $100. "The banking products aren't like the major insurance products we sell, because they don't generate residual income," he says.

State Farm Bank has responded to these complaints by convincing its parent to include bank product sales as part of the total for agents to achieve company-paid bonuses and end-of-year travel. But there are limits to how far the company can go without jeopardizing its relatively low-cost structure. "It's a balancing act," Ommen says. "We're trying to pass the efficiencies of our system along to customers with better rates, raising the question of how much we can afford to pay the agents."

As for forcing agents to sell banking products — forget it. Being independent contractors, the agents are free to sell whatever generates the most revenue. "I can tell agents I expect them to sell banking products, but it's really up to them," Ommen says.

For their part, the agents could face some operational risk in marketing bank products. A customer turned down for a mortgage loan, for example, might vent his ire on the agent by canceling more lucrative insurance policies. "There are synergies between banking and insurance products," says John Barreis, a senior director for Fitch Ratings in Chicago. "But the sum of the synergies could actually hurt the agents' core business model."

These challenges are even greater in today's environment of rising insurance premiums. Michael Herlihy, a former banker and now CEO of InsurBanc, a $25 million-asset institution in Farmington, Conn., says that independent insurance agents he works with are less willing to devote much attention to anything outside of their core offerings. "They're in a very hard market right now," he says. "When premiums rise like they have, it takes more work to market insurance products."

Training Regimen

In the face of these challenges, State Farm is doing what it can to prepare its agents to sell banking products. Nearly all the agents have now been through a training regimen focused on banking products, compliance issues and the internal systems that are used to initiate and monitor accounts. The course includes a book-based self-study program and a CD that walks the agents through systems navigation, followed by some classroom training.

Ommen says the program includes coaching on "identifying when it is appropriate to sell a certain product to a customer." This includes scripted conversations and pointers on getting the right forms filled out correctly and sent to the right place. "You need to build a process at the point of sale that enables a transition from an insurance discussion to a banking discussion," says consultant Effron, who is based in Westport, Conn. and has followed State Farm's efforts closely.

To support its agents in the field, State Farm employs 350 people at loan processing centers in Missouri and Indiana. Agents help their clients fill out loan applications and then send the documentation electronically to one of those centers for processing. When the paperwork is done, the forms are sent back to the agent's office for signature.

To boost public awareness, the bank has been buying newspaper and radio advertising in test markets. For established customers, it's using everything from statement inserts to messages on envelopes. It also is lobbying with its parent for inclusion of the word "banking" on State Farm's familiar logo. "We're trying to get the word out that we have a bank," Prus says.

Like its banking competitors, State Farm is experimenting with predictive modeling to target direct mail and other solicitations to customers considered most likely to buy banking products. The bank has already found that customers with life insurance policies have the highest propensity to buy, while those with health insurance are next. Using such insights, State Farm Bank's response rate on direct-mail pitches is 1%, about double the industry average, according to Ommen.

But as is also the case with banks, this customer relationship management effort is a work in progress, hindered by the inability of State Farm's own internal systems to communicate with each other.

Quest for Synergy

Assuming State Farm Bank can keep the agents on board and continue its rapid buildup, what are the implications for the parent company and the financial services industry in general?

First and foremost, State Farm gets some needed earnings diversification. The mutually-owned company reported a $5 billion loss last year, due mostly to rising claims in its core property and casualty business. This year, the company shuttered offices and stopped underwriting new homeowners' policies in many states.

"They've been hit very hard, especially in the homeowners' business," says Barreis at Fitch Ratings. While he says that banking "offers some component of diversification" to State Farm's revenues, the total amount ($52 million through August of this year) is still little more than a rounding error for a company that generated $40 billion in premiums in 2001. And this unit has yet to cover its startup costs. A spokesman says only that State Farm Bank will attain profitability "soon."

Beyond that, State Farm's banking venture will help determine whether financial service "convergence" can evolve from an attractive buzzword into a real business model. The business rationale for convergence is based on the concept of "one-stop shopping," or providing customers with one destination for purchasing the full range of financial products.

Gramm-Leach-Bliley may have promoted convergence by lowering the barriers separating banks and insurance companies (and brokerage/investment banking companies as well), but the practical effect so far has been minimal. In fact, some of the visible movement has been in the opposite direction. Citigroup Inc. early this year announced plans to sell the property and casualty unit of Travelers Insurance. "They found there wasn't any synergy between banking and the property and casualty business," Barreis says.

Synergy has been elusive for banks, as well. Consultant Effron cites Wachovia Corp., Bank of America Corp., and HSBC Holdings as banks that have done well selling insurance products. But she says most institutions have been hindered by overly rigid product silos, technical integration issues, and incentive systems that do little to encourage cross-selling.

State Farm's Rust currently serves as chairman of the Financial Services Roundtable, a Washington, D.C.-based lobbying group composed of top executives from the banking, insurance and investment industries. He says insurers are better positioned than banks for cross-selling because they deal regularly with financial service functions that cement customer relationships, such as servicing insurance claims. "Once you place a loan or take a deposit, there's not a whole lot of interaction required," Rust says. "When you're adjusting a claim loss, you're putting a value on things — or lives — that people have lost. That's very powerful."

Rust expects to see additional synergies with insurance as State Farm Bank becomes a larger, more integral part of the company. He envisions, for example, handing beneficiaries of deceased customers a State Farm Bank checkbook with the death benefit already deposited in the account. "Our goal is to be a comprehensive provider of financial services products, and strengthen our long-term customer retention," Rust says. "If we can continue to penetrate our property and casualty book of business, we'll be a major player in this whole game."

It is an ambitious plan, but — based on the progress so far — one that banks will dismiss at their peril.

Mr. Engen is a freelance writer based in Minneapolis.

Copyright © 2003 by Banking Strategies, published by BAI.

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