I N S U R A N C E I N D U S T R Y K N O W L E D G E F R O M O A K S T R E E T

F A L L 2 0 1 4

GEARING UP FOR YOUR NEXT STEPSCreativity & InnovationFive essential keys to business innovation

Community Banks and InsuranceIncreased regulatory and compliance costs hit

Flood InsurancePolitics and law suits make navigation more perilous

M&A IntegrationThe right strategies to achieve synergies

PublisherOak Street Funding

Editorial DirectorMichelle Wilson

Features

Tell Us Your ThoughtsIf you have any questions, comments or ideas for The Bridge, let us know. Email us at osf@oakstreetfunding.com.

Fall 2014

www.oakstreetfunding.com

Capital Success StoryAgency buy-out of existing, non-participating owners

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Creativity & InnovationFive essential keys to innovation

Community Banks and InsuranceIncreased regulatory and compliance costs hit

16

Flood InsurancePolitics and law suits make navigation more perilous

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4

M&A IntegrationThe right strategies to achieve synergies

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The Bridge is a newsletter produced by:

Oak Street Funding11350 N. Meridian Street, Ste. 600Carmel, Indiana 46032866-625-3863

Potential borrowers are responsible for their own due diligence on acquisitions. Loans and lines of credit subject to approval. California residents: Loans made pursuant to a Department of Corporations California Finance Lenders License. The materials in this paper are for informational purposes only. They are not offered as and do not constitute an offer for a loan, professional or legal advice or legal opinion and should not be used as a substitute for obtaining professional or legal advice. The use of this paper, including sending an email, voice mail or any other communication to Oak Street, does not create a relationship of any kind between you and Oak Street.

© 2014 by Oak Street Funding LLC. All rights reserved. Any duplication without prior written permission is strictly prohibited.

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Letter from the Founder/CEO

It’s hard to believe we’re already into the second half of the year. If you’re like me, you’re scratching your head and wondering how the time has passed so quickly. The old ‘time waits for no one’ cliché is more than just a saying.

Hopefully, 2014 has been a good year for you thus far and you’re on track to meet your goals. Whether your insurance business anticipates completing a successful year or has seen its share of challenges, it’s time to start planning for 2015. What do you hope to accomplish? What is your game plan?

Step back from your daily routine and think about what it will take for your business to experience significant growth, prepare for a transfer of ownership, increase profitability, improve customer retention or meet other targets. Will it require another producer to generate more business, more customer service staff, upgraded technology, a marketing campaign, an acquisition or a new office space in a quickly-expanding location?

At this point, it can take some serious out-of-the-box thinking to expand your practice. This issue of The Bridge offers insights, ideas and views exclusively for insurance professionals. In addition to resources we provide to help you grow and manage your business, we are ready to help with capital you may need to reach your goals.

Oak Street Funding remains fully engaged in the insurance industry and committed to keeping up with the challenges of agents and brokers. Our lending capacity remains strong with access to credit facilities and our products continue to fill the financial gap created by traditional banks that don’t prefer lending to insurance businesses. We’ve been lending to insurance professionals since 2003, and we expect to be here for years to come. We thank you for your continued dedication to the industry and support of Oak Street Funding.

Rick DennenFounder, President and CEO

What Are Your Next Steps?

Oak Street Funding Vision Statement

Oak Street Funding utilizes industry knowledge, well-developed

technology and passion to deliver best-in-class service and capital

products to insurance and finance professionals nationwide. Our

customer-focused mind-set and access to capital will allow us to

continue to fulfill customer needs, identify growth opportunities

and provide an empowering work environment for employees.

Don't miss our next issue of The

Bridge. Call or visit our website to sign

up or renew your subscription today!

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or method or a new way to look at an “old” thing. It involves acting on creative ideas to make a specific and tangible difference in the domain in which the innovation occurs. While creativity implies coming up with new ideas, innovation is bringing these ideas to life.

Innovation is the life blood to a successful business. Without it, there is stagnation. With it, there is energy, excitement, differentiation, value creation, passion, and purpose. Innovation is a dynamic process of continually considering alternative means of delivering products and

On December 17, 1903, a man walked into a restaurant in Norfolk, Virginia to announce that “there are two loony Yankees down at Kitty Hawk

trying to learn to fly.” Little did this man realize that these curious pair of innovators would achieve the first powered, sustained, and controlled flight of an airplane. Orville and Wilbur Wright would survive this flight and many others.

The credit card was introduced in the 1920s for automobile owners to make the purchase of gasoline easy and efficient. As companies like American Express and Diners Club made it possible to purchase meals, lodging, and merchandise with the swipe of plastic, the concept of the credit card took off.

In 1968, a scientist named Spencer Silver was researching ways to make 3M’s adhesive tape stronger. He failed to meet his objective, yet discovered something new – an adhesive strong enough to stick on many surfaces but could easily be removed and reused. In 1977, Post-It-Notes hit the market. The concept did not catch on immediately as consumers could not imagine why they would need such a product. It was not until 3M decided to distribute free samples that people understood and appreciated the versatility of the little sticky notes. Once this happened, the consumers’ imagination ran wild.

What do the Wright Brothers, the credit card, and Post-It-Notes have in common? Creativity leading to innovation. Creativity is the act of producing new ideas, approaches, or actions while innovation is the process of putting an idea into action. Creativity is always the starting point for innovation. People who have a gift for creative innovations tend to differ from others in three ways:

1. Expertise. Specialized technical knowledge in a particular discipline.

2. Creative thinking skills. Flexibility and imagination as relates problem solving.

3. Intrinsic motivation.

The ability to “think outside the box” is best supported in a flexible, open, nurturing environment with a leader who sees his or her primary role as supporting rather than directing. Creative people require this kind of environment to invent, imagine, problem solve and create fresh ideas and concepts. Creative ideas emerge when preconceived assumptions are discarded and attempts at new methods, which seem odd or unthinkable to others, are explored.

Commoditization is a huge issue in many industries. It is evidenced by ferocious price competition, leading to lower prices, margins, and profits. Unless a business offers

something unique or differentiated, price will win every time. In today’s fast paced, turbulent world, it is critical that industry leaders understand the importance of creating a culture that fosters imagination, originality, diversity of perspectives, and fresh ideas.

Innovation is the successful introduction of a new thing

Creativity Innovation

and

Think Outside the Box

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author of Purple Cow and The Big Moo, states, “The only way to grow is to be remarkable. The only barrier to being remarkable is your ability to persuade your peers to make it happen. You will grow as soon as you decide to become remarkable – and do something about it.” In other words, be creative and innovative.

Establishing a culture of creativity and innovation is not easy. It requires a management process comprised of specific tools, resources, rules, and discipline. Think of innovation in terms of planting seeds for a vegetable garden or flower

bed. The right combination of soil, water, sunshine, and air will determine how well the plants grow. For innovations to thrive, the conditions must be right.

Research indicates that there are five essential ingredients to the recipe for innovation – leadership, acceptance of failure, openness, patience, and motivation.

LeadershipThe innovative leader is a fearless visionary committed to backing bold ideas. He or she is keenly aware of the benefits of an environment where people feel comfortable and confident in voicing opinions about the firm’s business model. The innovative leader also understands the implications of rewarding creative thinkers.

The innovative leader encourages questioning, risk taking, openness, and a healthy attitude toward failure. He or she encourages the staff to challenge the status quo through questions such as, Is there a better way? What if we...? What would be impact if...? How would the customer react to...?

Many organizations – especially larger ones – have hierarchical structures that impede idea creation. The innovative leader recognizes this and responds accordingly. Innovation cannot flourish unless the barriers to creativity are removed in order to foster a culture of collaboration and free flow of ideas.

Acceptance of FailureEven the most beautiful garden has weeds. Innovative organizations must not only water and fertilize, but also kill off ideas that hold no potential for future growth. The acceptance of failure is a necessary step in the process of innovation. The willingness of a senior management team to be open and tolerant of failure encourages people to explore new ideas, take risks and be up front about problems.

It goes without saying that failure can impact the bottom line of an organization. It is for this reason that a “check and balance” system is required to spot potential problems so necessary alterations can be made. Open discussion and dialog is the best remedy to avoid costly failures. In innovative cultures, employees are encouraged to expose their ideas for early feedback and collaboration. If a creative idea does not appear to have merit, alternative strategies should be explored in a patient setting before the idea is put to rest.

services, improving customer experiences and opening new markets. Innovation is the single most essential element to aggressive top line growth and bottom line results. Organic growth, profitability and agency value are dependent upon innovation.

Seth Godin, the internationally recognized best selling

By: F. Scott Addis, CPCU, CRA

Creativity Innovation

and

Think Outside the Box

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OpennessFedEx has a corporate wide initiative that it calls “purple promise” – each employee’s commitment to making the FedEx experience remarkable. This shared mission encourages everyone at FedEx – from employees sorting and delivering packages to those answering phones, maintaining planes, and developing new IT systems – to suggest ideas each and every day.

While innovative breakthroughs sometimes come from a single source, the vast majority of innovations draw on many contributors. Open source innovation – the ability for a person to tap into the ingenuity of others – offers enormous potential for creative output.

Creativity flourishes in a vibrant culture that encourages people to imagine, think about possibilities and have the freedom to innovate. Positive cultures have open channels of communication that encourage people to bring forward new ideas so they may be captured, vetted, and prioritized. These channels include, but are not limited to, casual brain-storming sessions, strategic planning sessions, suggestion boxes, and online tools.

PatienceThe age old adage “patience is a virtue” applies to the process of creative innovations. Patience is required if innovation is to thrive. In The Big Moo, Seth Godin states, “There isn’t a logical, proven, step-by-step formula you can follow. Instead, there’s a chaotic path through the woods, a path that includes side routes encompassing

ABOUT THE AUTHOR

Scott Addis started his award-winning company, The Addis Group, in 1990. The company has grown to more than 1,700 clients and premiums over of $180,000,000. Scott was named “Entrepreneur of the Year” finalist by Inc. Magazine and one of the “25 Most Innovative Agents in America” by the National Alliance for Insurance Education and Research. He founded the Beyond Insurance® Global Network, the fourth largest insurance network in the U.S.; created the Certified Risk Architect® designation and Reach Your Peak™ producer model; and serves as president of Beyond Insurance®, a coaching and training organization. His new book, Summit: Reach Your Peak and Elevate Your Customers’ Experience, is a step-by-step training guide for peak potential. Visit BeyondInsurance.com or ScottAddisBook.com.

customer service, unconventional dedication, unparalleled leadership, and daring to dream.” In some cases, innovations take time because corporate infrastructure must be tweaked.

History taught us that the automobile was a plaything until highway systems were built. The telephone system didn’t work until millions of miles of wires were strung. Innovative leaders demonstrate patience to let creative ideas ripen. “The Purple Cow is not a cheap short cut. It is, however, your best (perhaps only) strategy for growth,” states Godin.

MotivationCreative ideas come in spades when people are motivated. An uninspired employee is not likely to wrap his or her arms around a problem. On the other hand, a motivated person can’t wait to find a solution to a challenging issue.

The keys to motivation include intellectual challenge, independence, and proper matching with a challenge. When an employee feels that work is meaningful, he or she will explore, design, and build. 3M used the practice of letting researchers spend a significant percentage of their time on projects of their own choosing. Google mastered a similar formula. 3M and Google noticed enhanced motivation when the employee was given ownership of a project that was appropriate and intellectually challenging.

The recipe to create an innovation culture is: leadership, acceptance of failure, openness, patience and motivation. This combination will create the one-two punch to knock out your competition.

Achieving growth – either organic or through acquisitions – is no small task as brokerages face

challenges from an uneven economy, stubbornly soft premium rates, evolving carrier demands and competitors eager to lure away top-performing employees.

The 8th Annual SNL Insurance Brokerage Summit brings together top industry executives, advisors and analysts for an open and informed discussion of strategic planning, growth, and the outlook for M&A in the insurance distribution marketplace.

Panel discussions include:• The economic factors currently impacting the industry’s

performance, as well as those most likely to affect future performance

• Key executives cover how to determine the best growth strategies for your business

• Top industry deal makers share the key elements of a successful negotiation

• An overview of the healthcare environment and the impact of regulations

Past Attending Organizations include:AmWINSGroupBenefits

ARS Americas

Arthur J. Gallagher & Co.

AssuredPartners, Inc.

BMO Capital Markets

Brown & Brown, Inc.

CBIZBenefitsandInsurance Services Inc.

Chubb & Son, Inc.

Corporate Synergies Group

Digital Insurance, Inc

Grand River

Hub International

Hylant Group

Integro Insurance Brokers

Kaplansky Insurance

Keefe, Bruyette & Woods

Lighthouse Insurance Agency

Macquarie Capital

Marsh & McLennan Agency LLC

National Financial Partners

Sandler O’Neil + Partners

The Hilb Group

Upshaw Insurance Agency

USI Holdings Corporation

William Gallagher Associates

Williams Mullen

Insurance Brokerage Summitin collaboration with

8th Annual

When and WhereNovember 5-6, 2014 The Union League Club, New York

RegistrationFor more details or forregistration details go to www.snlcenter.com/brokerage

Save $200 with our Early Bird rate until 9/12/14

Register Today!

Sponsorship opportunities: Please contact Steve Kruskamp at skruskamp@snl.com or call (434) 951-7579.

Platinum sponsors:

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Media Partner:

Keynote Speaker:

J. Patrick Gallagher, Jr. Chairman, President and CEO, Arthur J. Gallagher & Co.

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Industry News

Is Google’s next frontier the insurance industry?

36 percent of auto injury claimants were represented by attorneys

in 2012 — up 5 percent since 2007, according to a study by the

Insurance Research Council. The study also revealed that claimants

with an attorney were more likely to be linked to alleged claim abuse

and received less in net payments than those without representation.

Florida saw the greatest percentage of attorney involvement while

Kansas experienced the lowest. http://www.insurancejournal.com/news/

national/2014/07/08/334002.htm

More consumers seek attorneys

Small businesses still find it difficult to get bank loans

Google is potentially in a unique position to become a new force in the insurance industry. A recent report from the company says that insurance is in the top five of all products that are heavily purchased online and predicts that 75 percent of all insurance purchases will be made via the web by 2020. Armed with data and strong capabilities (the company can already monitor traffic in real-time, obtain data from Android devices to report on traffic, and just purchased a company that monitors home data to create “smart homes”) it’s possible that Google will enter the digital insurance space on its own or through strategic partnerships with established companies. http://www.insurancenetworking.com/blogs/the-google-propertycasualty-company-34525-1.html

Forbes recently reported on a study conducted by Pepperdine University, which revealed a gap between the number of small business that are enthusiastic about trying growth strategies and the number that have the capital to execute them. Only 46 percent of small businesses say they have the financial resources that are necessary to grow as they envision. Of the smallest companies with revenue less than $5 million, only 39 percent that applied for a bank loan in the prior three months of the survey actually succeed in securing one. The main reasons banks reported turning applicants down was due to insufficient collateral and too much debt. Pepperdine’s survey also showed the businesses that did try to obtain financing often turned to credit cards, friends and family instead of seeking funds from a bank. http://www.forbes.com/sites/sageworks/2014/03/10/why-business-loans-get-rejected/

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How Americans feel about the U.S. in 10 years

According to J.D. Power’s latest U.S. Auto Insurance Study, consumers are choosing to stick with their current insurance carrier more and shopping around less. This is, surprisingly, despite the fact that insurance premiums have been increasing. The decline in shopping could be due to more loyalty awards and programs or to better communications between insurers and consumers. Check out the full study results. http://www.liveinsurancenews.com/satisfaction-auto-insurance-never-higher-us/

Consumers shopping around less for insurance

How do online aggregators affect the insurance industry?In the UK, 50 percent of all personal lines policies are purchased via an online aggregator and the trend is catching on in the United States. The question is, are online aggregators aiding the sales of insurance products and services or driving process and profitability down? ResearchMoz published a report that details how this new channel is affecting all lines of insurance distribution and how leading insurers are increasingly challenged with declining customer retention rates, brand dilution, market share loss and other issues. http://www.digitaljournal.com/pr/2042102

25 charts highlight what Americans believe the United States will look like in 2024. The Atlantic and The Aspen Institute surveyed consumers about their feelings on the cost of education, employment, the federal budget and more. See how Americans' outlook about the country’s future compares to their outlook about their well-being as individuals. See a summary of the charts at http://www.lifehealthpro.com/2014/07/01/what-will-america-look-like-in-2024?.

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ABOUT AVALONAvalon Risk Management Insurance Agency is a premier provider of insurance and surety solutions to the logistics industry. Headquartered in Illinois, the company provides professional liability, commercial and auto insurance, but specializes in surety bonds, E&O and marine cargo insurance. Many of its customers are customs brokers, freight forwarders, warehouse operators, non-vessel operating common carriers and other transportation intermediaries.

Avalon was started in 1998 as a subsidiary of Kingsway Financial Services by former employees of Intercargo Corporation. The management team steadily grew the company over a ten-year period by more than 1000 percent and added seven offices in areas near major North American ports. In 2009 the management team, assisted by Fund Management Group and Jim Zuhlke, co-founder of Intercargo Corporation were able to acquire the assets of Avalon.

THE STRATEGYCapital obtained from the private equity investors facilitated the purchase in which participation by key employees of Avalon was of paramount importance. The private equity group was not actively involved in Avalon’s operations and its management was allowed

operational autonomy. Since the purchase, Avalon has been recognized for three consecutive years as one of the Best Places to work in Illinois and one of the Best Places to Work in Insurance in the mid-sized retail agent category. Jim shared the vision held by the other employee stakeholders to obtain a larger ownership stake in the company. He explored financing from traditional bank sources as a means to redeem out the passive investors. The decision to go with Oak Street Funding was based on the lender’s in-depth knowledge of the insurance industry. What’s more, Oak Street had demonstrated its successful record in structuring and closing deals for other program administrators and specialty agencies.

THE OAK STREET EXPERIENCEAvalon was able to secure a commercial loan from Oak Street within its targeted timeframe. Oak Street had experience with buy-out deals very similar to Avalon’s situation. The team of loan specialists, processors and underwriters was familiar with the dynamics of agency businesses, carrier contracts and relationships, premiums and commissions, and more. As a result of the loan, Avalon’s management team now owns 100 percent of the company. This not only allows the owners to build more wealth, it also frees them to pursue other growth strategies that may not have been possible.

“Going through the process of getting a business loan can take a long time, be quite complex and somewhat tedious. The Oak Street process was very smooth and quick. Follow up was good and documentation was clear. The company’s experience and knowledge saved us a lot of time and the frustration that usually comes with trying to explain insurance to potential non-insurance providers of financing services.” - Jim Zuhlke, Avalon Risk Management

Success Story

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“Whether you choose Arlington/Roe for our breadth of knowledge, product line diversity, market access or industry know-how, you may be assured we are in business primarily to serve you. We will do our best to earn and keep your trust. You have our word on it.”

– James A. Roe, CPCU, ASLI, President

IT’S THE RIGHT THING TO DO.

800.878.9891 • ArlingtonRoe.com

Arlington/Roe. You have our word on it.

Managing General Agents andWholesale Insurance Brokers

Aviation | Bonds | Brokerage | Commercial Lines | Farm | Medical Professional | Personal Lines | Professional Liability | Transportation | Workers’ Compensation

From left to right: Andy Roe, Katie Roe Weiper, Jim Roe and Patrick Roe

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12Simply put, the coverage is changing and there is significant upward pressure on premiums (even for those insureds not subsidized). Layered on top of the challenge of explaining the coverage itself and the expense of flood insurance is one more challenge: a difficult and perhaps contentious relationship between the homeowner and the lender over flood insurance issues.

A recent case from the First Circuit Federal Court of Appeals, Kolbe v. BAC Home Loans Servicing, LP, d/b/a Bank of America, illustrates how these sorts of disputes on flood insurance placement can play out.

BackgroundStanley Kolbe bought a house in Atlantic City, New Jersey. He obtained a mortgage in October, 2008 for nearly $200,000 from a mortgage company, Taylor Bean & Whitaker. Mr. Kolbe's loan was an FHA loan. His mortgage contained the following clause: Fire, Flood and Other Hazard Insurance. Borrower shall insure all improvements on the property, whether now in existence or subsequently erected, against any hazards, casualties, and contingencies, including fire, for which Lender requires insurance. This insurance shall be maintained in the amounts and for

Anyone who spends much time in personal lines insurance becomes at least somewhat familiar with the difficulties and intricacies of flood

insurance. Flood insurance is also a political issue, too. The national flood insurance marketplace and federal government’s involvement continues to make headlines in our national news as we reexamine the National Flood Insurance Program (NFIP) in light of the costs of events such as Hurricane Katrina and Superstorm Sandy.

According to a widely-publicized report from the Government Accounting Office, the NFIP owes approximately $24 billion to the United States Treasury. In 2012, the Biggert-Waters Flood Insurance Reform Act of 2012 (known as “BW-12”) was enacted in an attempt to put the National Flood Insurance Program on surer footing financially. The Federal Emergency Management Agency says that BW-12 will adjust “premium rates to more accurately reflect flood risk,” and will also trigger coverage and claims handling changes.

One of the more controversial ways in which BW-12 will generate more revenue is through phasing out grandfathered premium subsidies and through redrawing flood maps. FEMA says that only, “about 20 percent of all NFIP policies pay subsidized rates and only a portion of those policies that are currently paying subsidized premiums will see larger premium increases of 25% annually [until reaching full-risk premium status.” This has generated some substantial political consternation and legislative efforts are underway to slow the impact of BW-12.

Taken by themselves, these regulatory developments present significant challenges for insurance producers who handle flood insurance.

Politics and Law Suits Make Navigating Flood Insurance Even More Perilous

N F I PBy Rick Pitts

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13the periods that Lender requires. Borrower shall also insure all improvements

on the Property, whether now in existence or subsequently corrected, against loss by floods to the extent required by the Secretary [of Housing

and Urban Development].

Kolbe's house was located in what had been designated as a "special flood hazard zone" under the National Flood Insurance Act. The special flood hazard zones are those prone to flooding; according to FEMA, they are areas that have a one-in-four chance of a flood during a thirty year mortgage. So, with his house in a special flood hazard zone, Mr. Kolbe was required, under the regulations, to maintain a minimum coverage of the lesser of two amounts: his outstanding loan balance or the amount that could be obtained (which, in his case, was $250,000).

Taylor Bean & Whitaker never required Mr. Kolbe to obtain higher flood limits. However, after Taylor Bean & Whitaker went bankrupt, BAC Home Loans Servicing, a part of Bank of America, became the servicing entity for the Kolbe loan.

Shortly after it began servicing the loan, BAC wrote Kolbe a letter and told him that he was required to purchase $46,000 more in flood insurance. BAC said that this was necessary to increase the flood coverage level to the replacement cost for Kolbe's home.

BAC also informed Kolbe that if he did not purchase the insurance as required by the letter, BAC would lender-place or force-place the

insurance for him. (Kolbe would later allege that BAC had a financial interest in all of this through its affiliated insurer, Balboa.)

The LawsuitKolbe purchased the insurance, but also pursued a lawsuit in federal

court. He filed a class action lawsuit on behalf of all borrowers with similar mortgages who were required to purchase flood insurance above the amount of the outstanding balance of the loan (or available limits).

Two major theories were launched against BAC’s practice: the first was that BAC breached the actual terms and conditions of the mortgage by upping the

limits; the second was that BAC had violated the implied covenant of good faith and fair dealing.

The suit did not go well for Kolbe in the trial court. The federal district court judge ruled that BAC had the right to choose the amount of flood insurance that

it would require. The appeal began in promising fashion for Mr. Kolbe. Initially, a three judge panel of the court ruled that Kolbe's lawsuit could go forward and reversed the lower court’s order of dismissal. In September, 2013, though, all of the judges of the First

Circuit reheard the appeal. The judges then reinstated the District Court dismissal, but did so in a most unusual fashion, splintering into multiple opinions. The result was a tie:

three judges voting in favor of letting the lawsuit go forward; three against. By court rule, the original dismissal stood.

Politics and Law Suits Make Navigating Flood Insurance Even More Perilous

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Flood Insurance and MortgagesWith the First Circuit unable to come to a consensus on either rationale or result, it seems fairly evident that this is a complicated question. Other courts have struggled with the question of force-place in the context of flood insurance and the Kolbe court uses the term “sharply conflicting” to describe the various opinions.

The question revolves around the terms of the mortgage and the federal statutory and regulatory scheme for flood insurance and federally-backed, FHA mortgages. As the Kolbe court notes, this particular clause is a standard term in what are known as FHA mortgages, and one of many different mortgage clause HUD/FHA requires.

To paraphrase the clause for insurance purposes, there are three sentences and three basic requirements. The borrower must:

• Obtain insurance for hazards or casualties as the Lender requires.

• Maintain the insurance for the time and at the limits the Lender requires.

• Obtain flood insurance if required by the Secretary of HUD.

One of Kolbe's main arguments was that the first two requirements of this clause apply to insurance other than flood insurance. In essence, these two sentences address a lender’s ability to require something along the lines of the Insurance Services Office’s HO or DP insurance policy forms (along with any other ancillary coverages that might be necessary). To Kolbe, the only sentence that applied to flood insurance was the third sentence or requirement. It addresses flood insurance specifically.Even though a lender could dictate amounts of coverage for property and casualty insurance, Kolbe argued, it could not dictate amounts of coverage for flood insurance. The mortgage only specifies insurance in the amount required by HUD.BAC, in contrast, argued that the first and second sentences or requirements were also applicable to flood insurance. These two sentences gave it the authority to demand higher limits. With this reading in mind, BAC said the regulations on the required amount of flood insurance should be seen as a floor rather than a ceiling. This gave the bank the authority to demand the higher amount of insurance, probably closer to true replacement cost, even though that amount was not mandated by regulations or specified in the mortgage.

ABOUT THE AUTHOR

Rick Pitts has been vice president and general counsel of Arlington/Roe since 2004. A graduate of Wabash College (1983) and Indiana University School of Law - Indianapolis (1986), Rick has long been involved in the insurance industry and serves as general counsel to the Independent Insurance Agents of Indiana. Rick is a key speaker annually at the IIAI’s New Laws seminars. He frequently teaches classes on insurance, risk management, and employment related matters to insurance professionals in Indiana, Illinois, Ohio, Kentucky, and Tennessee.

True Insurance ImplicationsBAC’s argument or explanation obviously did not garner support from all of the judges; as noted, three voted one way and three the other. In fact, half the judges said that, even though this mortgage section is required by federal law for FHA loans, the mortgage document itself is still part of a private contract between Kolbe and his original lender.

But this actually leads to a point where the case becomes particularly instructive and helpful to producers who have to break the bad news of the cost of flood insurance to the personal lines customers. The Kolbe court discussed the nature of FHA loans and why the clause is required. In FHA loans, if the lender eventually forecloses on the property, the lender assigns the property to the Department of Housing and Urban Development. HUD pays the lender the proceeds of the mortgage insurance so that the lender does not suffer a loss on the loan. Now the owner of the house, HUD then sells the property to recoup some of its money for the program.

But what if there has been a casualty loss, such as a fire or a flood? According to HUD regulations, the lender cannot collect on the mortgage insurance until the physical damage has been repaired (or, the costs of the repair are deducted from the amount paid to the lender). Therefore, the risk of an uninsured fire or flood loss rests with the private lender, and not HUD / FHA.

Because the private bank or mortgage lender bears the risk of loss for a casualty loss, the mortgage clause gives that bank or lender the authority to dictate the length, type and term of the insurance. This is why the court found that BAC had the power to dictate flood insurance at replacement cost, rather than at the lower amount proscribed by regulation.

The ages-old axiom is that knowledge is power. In personal lines insurance, the old axiom may be most apt when it comes to flood insurance. Disappointed or financially strapped, insureds may not want to hear of the complexities of flood insurance rate calculations, the intricacies of BW-12, or the authority that the lender has to dictate limits. Yet having those discussions with insureds will educate the insured about where the coverage and limits decisions are made, where the cost pressures are created and directed, and may ultimately ameliorate some of the shock of flood insurance rates on a going-forward basis.

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When Robert Patrella, Chairman, President and CEO of Guernsey Bancorp, was recently asked why

his Westerville, Ohio based bank decided to sell itself after only 13 years in operation, the rationale given should not come as a shock. Rising compliance costs as a result of increased regulatory scrutiny was the main culprit. New regulations put in place, including but not limited to, Dodd-Frank, Basel III, the Bank Secrecy Act, the Consumer Financial Protection Bureau and the Volcker rule, have put many of the nation’s 6,728 FDIC-Insured Commercial Banks and Savings Institutions in

an unenviable position: either sell, or go under, just as 495 banks did from the beginning of 2008 through the end of April 2014. Additionally, pressures on net interest margins due to the low rate environment, and concerns regarding cyber security and high profile data breaches have left many banking executives looking for the exit sign.

Shrinking MarketplaceTo be fair, industry consolidation, regulatory oversight and interest rate risk are not new to bankers. Prior recessions have helped to trim the size of the marketplace – you don’t

Increased Regulatory and Compliance Costs Hit Community Banks

By Edward Mongon

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ABOUT THE AUTHOR

Edward Mongon is Vice President of Protx Risk Management, LLC, an established MGA in New Jersey. Edward specializes in underwriting professional liability for Community Banks, where he served until recently as Senior Underwriter at AIG. He has over seven years of insurance industry experience. In addition, Edward has an MBA from Rutgers University in Finance and Management and has earned the designation of RPLU. He can be reached at emongon@protxrisk.com or 609-750-9300.

have to look much further than the Savings and Loan crisis of the 1980’s and 1990’s for another example. However, what is most shocking, as reported by the FDIC’s most recent research study and highlighted by BankDirector.com in a recent article titled “Has Consolidation Killed the Community Bank?”, is the fact that the total number of FDIC-Insured Banks with Asset sizes of $100M and less has declined by 85 percent between 1985 and 2013. Indeed, M&A activity has played a big part here, but the true underlying problems here are higher regulatory/compliance costs, issues in obtaining capital in a more restrictive lending environment, and operating at a time when the demand for loans has slumped.

Consumer Influences Further, keeping up with changing consumer demands (i.e. the rise of virtual/mobile banking) in managing one’s household finances has created a new set of issues unknown to bankers of past generations. Safeguarding confidential financial information and personal data is of paramount importance in this day and age. From the implementation of a strong security and privacy policy, to the hiring of a Chief Privacy Officer, encrypting data, having a business continuity plan, carrying out an IT security audit, and more, there are a number of steps which Community Banks must undergo to reassure its customers (as well as regulators) that they are taking every possible precaution to protect themselves against security breaches. The recent high-profile data breach at Target is a perfect illustration in the financial and reputational costs that occur when not all of the proper controls and procedures are in place.

Increased Competition, Rate Risk, M&A So, what does all of this mean for insurance carriers operating in the Community Banks marketplace, or their insured’s? For starters, the reduced size of the market has created more competition among carriers for the “healthy” banks. Some Insured’s are starting to see three-year deals coming back in the marketplace at renewal in the “standard market.” Secondly, an increase in interest rate risk, which can cause asset-liability mismatches on

Sources Used: “Failed Bank List.” FDIC. 12 May 2014. Web. 12 May 2014. <http://www.fdic.gov/bank/individual/failed/banklist.html> “FDIC Statistics at a Glance.” FDIC. 31 December 2013. Web. 9 May 2014. <http://www.fdic.gov/bank/statistical/stats/2013Dec/industry.pdf>Lau Haslett, Kiah. “Declaring $125M bank franchises ‘dead,’ Ohio banker finds a deal.” SNL. 7 May 2014. Web. 9 May 2014. <http://www.snl.com/InteractiveX/article.aspx?ID=28006290&KPLT=2>Milligan, Jack. “Has Consolidation Killed the Community Bank?” Bank Director. 21 April 2014. Web. 9 May 2014. <http://www.bankdirector.com/index.php/board-issues/manda/has-consolidation-killed-the-community-bank>

a bank’s balance sheet, has caused carriers and the industry to do one of two things: a) focus on stress-testing banks for financial solvency, in order to make sure they don’t succumb to underwriting issues which affected the D&O marketplace during the most recent financial crisis; and b) focus on providing different professional services (i.e. financial advisory, trust services and specialty lending) to stem decreases in the bottom line for the bank. Thirdly, an

increase in M&A activity and bank failures has spawned an increase in shareholder and regulatory claims, which has caused insurance rates at most carriers to increase, and capacity to decrease.

Cyber ThreatsLast of all, the rise of identity theft and cyber fraud has helped spur the increase in state regulations for guarding consumer data, as well as the use of insurance by businesses as a risk mitigation mechanism. In the past couple of years, Cyber Insurance has been one of the fastest growing specialty insurance segments. However, because coverage is limited, and often does not include theft of intellectual property, it is important now more than ever for businesses, and banks especially, to maintain solid internal controls and audit procedures over IT exposures.

Rising regulatory/compliance costs, low interest rates and concerns over Cyber security are three key issues facing the Community Banking industry, and the carriers that insure them. While a number of banks have decided to close up shop or sell to a larger competitor during the last couple of years, how the rest of the market deals with these issues will be of great importance to insurance carriers wishing to steer clear of future underwriting losses in this sector.

Rising compliance costs, low interest rates and concerns over Cyber security are challenging

community banks.

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After months of searching, conference calls, due diligence, negotiations, spreadsheets, and lawyers,

the acquisition is now closed and the real work begins – integration of the business to achieve those strategies that led to the deal in the first place. Integration is the most critical part of an acquisition strategy, yet it is often short changed because so much energy is expended on the acquisition itself.

In most M&A deals, achieving positive results and ROI depends heavily on creating synergy between two companies. The degree of synergy needed depends on why the acquirer makes the purchase — for financial or strategic reasons, as an investor or operator. After being involved in the financial and operational side of several mergers and acquisitions over the past 20 years, I’ve seen successful deals and I’ve seen ones that failed to meet expectations. Here are some of the practical integration steps of acquirers throughout the insurance industry. Hopefully they can help you ensure acquisition success.

Pick the right integration approach• Of all the possible approaches, the wrong approach

is underestimating the effort and planning needed to execute the integration plan. Know that the process is almost always going to take a lot longer than you anticipate. Integration needs management mental energy and stamina.

• There are several integration approaches ranging from the gentle to heavy handed. To blend two strong leadership teams into one cohesive platform, a soft approach is often the right touch. Don’t knock

anyone down the organizational chart right away. For transactions involving large-scale objectives, a more deliberate, operational integration process may be appropriate. Many times both the soft and deliberate approaches are needed.

Some of the most successful acquisitions I’ve seen were ones in which acquirers put together teams with representatives from different departments to help determine the best integration approach. They realized groups could develop a better, more comprehensive plan than if only are one or two people were involved.

Don’t forget the little detailsIt may seem unlikely, but after developing a high-level plan to address key elements of an integration, the little things are often overlooked.

Many times, co-branding and/or rebranding should start immediately and at all levels. This sets the tone for customers and employees. Details are key to properly announcing the acquisition and communicating enthusiasm about the deal. Make sure the following are in place on the first day the acquisition is announced.

• Write a phone script so everyone answers the phone consistently. There’s nothing more unprofessional than lackluster greetings – both live and in voicemail. Consistent and new email signatures are also necessary.

One company had a special email signature designed just to be used for first six months or so after the transaction. It was a constant reminder to stakeholders and communicated enthusiasm for the deal.

By Kelly Drouillard

M&A Integration The right strategies to achieve synergies

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Communicate and follow-up with key customers and stakeholders together The acquisition news should be jointly communicated to key customers, partners, carriers and other stakeholders prior to the transaction to be sure contracts and relationships will stay in place. Communication, however, shouldn’t stop there.

• After two weeks, call key accounts again to provide reassurance of stability, discuss any major changes, progress with the integration, etc.

• Call your carrier representatives and stakeholders with a similar update and include status of key employees and accounts. This will reassure the markets of buyer competence.

Communicate with employeesThe insurance business is driven by human capital. As such, the human components of acquisitions are typically the most complex and essential to achieving the acquisition goals.

• Consider being transparent early in the process. With closed door meetings and outside visitors coming and going, there’s bound to be gossip and assumptions. You should discuss key target metrics at a high level, thus setting the stage for changes.

One client chose to be very transparent. A meeting was held prior to deal closing that introduced the buyer and announce the pending transaction. Expectations for due diligence process and timeline were shared and employees felt empowered because they were informed. This also enabled the buyer to meet each employee to discuss plans for the agency and growth opportunities for employees.

• Be prepared to discuss the basics, like change in vacation policy, 401k match, part time workers, office moves, parking, telecommuting or flex time policies. Realize this is very personal to the employees. Change creates anxiety about day-to-day policies. Employees at all levels appreciate practical information.

• If you don’t’ have answers to some questions, it’s ok to say that no decisions have been made. Uncertainty is better than bluffing. Employees can handle an interim assessment period communicated with honesty far better than a false assurance that there will be no changes and everyone will keep their job.

• Assign your managers the task of soliciting feedback after 30 days via one-on-one sessions. This shows employees their manager is “in” and part of the organization’s future rather than a lame duck. If you sense some management resistance to the transaction, this gives them an opportunity to get on board.

Despite having more than 100 employees, one client met had leader from a transition team meet with each individual employee for 15 – 30 minutes. They solicited their ideas, talked about their future vision of the integrated business and opportunities it might present for their personal gain.

Let the employees blend the two cultures• In addition to an all-hands event to introduce people from

both companies or implementing some type of structured program, one-to-one relationships often are the most effective way to blend two cultures. The more employees talk and share, the more the cultures come together.

I’ve seen clients pair up employees in a buddy system. Acquired-to-acquirer, peer-to-peer at all levels for all functions based on similar roles in the company: underwriting, customer service, reception, IT, were assigned a buddy. This gives each new employee a “go-to” person for questions about carriers, processes, procedures, culture and more. Employee from the acquirer have responsibility for developing a connection with their assigned peer.

Measure resultsIt’s important to determine what metrics you’ll use to gauge integration progress and then regularly look at actual results compared to established goals.

• Metrics that illustrate the acquisition synergy are most compelling. Cross-selling opportunities that are won from existing customers is an example of a daily victory that demonstrates the integration is working. This will be evident as more cross-sell opportunities are won as a result of the acquisition. The typical contract improving terms, account retention and employee retention metrics are critical.

• Publicly share results and acknowledge those employees who are helping to make the integration a success.

Many clients develop dashboards that are posted on their intranet sites or shared via email on a weekly or monthly basis. Others post their favorite or most important management metrics in break rooms, lobbies, copy areas and other visible, high-traffic areas where they can be seen.

Be visiblePeople are loyal to people, not companies, so it’s important to make sure new employees view the acquiring leaders as people who can earn their loyalty. Acquirers must remember to relate to employees on a human level. Thus, it’s important for the integration leaders and the buyer to be accessible and moving amongst employees.

• The buyer needs to physically be in the office. Avoid closing too many doors and booking constant conference calls. Be accessible and walk around.

Clients who value connecting to new employees make sure they don’t disappear for at least the first two weeks after the deal. They often postpone business trips, vacations and other out-of-office activities.

ABOUT THE AUTHOR

With over 26 years of experience in the insurance industry, Kelly Drouillard has designed debt capital solutions for insurance businesses and provided consulting on hundreds of loans and agency acquisitions. She can be reached at 317-428-5171 or kellyd@oakstreetfunding.com.

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