Kentucky Bank KBI (a Kentucky Bank Insurance Subsidiary)

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Kentucky Bank

KBI (a Kentucky Bank Insurance Subsidiary)

ABA Stonier Graduate School of Banking Capstone Project – March 01, 2014

James Braden

Kentucky Bank - 339 Main Street, Paris, Kentucky, 40361 jim.braden@kybank.com

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Overview

Kentucky Bancshares, Inc. (“Company”) is headquartered in Paris, Kentucky, and is a locally owned and publicly traded financial institution. The Company’s wholly owned subsidiary, Kentucky Bank (“Bank”), operates under a state bank charter and provides full banking services, including trust

services, to customers throughout its 15 branches located in 11 central and eastern Kentucky communities. Kentucky Bank’s tributaries date back to 1851. The Company’s business strategy is to

operate a well-capitalized, profitable, and independent community bank with a significant presence in central and eastern Kentucky.

This report presents an analysis of creating an insurance agency subsidiary under Kentucky Bancshares, Inc. to provide property and casualty insurance to customers and non-customers of the Bank. The analysis includes peer and competitive considerations, financial and non-financial implications, as well as possible approaches to enter the property and casualty insurance market.

Capstone Advisor: Paul M. Ratterman, Managing Director, Stifel Financial, rattermanp@stifel.com

Executive Summary

Overview - Since regulation changes in 1999 bank-owned insurance agencies have been on the rise. If structured properly the insurance agency can provide additional services to the bank’s current customers and increase the bank’s net income in way of insurance revenues. Banks can either develop their own insurance agency or purchase an existing insurance agency. Given the lack of internal insurance expertise most banks pursue acquiring insurance agencies rather than developing them internally.

Competition – Insurance agency competition is intense within the geographic footprint in which Kentucky Bank operates. There are at least 13 bank-owned insurance agencies and at least 50 non-bank owned insurance agencies within Kentucky Bank’s operating markets. That said the demand for insurance products continues to grow and the near and long term outlook remains relatively stable.

Financial Impact – High performing insurance agencies yield 15% - 20% annual returns. Stress testing acquisition examples can still yield 3% - 6% annually with a relatively modest investment. However, identifying the right acquisition partner to meet growth and profit expectations as well as agreeing to a mutually beneficial acquisition price is critical to the success of the business unit. Prime targets for acquisition are agencies that are financially strong with a core group of staff. Kentucky Bank would not likely be interested in an agency if there was a financial need to sell or if the principals view the sale as a vehicle for funding retirement.

Non-Financial Impact - Cultural differences would have to be managed with an insurance acquisition. Insurance agencies tend to have an intense sales culture whereas banks have a moderately paced corporate culture. Insurance agencies tend to be dependent on a group of key producers and, at times, promote individualism whereas banks have a collective group of key managers supporting a team of producers. In addition, to the cultural differences between banks and insurance agencies, the development or acquisition of an insurance agency would be a new line of business for Kentucky Bank. The introduction of new business lines has been relatively few and far between in the history of Kentucky Bank. This change would have to be accepted bank-wide to be successful. Cross selling would need to be reinforced, reinforced, and reinforced for the new product line to be successful.

Strategy - Given the lack of internal insurance expertise held by Kentucky Bank, the author suggests acquiring an agency. Ideally the candidate agency would be financially strong with a solid group of

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performers with an owner looking to expand their business dynamically through the partnership with a bank. This candidate would realize the benefits of partnering with a bank such as broader market, bigger marketing budgets, and perpetual survivorship. The candidate would also realize the transaction would be a long term commitment rather than a short term buyout and payout arrangement. The ultimate success of the transaction would depend on cultural fit and alignment of expectations.

Implementation – If Kentucky Bank elected to move forward with an insurance agency, the Bank would need to identify a partner, perform thorough due diligence including financial, legal, and operational due diligence, present the summary to the Board of Directors for approval, negotiate and execute a sales agreement, announce the transaction, and obtain regulatory approval.

Conclusion - Insurance agencies are not uncommon within banks and can be a means to generate additional revenue and additional net income. Success is possible but takes preparation, hard work, thorough due diligence, great implementation, reasonable expectations, and a reconciliation of whether achieving those expectations are sufficient for the Company’s stockholders’ best interest. Given the net income potential and the relationship enhancement potential, Kentucky Bank should move forward with an endeavor to acquire an insurance agency.

Introduction & Background

The Gramm–Leach–Bliley Act (“GLBA”) of 1999 expanded the capabilities for banks and bank holding companies to engage in insurance activities. Since 1999, many banks have entered the insurance market through starting or purchasing insurance agencies on the basis of expanding service offerings and increasing sales revenue. The banking industry’s interest in insurance agencies increased in the years following GLBA. As presented in Mike Kish’s article, Analyzing Agency Profitability: Using

benchmarking as a tool to assess an agency's financial growth, bank acquisitions of insurance agencies trended up in the early 2000’s before declining by mid-2000’s.

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Agency Acquisitions — by type of acquiring firm

Year Banks Pub. Brokers Agencies Companies Other Total

1999 67 26 77 85 19 274 2000 78 37 42 36 5 198 2001 70 60 29 28 19 206 2002 80 52 38 21 19 210 2003 67 57 37 24 17 202 2004 64 71 56 33 19 243 2005 44 64 39 32 23 202 Total 470 367 318 259 121 1,535

Exhibit 1: Analyzing Agency Profitability: Using benchmarking as a tool to assess an agency's financial growth

Although the trend of bank owned insurance subsidiaries has moderated from the peak of 2002, there continues to be interest in activity in the insurance subsidiary area. As an example, a local competitor, Whitaker Bank ($1.4 billion at December 31, 2013) started an insurance subsidiary in 2010. Whitaker’s website indicates, “Whitaker Insurance Group, a division of Whitaker Bank, is headquartered in

Lexington, KY… and was added to the bank's operation in March of 2010.”

Although not a local competitor, Oneida Savings Bank ($742 million at December 31, 2013) is a peer from a Uniform Bank Performance Report standpoint and announced in December of 2012 they were expanding their insurance offerings through the purchase of another insurance agency. In addition to smaller banks’ interest in insurance subsidiaries, larger banks continue to expand within the market.

BB&T continues to add to its insurance operations. In a recent press release announcing the acquisition of an insurance operation in 2012 BB&T stated, “BB&T Insurance operates 118 retail-insurance agencies across the United States. It has completed three insurance deals in 2011 and 15 since 2008.” The preceding excerpts and the following schedule from SNL Financial indicate a continued interest in bank owned and operated insurance agency activity.

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Agency Acquisitions — by type of acquiring firm Year Banks Ins

Broker

Ins

Company Other Total

2006 63 104 31 21 219 2007 59 123 36 37 255 2008 54 148 42 42 286 2009 24 99 17 38 178 2010 24 146 16 37 223 2011 35 171 28 56 290 2012 21 193 17 91 322 Total 280 984 187 322 1,773 Exhibit 2: SNL Financial

The economic outlook for insurance agencies is similar to banks. Deloitte’s 2013 Property & Casualty Insurance Industry Outlook indicates that “private sector rehiring, gains in the automobile and housing markets, and expansion of domestic energy production and manufacturing are among the macro-trends likely to instill more confidence in the economy and spur stronger growth in insurance sales. However, insurers need to be prepared to deal with a two-steps forward, one-step back type of economic recovery. To adapt to this new normal, there are actions carriers can take not only to leverage new opportunities emerging in the short term, but to set the stage for longer-range gains, in part by improving their technology and talent base as well as their marketing and distribution capabilities. In the face of some of the macroeconomic challenges mentioned above, U.S. insurers will have their work cut out for them securing new business while bolstering their bottom lines. Their task might be further complicated by stricter regulations concerning financial disclosure, risk assessment and capital management.” The insurance outlook is so similar to the banking outlook that the term ‘insurance’ could be replaced with ‘bank’ and it would be just as accurate. In short, the growth in the insurance industry will likely mirror

the overall economy.

The firm Michael White Associates (MWA) monitors and reports on bank-owned insurance activities. In 2012, insurance brokerage fee income (defined as commissions and fees earned by a bank holding company or its subsidiary from insurance product sales and referrals of credit, life, health, property,

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casualty, and title insurance) decreased 19.5% from $7.70 billion in 2011 to $6.2 billion in 2012. This decline was largely attributed to $1.5 billion in reductions at Bank of America and Citigroup which were driven for BofA by overseas insurance settlements for inappropriate sales of payment protection insurance (PPI) policies through international card services business in the United Kingdom. Absent those two companies, the rest of the group had modest gains in 2012. Bank holding companies between $500 million and $1 billion in assets grew insurance revenue by 8.1%.

Exhibit 3: Michael White – Dowling Hales Bank Insurance Fee Income Report

The above illustration and information indicates favorable long term trends for the industry as a whole. In addition, insurance offerings are viable at large and small banks. The following charts present the top five bank holding companies by asset size and insurance income as well as a summary of revenue contribution by asset size. Of particular interest is Exhibit 5 which highlights the fact that insurance operations have the potential to contribute in a more meaningful way to relatively smaller institutions.

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Exhibit 4: Michael White – IPI Bank Wealth Management Report

Exhibit 5: Michael White – Bank Insurance Fee Income Report

Current Insurance Offerings

Kentucky Bank currently offers credit life insurance through an arrangement with Investors Heritage Life Insurance Company and offers title insurance through an arrangement with Old Republic Title Insurance Company. Both of these associations are “agency” arrangements rather than joint ventures or

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combined ownership relationships. Kentucky Bank receives a fee for selling the service rather than retaining the relationship.

Competitive Analysis

The consideration of creating an insurance subsidiary, either through acquisition or internal development, would be incomplete without review of the current competitive landscape. The following subsections present two groups of potential competitors - (1) bank owned or affiliated insurance agencies and (2) non-bank owned insurance agencies. Both groups are within Kentucky Bank’s operating footprint or markets and were compiled as of July 31, 2013 from basic internet searches.

Geographic Competitors – Bank Owned

As illustrated in the list below, many local and national competitors within the Bank’s

geographic footprint offer property and casualty insurance services. At least one bank competitor offers insurance services in every market but Elliott County. This list includes banks ranging in size from $133 million in total assets (Financial Services Hldg Corp. operating as BankTrust Financial had $133 million in total assets as of December 31, 2013) to $100+ billion in asset size (Fifth Third Bancorp).

Bank Owned or Operated Insurance Subsidiaries within KY Bank Markets

Bourbon, KY Jessamine, KY

Fifth Third Bancorp Farmers Capital Bank Corp. (United Bank)

Clark, KY Central Bancshares Inc.

BB&T Corp. PNC Financial Services Group

Genbeach Co. (Peoples Exchange Bank) First Southern Bancorp Inc.

Central Bancshares Inc. JPMorgan Chase & Co.

Community Trust Bancorp Inc. Fifth Third Bancorp

PNC Financial Services Group _-

Harrison, KY Rowan, KY

Fifth Third Bancorp U.S. Bancorp

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Fayette, KY Scott, KY

Central Bancshares Inc. Farmers Capital Bank Corp. (United Bank)

JPMorgan Chase & Co. Whitaker Bank Corp. of KY

Fifth Third Bancorp Central Bancshares Inc.

PNC Financial Services Group Fifth Third Bancorp

BB&T Corp. PNC Financial Services Group

Community Trust Bancorp Inc. Republic Bancorp Inc.

Republic Bancorp Inc. Genbeach Co. (Peoples Exchange Bank)

Woodford, KY

Farmers Capital Bank Corp. (United Bank) Community Trust Bancorp Inc.

PNC Financial Services Group

Exhibit 6: SNL Financial

The schedule above clearly indicates the pervasiveness of bank owned or operated insurance agencies.

Geographic Competitors – Non-Bank Owned

In addition to bank owned or operated insurance agencies, there are a number of independent insurance agencies in each of the Bank’s nine markets. While not an all-inclusive list, the schedule is a representation of a non-bank competition by county.

Non-Bank Owned or Operated Insurance Subsidiaries within KY Bank Markets

Bourbon, KY Clark, KY

Nationwide Insurance Nationwide Insurance

Woodford Hill Thompson Insurance Allstate Insurance Agent State Farm Insurance Agent Lumpkins & Logan Agency Kentucky Farm Bureau Insurance State Farm Insurance Agent

Hopewell Insurance Kentucky Farm Bureau Insurance

Clay Ward Agency Inc Shelter Insurance

Harrison, KY Jessamine, KY

Shelter Insurance Nationwide Insurance

Smith Insurers Inc Allstate Insurance Agent

Palmer-Hampton Agency Shelter Insurance

State Farm Insurance Agent Ace Insurance Services, Inc. Kentucky Farm Bureau Insurance Farm Bureau Insurance

Whalen & Company C M Space & Associates Inc

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Rowan, KY Woodford, KY

C Roger Lewis Agency Inc Kentucky Farm Bureau Insurance

Aflac Shelter Insurance

State Farm Insurance Agent Humston Insurance & Realty

Shelter Insurance Woodford Insurance Services Inc

Kentucky Farm Bureau Insurance State Farm Insurance Agent

Nationwide Insurance Bennett & Associates

Scott, KY Bohannon-Meyer Insurance, Inc.

Hockensmith Insurance Agency Kruse Insurance LLC Kentucky Farm Bureau Insurance Elliott, KY

Craig & Hall Insurance Inc Kentucky Farm Bureau Insurance

State Farm Insurance Fayette, KY

Collins & Co Inc Too many to list

Exhibit 7: Google search

The schedule above clearly indicates a full competitive landscape within the Bank’s operating

market. SEC Peers

In addition to competitors within the Bank’s operating area, the author sought to identify public banks

located in regional proximity to Kentucky Bank for analysis purposes. Two public banks were identified - MainSource Bank and German American Bancorp. Both banks are SEC registrants which allow for more transparent information and both banks have maintained insurance agency subsidiaries.

German American Bancorp is a $2 billion bank located in Southern Indiana operating over 35 branches. German American Bancorp began insurance services in 1999 with the acquisition of Doty Insurance Agency and continues to offer a full line of insurance products.

MainSource Bank is a $2.7 billion bank located in Indiana, Illinois, Ohio, and Kentucky operating over 75 branches. MainSource Bank continues to offer credit life and annuity products, but sold its subsidiary, MainSource Insurance (MSI), to Encore Insurance Group LLC, effective Oct. 1, 2010 for a gain of approximately $900 thousand. At the time, MainSource Financial President and Chief Executive Officer Archie M. Brown Jr. stated, “This transaction

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allows MainSource Financial Group to focus on our strengths, which are to provide a robust set of banking and investment products to our customers. We are separating our interests in property and casualty insurance, as well as health insurance, from our core business model and allowing Encore Insurance Group to focus solely on this area. However, MainSource Bank will continue to offer annuities and credit life insurance to our customer base as the products align very well with our core business model.”

This divergent strategy is consistent throughout the industry and should be evaluated before a final conclusion is reached regarding the decision to pursue an insurance agency subsidiary.

Financial Impact

Estimating the financial impact of an insurance agency is a difficult task. Unlike banks, there is not a central reporting mechanism for insurance agencies like the quarterly call reports for the financial institution industry. In addition, the public information on bank purchases of insurance agencies do not disclose multiples of earnings used to value the purchase. In addition to the lack of industry-wide financial information, many factors influence the financial impact of an individual agency making an estimation of results challenging. Factors such as key stakeholders and personnel, incentive arrangements and motivators, integration and cross selling execution, and finally culture all impact the success of an insurance agency. However, The National Alliance Research Academy publishes a Growth and Performance Standards report on a periodic basis. The most recent performance standards were published for 2010-2011.

According to the 2010-2011 Growth and Performance Standards (GPS) study, pre-tax agency profit varies from 4.25% to 10.00%, depending on agency size. The smallest agencies in the revenue range of

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$500,000 and less had the lowest profit of 4.25%, while agencies in the largest revenue range of $3,000,001 and over had the highest profit of 10.00% percent calculated as a percentage of total revenues. The best performing agencies for these same revenue groups range from 15.00% to 20.00%. So, the best of the best have profit margins up to 20% while the rest hover within the 5% - 10% range. GPS study went on to indicate the annual revenue growth rate for participating agencies was 7% and the account retention rate was approximately 90% for both commercial and personal business. A pretax profit estimate of 6% and a growth rate of 4% will be factored in to the financial impact subsections as conservative estimates. However, given the prospect of cross selling the growth rate projections will be 10%, 8%, 6% for the first three years, respectively, before settling on 4% for the remainder of the model.

In addition, to performing proforma financial estimates, the author reviewed bank return on asset (ROA), return on equity (ROE), and insurance income results for a sample of local competitors who have insurance agency subsidiaries as a simplified approach of answering the question, “Would Kentucky Bank be better off with an insurance subsidiary?”.

Bank Name Total Assets 12.31.13 ($000) 5 Year Mean Return on Assets (%) Republic B&TC 3,253,875 2.07 Kentucky Bank 769,102 0.88

BankTrust Financial Corp 133,467 0.65

Central Bank & Trust Co. 1,921,853 0.56

Peoples Exchange Bank 320,841 0.51

Whitaker Bank Inc. 1,384,836 0.43

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Bank Name Total Assets 12.31.13 ($000) 5 Year Mean Return on Equity (%) Republic B&TC 3,253,875 17.92 Kentucky Bank 769,102 8.08

Peoples Exchange Bank 320,841 6.35

Central Bank & Trust Co. 1,921,853 6.28

BankTrust Financial Corp 133,467 5.82

Farmers Bank & Capital Tr Co 689,184 4.57

Whitaker Bank Inc. 1,384,836 4.25

Bank Name Total Assets 12.31.13 ($000) 5 Year Mean Insurance Income ($000)

Central Bank & Trust Co. 1,921,853 3,271

BankTrust Financial Corp 133,467 708

Peoples Exchange Bank 320,841 528

Whitaker Bank Inc. 1,384,836 354

Farmers Bank & Capital Tr Co 689,184 351

Republic B&TC 3,253,875 335

Kentucky Bank 769,102 301

Exhibit 8: SNL Financial

Clearly, there is no direct correlation between return on assets or return on equity with owning an insurance agency. However, there is a correlation with insurance income and owning an agency. Using the mean insurance income over total assets results in an average income amount of 0.16% compared to Kentucky Bank’s 0.04%. An oversimplified back of the envelop calculation results in an increase in

insurance income from $301 thousand to $1.2 million if Kentucky Bank had an insurance agency.

Proforma Estimates via Acquisition

While a simple calculation shows an upside of an additional $1 million annually in income, a deeper analysis and modeling is warranted when estimating the net return of the additional $1 million in revenue. The May, 2013 MarshBerry Letter provides a recent pricing basis for the analysis and indicates the 2012 EBITDA pricing average was 8.41% broken into 6.06% guaranteed payout and 2.35% possible additional payout. Considering full payout was not guaranteed, the average likely

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payout for 2012 was 7.41%. Using the previously provided estimates of 6% profit margin and 4% annual growth rate result in the following proforma financials.

Model 1 Assumptions Annual Revenue 1,000,000 20% Average EBITDA 200,000 Multiple of EBITDA 7.41 Price 1,482,000 Growth Year 1 10.00% Growth Year 2 8.00% Growth Year 3 6.00% Growth Year 4-20 4.00% Profit Margin 6.00% Goodwill 60.00% Customer Relationships 30.00%

Covenant Not to Compete 10.00%

Model 1 Results

Investment 1,482,000 Months to Profitability 48

5 Year Avg Annual Return 4.74%

Exhibit 9: Proforma 1 results

As indicated above, the potential exists for an insurance agency to be accretive to the Bank’s bottom line in a relatively short amount of time. In the interest of conservatism, the model was rerun to stress the assumptions. See below for model 2 assumptions and results.

Model 1 Assumptions Model 2 Assumptions

Annual Revenue 1,000,000 Annual Revenue 1,000,000

20% Average EBITDA 200,000 20% Average EBITDA 200,000 Multiple of EBITDA 7.41 Multiple of EBITDA 9.00

Price 1,482,000 Price 1,800,000

Growth Year 1 10.00% Growth Year 1 6.00%

Growth Year 4-20 4.00% Growth Year 4-20 4.00%

Profit Margin 6.00% Profit Margin 5.00%

Goodwill 60.00% Goodwill 50.00%

Customer Relationships 30.00% Customer Relationships 30.00%

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Model 1 Results Model 2 Results

Investment 1,482,000 Investment 1,800,000

Months to Profitability 48 Months to Profitability +72 Months

5 Year Avg Annual Return 4.74% 5 Year Avg Annual Return 3.06%

Exhibit 10: Proforma 1 vs 2 results – changes denoted in red

The results from Model 2 are dramatically different from Model 1 and essentially make purchasing a 20 year municipal bond more attractive than purchasing an insurance agency on a risk-weighted basis. The difference between the two models illustrates the importance of identifying the right acquisition partner to meet growth and profit expectations as well as agreeing to a mutually beneficial acquisition price. Prime targets for acquisition are agencies that are financially strong with a core group of staff. Kentucky Bank would not likely be interested in an agency if there was a financial need to sell or if the principals view the sale as a vehicle for funding retirement.

Non-financial Impact

Having been through multiple acquisitions in the past, Kentucky Bank recognizes non-financial impacts are a byproduct of mergers and acquisitions. Given the prior acquisitions have been bank-to-bank acquisitions, the cultural differences have been minimal and manageable. The likelihood of cultural clashes is much higher in an insurance-to-bank exchange. Insurance agencies tend to have an intense sales culture whereas banks have a moderately paced corporate culture. Insurance agencies tend to be dependent on a group of key producers and, at times, promote individualism whereas banks have a collective group of key managers supporting a team of producers. In addition, to the cultural differences between banks and insurance agencies, the development or acquisition of an insurance agency would be a new line of business for Kentucky Bank. The introduction of new business lines has been relatively

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few and far between in the history of Kentucky Bank. This change would have to be accepted bank-wide to be successful. Cross selling would need to be reinforced, reinforced, and reinforced for the new product line to be successful.

The insurance agency would have to manage those same cultural differences and learn to succeed in a different environment. Some benefits for the agency would include expanded geographic footprint, ability to grow via additional agency acquisitions, larger marketing budgets, and ability to cross sell to existing Bank customers.

The successful development of an insurance agency could be win-win-win for all parties. It would be good for the customers because it would expand the suite of products offered by their financial institution. It would be good for the Bank because of the increase in revenue and good for the agency because of the ability to grow and expand.

Strategy

Financial institutions typically enter the insurance agency market in one of two ways. They either purchase an agency or develop an agency in-house. Given the lack of internal insurance expertise held by Kentucky Bank, the author suggests acquiring an agency. Ideally the candidate agency would be financial strong with a solid group of performers with an owner looking to expand their business dynamically through the partnership with a bank. This candidate would realize the benefits of partnering with a bank such as broader market, bigger marketing budgets, and perpetual survivorship. The candidate would also realize the transaction would be a long term commitment rather than a short term buyout and payout arrangement. The ultimate success of the transaction would depend on cultural fit and alignment of expectations.

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Potential targets include any of the agencies listed under the non-bank competition section of this report with the author noting a possible emphasis on two agencies which are owned and operated by board members. In addition to local word-of-mouth opportunities, there are also national groups that coordinate the acquisition of agencies such as Oak Street Funding LLC and Agency Equity.

Implementation

Implementation of an insurance agency would require a number of steps. First, is identifying a number of qualified targets via the Bank’s professional network relationships as well as exploring national or regional consultants with agency expertise. Second, is thorough due diligence including financial, legal, and operational due diligence. Operational due diligence would include peer review, bench marking, staff assessment, and a cultural assessment. Third, the selection of the target and presentation to the Board of Directors for approval. Preliminary indication of support for new business lines was granted in the 2013 Strategic Plan. Finally, the negotiation and execution of a sales agreement, an announcement of the transaction, and regulatory approval. Once the transaction was solidified, an assimilation plan would need to be created including internal training, benchmarking, and monitoring.

To aid in the implementation process, a proposal was obtained from a bank insurance consulting group. Michael White Associates is a bank insurance consulting group led by Dr. Michael White who has a long career in insurance and bank owned insurance agencies. He has served as a member of the board of directors of the Financial Institutions Insurance Association (FIIA), now known as the Bank Insurance & Securities Association (BISA), he served as founding chairman of the FIIA Honors, State Initiatives and Public Policy Committees. Previously, he held the Frank M. Engle Distinguished Chair and was graduate professor of economics, international markets and financial institutions at The American

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College in Bryn Mawr, PA. Dr. White earned his Ph.D. in Economic Philosophy, four master’s degrees,

and the professional insurance designations Chartered Life Underwriter (CLU) and Chartered Financial Consultant (ChFC). A former U.S. delegate to the OECD Insurance Committee in Paris, France, Dr. White also served ten years as treasurer and executive steering committee member of the Pacific Insurance Conference (PIC), the world’s oldest international life insurance company trade association. He was a charter member of the International Insurance Society, Inc. (IIS) and an elector of the international Insurance Hall of Fame.

Michael White Associates has provided a proposal for the following services:

Phase I: Establish a Meaningful Goal and Assess its Financial Impact (4 weeks)

 Calculate a meaningful amount of insurance revenue for a bank the size of Kentucky Bank.

 Convert selected amount of insurance revenue into the general size of an agency to be targeted.

 Calculate pre-tax profit of the agency to be targeted using industry performance ratios.

 Convert the size of this prospective target agency into an estimated range of likely prices.

 Using benchmark valuation ratios arrive at an estimated fair value of the agency’s enterprise.

 Compare the estimated price to the bank’s capital ratios and calculate estimated impact.

 Compare prototype agency’s revenues to those earned by banks in Kentucky Bank’s asset class.

 Provide additional characteristics of this prospective target agency that may further enable identification among the general population of independent agencies in KB’s footprint.

Put another way, Phase I answers the question, “What would it take for Kentucky Bank to be a serious

player in the game of bank insurance brokerage and increase the probability of positive financial impact?”

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Phase II: Quantify and Present the Insurance Strategy (4 weeks)

 Define basic options for entering the insurance marketplace with respective pros and cons.

 Provide competitive reports on banks with insurance brokerage income nationally and the Midwest Region.

 Evaluate recent insurance divestitures by banks.

 Identify and compile a list of independent insurance agencies appearing to meet the characteristics identified in Phase I.

 Present Phase I and II to the Board.

Phase II completes the evaluation of Phase I with a formal presentation to the Board of Directors and viability conclusion of pursuing Phase III.

Phase III: Execute Strategy (6 months)

 Refine list of independent insurance agencies matching the characteristics identified in Phase I and II.

 Contact and determine if they are interested in being acquired.

 Complete appraisal of those agencies interested in transaction.

 Pursue and negotiate purchase agreements for the most likely candidates simultaneously including structure, incentive thresholds, and payout periods.

 Execute contract, formulate assimilation plan, and complete transaction.

 Monitor and track results after transaction completion.

Phase III puts preparation, research, and evaluation into action resulting in the development of an insurance agency.

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Conclusion

As presented in the preceding sections, insurance agencies are not uncommon within banks and can be a means to generate additional revenue and additional net income. Success is possible but not certain. Success takes preparation, hard work, thorough due diligence, great implementation, reasonable expectations, and a reconciliation of whether achieving those expectations are sufficient for the Bank’s stockholders’ best interest. Kentucky Bank does not shy away from opportunities because they are

challenging. As Thomas Jefferson once said, “Opportunity is missed by most people because it is dressed in overalls and looks like work.”

Given the net income potential and the relationship enhancement potential, Kentucky Bank should move forward with an endeavor to expand insurance offerings through an acquisition of an insurance agency or increased third party affiliation. An appropriate next step would be to engage a consultant within the bank-insurance field such as Michael White Associates to complete a “Bank Insurance Economic Assessment” and examine our bank's retail and commercial customer bases to determine what insurance products and delivery systems would be best to serve our customers and generate fee income for Kentucky Bank. At the completion of the evaluation, Senior Management would review the results and conclude on the best way to expand insurance offerings.

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Bibliography

Source Information:

1. Analyzing Agency Profitability: Using benchmarking as a tool to assess an agency's financial growth. By Mike Kish http://www.roughnotes.com/rnmagazine/2006/august06/08p106.htm

2. Whitaker Bank Insurance http://www.whitakerbank.com/2074/mirror/ins_insurance1.htm

3. BB&T Press Release http://www.journalnow.com/business/article_14155833-27c2-533f-b850-563bc384ae09.html

4. Oneida Savings Bank Press Release

http://www.snl.com/Cache/15668628.pdf?IID=4040228&FID=15668628&O=3&OSID=9

5. MainSource Press Release on Sale of Insurance Subsidiary

http://www.insurancejournal.com/news/midwest/2010/10/04/113775.htm

6. The National Alliance Research Academy’s 2010-2011 Growth and Performance Standards

www.TheNationalAlliance.com

7. Oak Street Funding http://www.osfagencyexchange.com/Home.aspx

8. Agency Equity https://www.agencyequity.com/

9. Deloitte: 2013 Property and Casualty Insurance Industry Outlook

http://www.deloitte.com/view/en_US/us/Industries/Insurance-Financial-Services/259a252dbee1c310VgnVCM1000003256f70aRCRD.htm

10. Banks and P&C Insurance Agencies: A Reality Check by Chris Burand http://www.burand-associates.com/Articles/Banks&Agencies.pdf

11. The MarshBerry Letter: State of the Industry – Part I, May 2013

http://www.iiaba.net/webfolder/ne/website_folder/enews/marshberry/2013/1305_ml.pdf

12. Michael White Associates http://www.bankinsurance.com/home/home.htm