Purchase of Cal-Farm Offers a Chance to Diversify : Insurance Company at Its Nadir May Help Zenith Reach New Apex

At first blush, the company acquired last week by Encino-based Zenith National Insurance Corp. doesn’t look like much of a bargain.

Cal-Farm Insurance lost $540,000 in 1983 and $1 million last year. Then the roof fell in. Cal-Farm turned out to have guaranteed overvalued collateral in its surety bond business, and ran up losses of at least $40 million when loans backed by the collateral went into default. On March 29 state regulators seized the company and put it on the block.

But Cal-Farm, which was founded in 1948 and writes property, casualty and life insurance, is a better company than its circumstances might indicate, experts say. And its acquisition by Zenith, a leading performer in the specialized field of worker compensation coverage in California, marries two firms that appear to be complementary.

“The acquisition of Cal-Farm adds a new dimension of potential earnings for Zenith,” said Dan Williams, who follows Zenith for Sutro & Co., a San Francisco brokerage.

Sacramento-based Cal-Farm collected $79.7 million in premiums last year, and, Williams said, it represents a strong step by Zenith toward diversifying its insurance business, which until now was limited almost exclusively to California workersd’ compensation.

Zenith paid $56.5 million for Cal-Farm, which was owned by the California Farm Bureau Federation, a farmers’ organization. It also assumed $28 million in responsibility for unexpired policies, but did not have to assume past claims or buy Cal-Farm’s disastrous surety business.

The surety business fell apart after Cal-Farm suffered a high default rate on mortgage-guarantee bonds issued for it by Eagle Bonds & Insurance Brokers of Agoura. Cal-Farm blames Eagle, but Eagle says Cal-Farm knew of the bond sales and authorized them. In any case, the entire debacle is now the subject of a court fight and an inquiry by the state Insurance Department. Cal-Farm, under the state’s conservatorship, will use the money from its sale to cover at least part of its surety bond liabilities.

Defaults have already occurred on about $100 million in bonds, which are backed by an undetermined amount of collateral. There are up to $70 million more in bonds outstanding.

Zenith outbid Fremont General, another Los Angeles insurer, for Cal-Farm by just $2 million, so it was not alone in seeing prospects in Cal-Farm, a company that was enticing to Zenith for a number of reasons.

First, premiums for Cal-Farm’s main lines of business are unregulated in California, unlike workers compensation, in which minimum rates are set by the state.

Second, Cal-Farm’s rates are extremely low compared with its competition, said assistant state Insurance Commissioner Richard Roth. And it has an extremely stable customer base of about 100,000 policyholders, including many small businesses that might want to switch workers compensation companies. Unfettered by regulators and blessed with loyal customers, Zenith may be able to raise Cal-Farm’s prices.

Also, Cal-Farm’s insurance lines are more predictable than workers compensation, in which litigation over claims often drags on for years.

Finally, the acquisition offers Zenith long-term access to a network of 250 Cal-Farm insurance agents operating in every county in the state. Zenith does not have its own agent network, and Cal-Farm’s agents now refer customers asking for workers compensation coverage to the state Compensation Insurance Fund, the biggest but by no means only provider in this fragmented industry.

Statewide, Zenith ranked seventh (based on 1983 figures, the latest available) as a provider of workers compensation coverage, with a 3.5% share of a market that is expected to grow to $4.4 billion in premiums in 1985. Zenith has about 24,000 of the 600,000 policies in California, with 150 insurance groups writing the rest. Experts say workers compensation is generally a good business in a place like California, where wages and employment are growing. Coupled with what is generally considered a good regulatory climate, and what observers say is good management at Zenith, the company has prospered.

“Stan Zax runs a tighter operation than the industry” as a whole, said Roth, referring to Zenith’s chairman and president.

For example, Zenith did better than average in the ratio of losses incurred to premiums earned. The industry average last year was 67%, and the state fund’s ratio was 75%. But Zenith’s was a superior 60%.

And, except for last year, Zenith has been profitable on an underwriting basis for several consecutive years. Besides making money by investing premium revenues before claims came in, that means the company also made money on its insurance underwriting.

“Most companies had a poor year in (workers) compensation in 1984, following several good years,” said Robert Meyer, a senior vice president at the Worker’s Compensation Insurance Rating Bureau, an industry group that helps state regulators set premium levels.

Claims losses last year were unexpectedly high, and, for two years in a row, rate adjustments failed to keep pace with benefit increases. As a result, Zenith earned $8.2 million on total premiums of $130.3 million last year, contrasted with $18.3 million on premiums of $123.3 million in 1983.

In fact, it lost $3.6 million in the fourth quarter last year, and $2.6 million in the first quarter of 1985. But minimum rates increased 8.5% in January and 3.1% in March, and the company is looking for things to pick up.

“We see trends in our own business improving,” said Zax.

Zenith was not always a good performer. Investors Eugene V. Klein, Harvey L. Silbert, and Daniel Schwartz bought 2.4 million Zenith shares for $3 a share in 1977, acquiring the 55% of stock that was outstanding from City National Bank of Beverly Hills, which came to own it by foreclosure.

Since then the company’s fortunes have turned around, and, in 1980, investor Saul Steinberg’s Reliance Group paid $19 a share for 1.1 million shares. Lately the stock, which trades over the counter, has sold for about $16.

Ira Zuckerman, who follows the company for Swergold, Chefitz, & Sinsabaugh, a New York brokerage, said Zenith has done particularly well investing its premium money, avoiding most taxes by emphasizing floating rate preferred stocks, 85% of which yield dividends that are excluded from income.

He said the purchase of Cal-Farm is likely to be “an isolated incident,” however, and Zenith’s management seems to concur.

“We have no plans to do anything further” on the acquisitions front, said Zax. “We want to digest this acquisition.”