Fairmont Defies Insurance Trend With Record Profit

Things are going Joseph G. Havlick’s way. He expects the Burbank-based insurance business that he founded eight years ago, Fairmont Financial, to bounce back from a difficult period in the early 1980s with record earnings for 1985.

While some of its competitors are retrenching, Fairmont is expanding into new markets in Colorado and Texas, and into new product lines such as surety bonds for the construction industry. And in its principal line of business, writing workers’ compensation insurance for companies in California, Fairmont is flourishing.

In fact, securities analyst Robert W. Back of Rodman & Renshaw brokerage house in Chicago says Fairmont officials are “in the enviable position of having customers camping out on their doorstep.”

Fortuitous Rejection

Havlick, 55, who left Encino-based Zenith National Insurance to found Fairmont after he was passed over for a promotion, has prospered as well. According to a Fairmont prospectus, Havlick, the company’s chairman and chief executive, received nearly $498,000 in salary, bonus and deferred compensation in 1984. That is more than twice the average pay for a chief executive of a California insurance company of about the same size, according to Ron Gerevas, managing partner of the Los Angeles office of Heidrick & Struggles, an executive compensation consulting firm.

The company’s prosperous state of affairs, capped by a spectacular rise in the price of its stock during 1985, didn’t come about by chance, Havlick insists. In the early 1980s, “when everyone was expanding, we were sort of sitting by, biding our time,” he said. Specifically, Fairmont avoided the intense price competition in the workers’ compensation business that eventually pushed out some competitors.

The workers’ compensation business is regulated by the state Department of Insurance, which sets premium and benefit levels. Thus, for a particular category of business--the state defines more than 400 categories--all insurance firms might be expected to offer the same coverage rates. But in practice, it isn’t quite that simple.

Price War

In the early 1980s, when premium rates were relatively high, many of Fairmont’s competitors tried to attract new business by offering large discounts to the standard, state-set rates in the form of rebates paid to customers at the end of the policy year. These firms engaged in a classic price war, and they expected to cover much of their insurance claims by investing customers’ premiums at very high returns.

When the prime rate was near 20% and money-market investments yielded big returns, such a strategy may have made sense. With today’s much lower interest rates, however, it has become far more difficult for investment income to offset deficits from insurance operations. That, in turn, has prompted some of Fairmont’s competitors to stop writing workers’ compensation insurance.

The weakening of the workers’ compensation business in California, which totaled $3.9 billion in premium revenue in 1984, is reflected in the rise in the industry’s loss ratio, a key measure of financial performance. The ratio--the percentage of the premium revenue received by insurance firms that is paid out to disabled workers--climbed in California to an average of 70% in 1984 from 55% in 1981, according to Richard Roth, an assistant state insurance commissioner.

Fairmont, which in the early 1980s did not have a large bond and money-market portfolio to rely on for investment income, stayed away from the big customers who had the clout to demand big discounts. Instead, it concentrated on smaller clients who had no choice but to pay more, since all employers are required to provide workers’ compensation coverage.

Still, Fairmont took its lumps. After earning a record $1.9 million in 1981, the company’s profits fell to $1 million in 1982 and to a loss of $968,000 in 1983. Fairmont was growing, but expenses were rising faster than revenue. The company began to turn around in 1984, when it earned $1.1 million, and it is predicting profits for 1985 of $4.6 million to $4.8 million.

Besides charging healthy premiums--which the state helped bring about by raising rates more than 11% in early 1985--the most certain way to make money in the insurance business is to keep the number of claims low. That means finding clients who tend to file relatively few claims.

Havlick tries to accomplish that by avoiding certain kinds of customers. For example, Fairmont will insure upscale restaurants but not bars or restaurants that are essentially drinking places. The company will insure nicer coffee shops but not greasy spoons.

Better Risks

Havlick’s reasoning is that a waiter in an upscale restaurant has a better--and safer--workplace than average and makes a good living from tips. If that waiter is injured on the job, he has a strong economic incentive to return to work as soon as possible, thereby minimizing his insurance claim.

Taverns are a bad risk, Havlick said, because of potential barroom brawls and because the work involves a lot of heavy lifting--and an increased potential for strained backs resulting in more claims.

Despite the company’s efforts to hold down claims expenses, however, investment income is crucial to Fairmont’s financial health, analyst Back said. It has become increasingly important to Fairmont in recent years as the company has built its financial reserves, the funds that insurance companies maintain to cover future claims and channel into investments.

The buildup of Fairmont’s reserves also has other financial implications. For accounting purposes, injections into reserves are subtracted from earnings.

As a result, they increase a company’s supply of cash by sheltering some income from corporate income taxes. At the same time, the allocations for reserves reduce a company’s reported net income over the short term.

Havlick’s prediction of record net income for Fairmont in 1985 is all the more impressive in light of the steps the company is taking to increase its reserves. But, he said, his primary goal is neither short-term earnings nor dividend payments to shareholders. Instead, Havlick said he wants to keep a conservative financial structure that will ensure continuing profits.

“We’re really a growth stock,” said Havlick, who, with a 5% stake, is Fairmont’s third-largest individual shareholder.

Havlick also has made sure he and other top executives are paid well. His 1984 compensation of nearly $498,000 dwarfs the typical pay of $180,000 to $200,000 among chief executives of comparable insurance companies, Gerevas said.

Wife Paid $83,000

Havlick’s wife, Tanna P. Handley, the company’s corporate secretary, earned more than $83,000 in 1984.

In defense of his pay, Havlick said that his base pay is $250,000 and that he can earn up to another $250,000 in bonuses only if the company exceeds its goals. He said three other senior executives can increase their pay by 50% annually as well. “It gives the executives an incentive to make sure they keep things running smoothly,” he said.

To keep growing smoothly, Fairmont is expanding into Texas, the nation’s second-largest workers’ compensation market, and into Colorado, where fewer claims are disputed in court and rebates are less common than in California. Fairmont Financial’s non-insurance subsidiaries, including surety bonds, leasing services, premium financing and commercial printing, are expected to continue making contributions to earnings.

Wall Street is enthusiastic about the company as well. Since hitting a 52-week low of $6.25 a share last January, Fairmont Financial’s stock has soared on the American Stock Exchange, closing Monday at $19.625. In fact, Fairmont’s stock posted the seventh-largest percentage gain on the Amex in 1985.

At least until the industry begins another round of price competition, Fairmont’s prosperity seems virtually assured.

After all, as analyst Back said, “marketing is easy now. You just pick up the phone and answer it.”