Insurer Relies on Stability in Takeover Bid : Acquisition: Newport Beach-based Pacific Mutual is counting on lessons learned and a steady conservative investment philosophy in its effort to assume control of failed First Capital.
There is little in the boom-and-bust cycle of business that has escaped Pacific Mutual Life Insurance Co. during its 124 years of operation.
Steeped in history and tradition, the Newport Beach firm has become the state’s largest life insurance company and one of the industry’s more influential leaders. But along the way, it hit rock bottom. It was seized by the state during the Great Depression and reorganized over a 23-year period.
Now, in its bid to take over the failed business of First Capital Life Insurance Co. in San Diego, Pacific Mutual is relying on the lessons it has learned and a steady, conservative investment philosophy that has made it one of the highest-rated life insurers in the nation.
“It’s a solid, stable and progressive insurance company, and we have confidence that if the court approves its bid, it will successfully take over and manage First Capital,” said John Garamendi, commissioner of the state Insurance Department.
Garamendi has recommended that Pacific Mutual get the nod because its offer returned more benefits to First Capital’s 250,000 policyholders than any of the other bidders. In fact, in the department’s evaluation, Pacific Mutual headed the list on every significant financial aspect involved in what the industry calls a “rehabilitation” of First Capital.
A final decision on whether Pacific Mutual acquires First Capital--the nation’s second biggest insurance company failure behind Executive Life Insurance Co. in Los Angeles--will likely come sometime after a Los Angeles County Superior Court judge hears remaining testimony this week on four bids.
At least two bidders are expected to continue their efforts to win a court ruling that would put First Capital in their hands, and one of them is threatening to bollix up any rehabilitation plan for the failed insurer through court appeals.
“If another bid isn’t considered, it’s our intent to challenge the procedure being used here,” said Dean Ziehl, a lawyer for bidder Leucadia National Corp., the parent company of Colonial Penn Life Insurance Co. Leucadia is aligned with First Capital’s creditors.
Garamendi asserts that Leucadia essentially dropped out of the bidding because it failed to respond to a second round. It also offered the least return to policyholders, according to the agency’s review of the bids.
Regardless, industry insiders believe that Pacific Mutual’s only real competition is Transamerica Occidental Life Insurance Co. in Los Angeles, which scored right behind Pacific Mutual on all the significant financial issues that the agency evaluated.
The remaining bidder, Shearson Lehman Bros., which owns 28% of First Capital’s parent company, still has its plan before the court. But a spokesman would not comment Friday on whether it would continue to pursue the acquisition. It will seek unpaid commissions for its agents who sold First Capital policies, a lawyer said.
All four bidders offer 100% of the policy benefits at the end of a five-year rehabilitation plan, but from there they vary on how much interest and profit participation the policyholders would receive.
Thomas C. Sutton, Pacific Mutual’s chairman and chief executive, believes that being organized as a mutual--a company owned by its policy owners rather than by stockholders--gives his company an advantage over the competitors, all of which are stock companies.
“We have the one constituency to satisfy,” he said. “And we can afford to take a longer-term view. Doing something like this is not going to help current earnings. It only has value in the long term, and that value is only to the extent we can retain those policy owners.”
Pacific Mutual’s bid is aimed at picking up more customers through the eventual merger of First Capital into its individual life insurance operations. First Capital would give it twice as many policyholders and nearly 40% more assets.
At the end of March, Pacific Mutual had about 200,000 policy owners, mostly individual life customers, and $10.7 billion in assets. First Capital had about 250,000 policyholders, mostly holders of annuities, and $4.1 billion in assets. A merger would allow Pacific Mutual to climb from the nation’s 29th largest life insurer to the 17th largest, just ahead of Allstate Insurance Co., based on 1990 figures.
It already boasts that its clients include “30 of the 50 largest U.S. industrial firms,” but it won’t reveal names.
A chance to expand wasn’t Pacific Mutual’s only interest in bidding.
Sutton has led or participated in several industry groups that focused on insurance insolvency issues. He has become familiar with how some insurance companies got into trouble and has several ideas about how to correct the problems.
“One of the things we’ve been concerned about is the negative publicity about the life insurance industry,” he said. “That certainly has a big effect on us in the sense that we have spent an enormous amount of time talking directly to policy owners, to agents who sell our products, to rating services, to everybody who will listen . . . about ourselves.”
Pacific Mutual has also hired about a dozen top executives from First Capital since the mid-1980s, and their knowledge of their former employer has bolstered Pacific Mutual’s confidence that it can correct the problems.
In addition, Sutton said, “First Capital is here. It’s a California problem. It’s nice to have a California solution for it.”
Sutton and others in the industry believe First Capital’s operations would meld well into Pacific Mutual’s, even though the failed insurer has a slew of risky, high-yield corporate securities, known as junk bonds, and a chunk of bad commercial loans.
“It’s highly unlikely that Pacific Mutual would be hurt by this acquisition,” said Ernest Long, executive director of the California Life Insurance Guaranty Assn., which protects 80% of policyholder account values up to $100,000. “It has a very sound bunch of leaders. There’s no speculation on their part. They looked at it really carefully.”
The nation’s biggest industry rating agency, A.M. Best Co. in New Jersey, also isn’t worried.
“Initially, I think it’s a fine fit for Pacific Mutual,” said Larry Mayewski, a Best vice president. “The company is acquiring seasoned assets at a modest cost. They believe they will be able to generate good returns. And its rehabilitation plan maximizes the value to First Capital policyholders.”
Pacific Mutual has long enjoyed an A-plus rating from Best. And it believes its top rating won’t suffer with the acquisition of First Capital. But Mayewski said the annual evaluation of the company won’t be completed for several weeks.
When the state seized it last May, First Capital had 42% of its assets in junk bonds, but those investments are quite different in nature from the junk bonds that brought down Executive Life Insurance Co. in Los Angeles--the nation’s largest failure when the state seized it in April, 1991.
Executive Life took major positions in shaky companies, which put it in control of the management at those firms. First Capital has a more diversified junk bond portfolio with smaller ownership stakes.
Under Garamendi, the state agency has reduced First Capital’s junk bond portfolio by nearly half to 23% of its invested assets at the end of March. Its bad loans represent about 4% of its portfolio.
Pacific Mutual believes it can manage the junk bonds, though it keeps its own similar investments to about 2.3% of its portfolio. Its expertise, Sutton said, is residential real estate and mortgage loans, which make up 23.5% of its investments.
The rest of the portfolios at both Pacific Mutual and First Capital, he said, consist of investment-grade stocks and bonds, government securities, loans to policy owners from their accounts and various short-term investments.
Famous Founders
Pacific Mutual was founded in Sacramento in 1868 by such wealthy business leaders as Leland Stanford, Charles Crocker and Mark Hopkins. Stanford, its first president, was a former governor, railroad executive, soon-to-be U.S. senator and founder of Stanford University.
The company’s first policy was reserved for Stanford, and that policy has become part of the folklore at Pacific Mutual and at the Leland Stanford Jr. University that Stanford founded as a memorial to his only son.
When Stanford died during the recession known as the Panic of 1893, his financial affairs were in a tangled state and the university, which was supported totally by Stanford’s fortune, was unable to pay professors’ salaries. The future of the 2-year-old school was in doubt.
His widow learned of the life insurance policy and presented it to Pacific Mutual, which paid the policy amount: $11,784. She turned the check over to the university to help pay the salaries until her husband’s estate could be straightened out.
Pacific Mutual moved its headquarters to San Francisco in 1893 and continued to prosper through several recessions. Its last major acquisition came in 1906 when it bought Conservative Life Insurance Co. in Los Angeles.
The purchase was fortuitous. Several weeks after the deal closed, the company’s headquarters was dynamited in an effort to halt the spreading fire sparked by the historic 1906 San Francisco earthquake. The company quickly moved its headquarters to Conservative Life’s headquarters in Los Angeles.
The company stayed in Los Angeles until 1972 when it became the first major white-collar company to set up headquarters in Orange County.
Pacific Mutual wasn’t always so lucky. The company was brought to its knees during the Great Depression.
Its problems started in 1918 when it introduced a unique insurance product called the “non-cancelable disability income policy.” The idea was to provide coverage for temporary disabilities while prohibiting the company from canceling the policy, even if the policyholder became uninsurable.
But Pacific Mutual, at first, simply didn’t charge enough in premiums or vary its rates among different age groups. Nor did it sock enough away in reserves as it continued to sell the popular policy throughout the Roaring ‘20s.
After the 1929 stock market crash, many out-of-work policyholders began filing claims, citing illness caused by worry and frustration. Pacific Mutual began paying up to $4.1 million a year on disability benefits on the so-called non-can policies.
A 1936 state audit of the company revealed that future claims on these policies would be so substantial that additional further sales of “non-cans” would be “hazardous to all policyholders.”
The state seized the company and ordered its reorganization, even though all other lines of business were operating soundly.
Though called Pacific Mutual, the company was owned by shareholders, many of whom were speculators who bought stock after the company got into trouble. They sued the state over its rehabilitation plan for Pacific Mutual and fought against a proposal to get rid of the shareholders and turn the company into a mutual organization.
Experts were predicting then that Pacific Mutual couldn’t resolve its problems until 1973, but the company paid off its last non-can policy in 1955 and completed its change to a mutual company in 1959 after lengthy court challenges had ended.
Since then, the company’s growth has burgeoned.
In 1955, the company had $500 million in assets. It took 17 years to reach the $1-billion mark, and six more years to pass the $2-billion mark. It has added in excess of $8 billion more since 1978.
Like First Capital, Pacific Mutual sells individual life insurance and annuities. But unlike the failed company, the Newport Beach firm has two other highly successful lines of business.
One line, headed by PM Group Life Insurance Co., handles employee benefits, primarily group life and group health insurance. Its main focus is on companies with fewer than 50 employees, but it also serves employers with as many as 2,000 workers. Among its customers are the Irvine Co. and the cities of Irvine and Newport Beach.
The other line, mainly Pacific Investment Management Co., has become a premier manager of pension funds and other fixed-income assets. It has earned an international reputation for managing those assets for clients, such as AT&T.; At the end of March, PIMCO and its sister subsidiaries were managing nearly $40 billion worth of assets.
Pacific Mutual’s success can be attributed to a great extent to its innovative products, solid investment strategy and tough underwriting, said independent agents who sell the company’s policies as well as policies from other companies.
“It’s a company that makes you cross all the Ts and dot all the I’s,” said Sam Cunningham of the Anderson & Anderson agency in Irvine. Cunningham sells mostly group insurance plans to small companies. “I find them to be fair and I find them to be responsible.”
While the company’s rates might sometimes be high, the service is excellent, the agents said.
“They always do the right thing,” said Guy Baker of Baker-Thomsen agency in Newport Beach. In 1985, for instance, Baker sold a Pacific Mutual policy to the city and school district in Barrow, Alaska.
“The client was slow in the I-dotting and T-crossing, but Pacific Mutual paid two death benefits when they didn’t have to technically,” Baker said. “They are sticklers, but they do what’s right. They’re not pushing aside the human side just to enforce the bureaucracy.”
Baker, who heads a group of agents that meets several times a year with Pacific Mutual’s top executives, said the company learns from the field which products work, which don’t, which products are needed and what issues are on the minds of its customers.
* AN INNOVATOR: Pacific Mutual has an impressive list of new ideas in life insurance. D9
