Zenith Getting a Handle on Risk : Woodland Hills: The insurer has cut its holdings in junk bonds from 14% to 2% of assets and expects to win the Proposition 103 fight.
Stanley R. Zax, the chairman of Zenith National Insurance Corp., is certainly familiar with risk, whether it’s junk bonds or insurance reform.
In the mid-1980s, Zenith loaded up on junk bonds, those high-risk, high-yield debt securities made famous by Drexel Burnham Lambert Inc. and its junk-bond chieftain, Michael Milken. By the end of 1989, junk bonds amounted to 14% of Zenith’s total assets.
No surprise there, perhaps, because Zax is Milken’s cousin, and Zax remains an advocate of junk bonds. But as the 1990s arrived, the investments hurt Zenith, a Woodland Hills-based provider of workers’ compensation and other property-casualty insurance.
As junk-bond prices and Drexel collapsed--and as Milken prepared to serve a 10-year prison sentence for securities laws violations--Zenith was posting a $33.6-million loss for the fourth quarter of 1990 after taking $42.6 million in charges to reflect its junk-bond losses.
Since then, Zenith has sharply pared its junk-bond holdings, and they amounted to a mere 2% of Zenith’s $1.5 billion in assets as of March 31.
Now Zax is squaring off against a new risk. He’s betting that Zenith won’t have to give its customers rebates under Proposition 103, the controversial insurance-reform initiative passed by California voters in late 1988.
Zenith, like most other insurers in the state, is fighting the measure, which among other things ordered 20% rollbacks in auto and property insurance rates. State Insurance Commissioner John Garamendi also wants the insurers to pay rebates--potentially costing millions of dollars--to cover the period that the insurers have resisted the rate rollbacks.
Garamendi is also charging the insurers 10% annual interest on the rebates, retroactive to May, 1989.
Garamendi has issued specific refund orders to several insurers but has not yet announced an amount for Zenith. Zenith is not in the dark about its potential liability, however.
In its first-quarter filing with the federal Securities and Exchange Commission, the company said “preliminary and informal” talks with Garamendi’s office have led Zenith to estimate its potential refund to be between $30 million and $41 million, excluding the interest charge. If the $41-million refund has to be paid, the interest on that amount is already about $12 million and growing by $340,000 a month, Zenith stated.
But Zenith has not set aside any cash for Proposition 103 and, if it loses its fight, the company likely would have to take another expensive special charge that would drain its earnings.
In its SEC filing, Zenith said simply that it “believes that its rates for the period were fair and reasonable,” and that it will not incur any rebate order that would have “a material impact” on the company.
Zenith’s posture is not unique, said A. Michael Frinquelli, who follows the industry for Salomon Bros.
“Most companies operating in California are not reserving anything,” he said. “They are convinced that they have no liability; therefore to put money up would suggest that they may have a liability and they don’t want to suggest that.”
In an interview, Zax said: “The bottom line is we think the issue at this moment is speculative. The refund amount is being computed on a standard I believe is invalid.”
So far, Wall Street seems unconcerned, with Zenith’s stock having edged up about 5% this year. (It closed Monday at $17.875 a share in New York Stock Exchange composite trading.) That’s because, even if Zenith ends up paying the refunds, the special charge it would have to take would be a one-time shock to its profitability, Frinquelli said.
Indeed, when another insurer, Mercury General Corp. in Los Angeles, agreed last month to refund $46 million to its customers, the company’s stock jumped, reflecting investors’ delight that the matter was behind the insurer.
Mercury General had reserved only $25.5 million for Proposition 103, so the final refund forced the company to take a $20.3-million charge against earnings in the current quarter.
As for Zenith’s shrunken junk-bond holdings, Zax said the company was forced to cut them not because they were financially dangerous, but because “regulators frowned upon companies having a high proportion of their assets in non-investment-grade securities.”
Also, the bad publicity about junk bonds “caused customers to wonder whether, if you have a high proportion of non-investment-grade securities, if you’re as solvent as you could be,” he said.
Zax contended that if Zenith had stuck to its earlier investment strategy--junk bonds included--”we’d be a stronger company today; we would have made more money. But we did the prudent thing and reduced our exposure in order to play in what we perceived to be the new environment.
“I don’t have any regrets” regarding junk bonds, Zax added. “We did what we thought was the prudent thing at the time.”
Zenith National’s ‘Junk’ Zenith National Insurance Corp., a Woodland Hills-based insurer, was once heavily invested in “junk bonds”, the high-risk, high-yield debt securities. But losses and bad publicity surrounding the bonds prompted Zenioth to sharply cut its holdings.
Junk bonds as Date Amount of junk bonds* % of total assets 3/31/92 $34 million 2% 12/31/90 $123 million 9% 12/31/89 $161 million 14% 12/31/88 $145 million 14% 12/31/87 $141 million 15% 12/31/86 $178 million 22%
*The bonds’ value as carried on Zenith’s books, as opposed to their current market value. Source: Zenith National Insurance
