Into Higher Gear : TURNAROUND: Today's Auto Club Fashioned as a Different Model

By LIZ PULLIAM

Aug. 23, 1998 12 AM PT

TIMES STAFF WRITER

Seven years ago, the Automobile Club of Southern California was on the brink of financial disaster.

Years of insurance premium hikes had driven away hundreds of thousands of the club’s customers. Financial reserves were perilously low, and there was little money to invest in new facilities and technologies. At the same time, competitors were making deep inroads into the Auto Club’s core businesses of emergency roadside and travel services. Layoffs and branch closures seemed inevitable; there was even talk of shuttering the club’s decades-old insurance business for good.

Today, the Auto Club is once again one of the state’s leading insurers, and 43% of Southern California households carry the familiar white, red and blue membership card. The not-for-profit organization has quietly grown into a financial services powerhouse that offersstudent loans, life insurance, investments and mortgages in addition to its car and travel services.

The turnaround has been so successful that the Auto Club recently bought counterparts in Texas, New Mexico and Hawaii from the parent organization, the American Automobile Assn., in the nonprofit equivalent of a corporate takeover.

Some are concerned about the club’s transformation from a sleepy member services organization to a corporate model focused on competition and market share.To these critics, the changes have been too many, gone too far and come at the expense of employees and customer service.

Consumer advocates question the takeovers, saying the club should return money to members rather than grow beyond its borders. The club’s expansion into new fields also exposes it to new risks and new competition.

“When they extend themselves into fields they don’t know as much about, there’s a potential for disaster down the road,” said Harvey Rosenfield, an insurance activist and director of the Foundation for Taxpayer and Consumer Rights in Santa Monica. “Then if they goof in one area, do they come back, as other companies have, and say we’ve messed up, we’ve got to increase our [insurance] rates?”

To others, however, the changes are long overdue. The club’s survival depends on diversifying and shedding its long-standing reluctance to change, these advocates say.

“For many, many years the Auto Club was extremely conservative, not necessarily one to take even a small step into uncharted territory,” said Robert De Bock, a former Auto Club executive who now manages auto underwriting for rival 20th Century Insurance.

“Now it’s become extremely aggressive in offering new products and expanding. They’ve become multi-task oriented, and that’s the future.”

The Auto Club has also imported lessons from profit-oriented, publicly owned companies that make the not-for-profit organization better able to serve its members, said Brian Sullivan of Risk Information Inc., a Laguna Niguel company that tracks insurance industry trends.

“More often than not, the lack of a profit motive results in mediocrity,” Sullivan said . “But at the Auto Club, they think like a competitor. They act like they’re desperate for success.”

The turnaround’s engineer, Chief Executive Tom McKernan, has little doubt the Auto Club is finally on the right road. In his eyes, the slow-moving, cautious and somewhat paternalistic culture had to go.

“It was right for a time, but the time had moved away from that,” McKernan said. “Someone had to recognize that and have the guts to face it, and we did.”

The club’s culture had deep roots. The Southern California club traces its history to 1900, when a group of 10 well-heeled Angelenos started the organization to stage races and tours, promote the rights of motorists and lobby the Legislature for better roads.

By the 1920s, the core Auto Club services were already in place. It offered emergency roadside assistance, low-cost auto insurance and a list of approved mechanics and hotels, along with travel guides and maps. The Auto Club was also responsible for placing road signs throughout Los Angeles, a job the city didn’t take over until 1947.

The focus for most of its history was serving members rather than boosting revenue.

“It was very member-oriented, service-oriented, very focused on meeting members’ needs,” said Robert Nida, the club’s former general counsel, who retired two years ago. Controlling costs and boosting revenue ranked far down on the list of priorities, Nida said.

By the mid-1970s, the club had more than 2 million members, and more than a third of them bought their auto coverage through the Interinsurance Exchange, the club’s insurance arm. Almost any member who wanted insurance, in fact, could get it through the exchange.

That inclusiveness would prove expensive.

The late 1970s and early 1980s were bad times for the auto insurance industry in general. Soaring inflation and a rising number of and dollar amount in auto liability claims first wiped out profit and then cut deeply into insurers’ reserves--their cushion against losses. Reserves at the Interinsurance Exchange dropped to less than 30% of its annual premium income--the level at which regulators and rating agencies become concerned about a company’s financial stability.

The Auto Club responded by jacking up its rates as much as 12% a year and by improving its underwriting, so that riskier drivers paid more. The moves stopped the bleeding from the reserves, but eventually the increases began driving customers away. Between 1983 and 1989, the number of policies the Auto Club wrote fell by 37%.

For the next few years, the insurance exchange floundered. Reserves remained below industry norms, while the club’s rates made it one of the most expensive insurers in the state. Car manufacturers including General Motors and Ford Motor and credit card companies including Visa launched rival roadside services programs, but the Auto Club had little money to spare for improving its service and fighting back.

It was then, in 1991, that the club’s board called on McKernan to succeed its retiring CEO.

McKernan started his career with the Auto Club in 1966 at the service counter of the Pasadena office, eventually working his way up to chief financial officer. Although he was well-regarded, some directors had doubts about making McKernan at 46 their youngest-ever CEO.

Board member Don Miller recalls protesting that McKernan was too young to tackle the daunting challenges facing the club.

“I thought, wasn’t it unfair to Tom to promote him that early in his career?” Miller said. “My fellow board members convinced me that he may be young in years, but he had a great deal of experience. My concerns were completely overcome by their confidence in him.”

McKernan said he was determined to preserve the best parts of the Auto Club’s culture while ensuring its survival.

“I think you owe something to the institution you’re part of. You owe something to the people who are part of that organization,” McKernan said. “You don’t want to destroy it in the process of changing it, but you have to change it.”

McKernan’s first task was convincing both employees and members that change was necessary. Through meetings and bulletins, McKernan hammered on how deep the problems were.

“Employees had been pretty much sheltered from the results. It was a big awakening for them to see the charts” showing business plummeting, McKernan said.

To boost productivity, McKernan ended the 37.5-hour workweek, a cherished perk in place since the 1920s, and instead required employees to work 40 hours at commensurately higher pay.

Then the pay schedule itself switched to a performance-based system. Employees would be paid 90% of what they had earned before, plus a bonus based on how well their particular work group met financial and customer service goals.

Because the Auto Club is a not-for-profit organization, the idea of controlling costs and maximizing income was relatively novel, McKernan said. But McKernan convinced his executives and the staff that the measures were needed to fund new services and expansion.

To further contain costs, the Auto Club closed some branches and centralized the club’s insurance claims adjusters into a single office, rather than leaving them scattered through the branches. Claims service was shifted to a toll-free number to speed the process and reduce branch traffic.

“At the district office operations, the idea was always ‘service, service, service, at any cost,’ ” former executive De Bock said. “At some point, there wasn’t any more ‘at any cost.’ The idea was: Let’s look to see what’s costing us money.”

In 1997, the club moved many of its administrative operations and more than 700 jobs from its historic Figueroa Street headquarters to its Costa Mesa processing facility.

At the same time it was trimming expenses, the Auto Club was looking for ways to invest in technology and expand its reach. The budget for maintaining and improving technology was boosted about 20%, to $50 million a year, said John Boyle, the Auto Club’s current chief financial officer.

Auto Club executives also looked for ways to maximize the organization’s biggest asset: its brand name. Surveys showed that even consumers who had no business contact with the Auto Club recognized and respected its image, McKernan said.

The club started cautiously, by offering a branded credit card with low interest rates. Next came car loans, and then a car-buying service. The club made alliances with Hertz and AirTouch Cellular to offer member discounts.

McKernan said member surveys showed people wanted to have more of their financial services under one roof. The Auto Club had made the jump from offering auto insurance to writing homeowners’ insurance in the mid-1980s. Financial services were a bigger leap, but one the Auto Club made in 1997 when it began offering life insurance, through an underwriter owned by the Michigan auto club, and savings and investments through an alliance with Pittsburgh-based PNC Bank.

Club members can sign up for special checking and savings accounts, invest in certificates of deposit or money market accounts, and get a variety of loans, from education funding to mortgages and home equity lines. The idea--shared by many other insurers and financial services companies--is to offer as many services as possible to keep the customer from leaving.

“Things that members would look to us for are the things we want to get together and package,” said board member Waldo Burnside.

Most of the new services involve marketing products carried by other companies, such as the investments and loans, Boyle said. But the Auto Club takes on some of the risk for the life insurance underwriting, and plans to launch its own life insurance unit by the end of the year.

In addition, the Auto Club is considering offering more extensive investment options, including mutual funds, and may take on the financial risk for those products, Boyle said.

The club’s insurance arm currently has a $1.3-billion pad to guard against catastrophic losses, and its financial strength is considered superior by insurance rating agencies. But, as other insurers have learned, big losses can wipe out a company’s reserves and leave it subject to takeover by state regulators.

Some critics, including Rosenfield, worry that the Auto Club is over-reaching. 20th Century Industries, for example, stumbled badly when it expanded from auto insurance to homeowners coverage, only to suffer $1 billion in claims from the Northridge earthquake. Adding financial services to the mix adds to the Auto Club’s risks, Rosenfield said.

But others disagreed, saying that diversification can actually help spread the Auto Club’s risk.

“There’s always a danger of reaching too far, but so far the Auto Club is doing it right,” said insurance trend tracker Sullivan. “The membership is definitely better served by an aggressive, competent organization that’s able to give lower rates and continue to attract new members.”

Some ideas have worked better than others. Along with maps and tour books, the club started selling luggage and other travel accessories at branches--but few members bought, until the club assigned an employee to help promote the feature. Now the 10 travel stores are profitable, and the club is thinking of adding more, said spokeswoman Carol Thorp.

The 24-hour telephone claims service, designed to reduce office visits, generated more than 4 million calls last year but failed to stem traffic at the branches. In fact, visits to offices went up slightly, to 4.6 million, as members came in to buy travelers’ checks, make travel reservations or register their vehicles through the club’s free Department of Motor Vehicles liaison service.

The changes also didn’t come without trauma. Customer service sometimes suffered as employees tried to cope with new procedures and new products. Members sometimes still complain about the closed branches and long waits on the telephone. At one office, for example, a new voicemail system sent callers into a near-endless loop that made it difficult to reach a human being directly.

“When you stretch and ask people to do more with less, something has to give,” said one former employee.

For a time, morale plummeted, particularly among some longtime workers who protested that McKernan was trampling on years of tradition.

The changes, however, paid off financially. Controlling costs helped the insurance arm to lower its rates, which in turn helped attract new business. Reserves started a steady climb; today, the club’s cushion is 119% of its annual premium income, well above the industry average of 112%.

Membership soared as well, from 3.5 million in 1989 to 4.5 million today.

“The real test of an organization is if it continues to grow,” retired general counsel Nida said. “If you’re growing more than the competition, that has to be some kind of endorsement that you’re doing the right thing.”

In an effort to continue that growth and diversify its business geographically, the Auto Club in 1996 bought clubs in Texas, New Mexico and Hawaii that had been operated by the national AAA organization. The national organization, which acts as a not-for-profit administrative body for 96 regional affiliates including the Auto Club, decided to divest itself of individual clubs and instead focus on supporting its member clubs.

Unlike the Auto Club, the three smaller clubs could claim membership in just 11% to 12% of their states’ households, said CFO Boyle. The clubs also had much smaller insurance operations and less extensive roadside service. The Southern California club saw opportunities to add members by beefing up services.

To make the $39-million purchase, the Auto Club tapped its so-called Members Protection Fund--a pot of money used to finance improvements and help cover any gaps between revenues and expenses. In fact, last year the club used $18.8 million in investment income earned on the $237-million fund to help cover its $509.3-million operating budget.

Critics, including Rosenfield, argue that the purchase is proof the pot has grown too big, and that money should be returned to members. McKernan says the fund helps fuel necessary improvements and future expansions.

Competition and consolidation has slashed the number of auto clubs nationwide from nearly 200 in 1980 to 96 this year, and many observers expect no more than 10 to 12 large clubs to survive in the future. McKernan said he is determined the Automobile Club of Southern California will be one of them, and said he could not rule out further expansion.

“There are some that would have you believe if you’re not Goliath, you’re not going to make it,” McKernan said. “I hope you don’t have to be a Citibank or a Travelers . . , [but] we will do whatever we have to do to be viable.”

* HIGHWAY 1

For more autos coverage, including stories on maintenance, financing and safety, see the next monthly issue of Highway 1, coming Thursday.

(BEGIN TEXT OF INFOBOX / INFOGRAPHIC)

Lower Rates, More Policies

Lower auto insurance premiuns, new services and an expansion into financial services have helped the Auto Club reach into more Southern California households.

PRICES

After years of raising auto insurance premiums, the Auto Club began cutting rates in 1993, hoping to attract more customers . . .

January 1986: Rate Change +10.9%

January 1987: Rate Change +10.7

July1987: Rate Change +4.9

Jan 1988: Rate Change +12.5

July1989: Rate Change +6.8

July1993: Rate Change -5.0

May 1994: Rate Change -5.0

October 1996: Rate Change -2.9

January 1997: Rate Change -5.0

October 1997: Rate Change -2.4