Here is an interesting article (not related to CNC)
Link - interactive.wsj.com
Lethal Policies
Did greed and miscalculations doom Saul Steinberg's Reliance Group?
By Jonathan R. Laing
After some three decades of flying too close to the sun, it was hardly surprising that Saul Steinberg and his debt-burdened insurance holding company, Reliance Group Holdings, crashed and burned this summer.
But what was perhaps more unexpected has been the frank deference the press and many on Wall Street have accorded the one-time enfant terrible and corporate raider in his hour of financial humiliation. Perhaps this new politesse was provoked by pity over the stroke he suffered in 1995, which has left him with a permanently bent left arm and shuffling gait. Or maybe it's his longevity in the U.S. business arena and the New York social scene that has led to the nostalgic, elegiac tone of much of the coverage.
For example, publications as diverse as The Wall Street Journal, New York Times and New York Post described the $36 million sale of Steinberg's 34-room Park Avenue triplex, the auctioning of the apartment's grandiose antique furniture and other furnishings for over $12 million and the placement of some 60 old master paintings, said to be worth $60 million, with New York art dealer Richard Feigen, with the kind of breathlessness that People magazine grants all celebrities. One article in New York magazine, entitled "The Fall of the House of Steinberg," even described the final party that Steinberg and his third wife, Gayfryd, threw as heavy "with an end-of-an-era pall reminscent of the dismantling of Xanadu in the final scene of Citizen Kane."
For years, Saul and Gayfryd Steinberg moved in a glittering world.
And no less than the Times tabbed the million-dollar 50th birthday party Gayfryd threw for Saul in 1989 at their Quogue, Long Island, estate as one of the 10 most memorable soirees of the 20th century. Indeed, it was an affair of extraordinary excess -- some might say vulgarity. Among other things, Gayfryd staged tableaux vivants depicting 10 of Saul's favorite old master paintings. The highlight of the evening came when James Wolfenshohn, then an investment banker and now head of the World Bank, brought the house down by asking a naked model playing Rembrandt's Danae to boogie on the dance floor, according to New York magazine.
And perhaps more extraordinary has been the air brush applied to Steinberg's long and picaresque business career that saw him pioneer greenmail, act as a confidant and henchman to disgraced junk-bond king Michael Milken and unabashedly pursue his self-interest, sometimes to the detriment of his fellow shareholders.
Even Bryan Burrough, co-author of the classic on the 'Eighties takeover era, Barbarians at the Gate, and special correspondent for Vanity Fair, seems to have developed a soft spot for the fallen financier. In a June New York Times column, he ruminated that Steinberg isn't necessarily to be disdained, despite the celebrated threatened raid on Disney in 1984 that netted him some $60 million in greenmail profits. Asseverated Burrough: "Put aside all the envy, all the sniping about gold-plated cabinetry, and Mr. Steinberg and his ilk were agents of change, pure and simple. They were wolves clearing out the stragglers, forcing the other animals to get into fighting trim. True, they inflicted a great deal of pain, but financial Darwinism has never been for the squeamish."
Though Steinberg first came to national prominence with his failed hostile takeover of Chemical Bank in 1969, his corporate base for three decades and the source of the bulk of his wealth has been the old-line Reliance Insurance, which he got control of in 1968.
Through intermediaries, Steinberg declined to comment on his or the company's current situation. However, to hear other sources close to the company tell it, Steinberg and Reliance, 43% of which is owned by his family, have been laid low by a confluence of perverse events that individually posed no severe threat to the company but collectively were devastating. A perfect storm, in other words.
The unraveling began last summer, touched off by the continuing vicious price war in the property/casualty insurance business. Underwriting results were deteriorating as policy claims accelerated beyond expected levels. Even worse, a review by the independent actuarial firm Tillinghast-Towers Perrin found that Reliance had laid up insufficient reserves to meet the probable claims on outstanding policies.
And that wasn't the only problem. As fall rolled around, news trickled out of a giant workers' compensation reinsurance fiasco called Unicover, whose underlying actuarial assumptions had gone hideously wrong.
In a complex series of transactions arranged by Unicover, Reliance was a middleman between a group of primary insurers and a chain of reinsurers for what it thought was a completely riskless commission of around $40 million. However, reinsurers began incurring claims for losses some four times the sizes of the premiums that Reliance had channeled to them. Two of Reliance's main reinsurers refused to keep paying and withdrew from the deal, which insurance analyst V.J. Dowling dubbed the "Unibomber."
In one stroke, Reliance found itself on the hook for more than $1 billion of claims losses, a sum roughly equaling the company's net worth.
Reliance insisted that it had no loss exposure because of ironclad reinsurance contracts. Nonetheless, it soon caved and, as part of an omnibus industry settlement, paid the $170 million difference between what its reinsurers had agreed to pony up and the claims being made on Reliance by Unicover's primary insurers.
As a result of Unicover and a pre-tax $386.8 million charge to fix Reliance's policy reserves, Steinberg's company reported a loss of $310.5 million last year, compared with a net profit of $326.4 million, or $2.72 a share, the year before. Even worse, these special charges, plus a major hit to one of Reliance's stock positions, chopped the net worth of parent Reliance Group Holdings from $1.3 billion to $1 billion, and the statutory surplus of its insurance companies fell from $1.7 billion to $1.2 billion. The latter number, of course, is of the utmost importance to state regulators and rating agencies, because statutory surplus is what ultimately stands behind an insurer's claims-paying ability.
The final element to the perfect storm was the looming maturity this year of some $530 million of Reliance's $730 million in debt. Management, distracted by the reserve shortfall and the Unicover mess, dithered on the debt refinancing for months.
In February, Reliance succeeded in extending the maturity on some $237 million in bank debt from March 31 to August 31 after it announced an agreement to sell its highly profitable fidelity and surety bond business to Travelers Property 7 Casualty for $580 million. The sale, the company announced, would bolster the capital of the holding company by about $250 million and increase the insurance company's statutory capital by $300 million. Reliance also disclosed a minor restructuring program to try to cut its bloated expenses.
More hopeful news followed in late May. Leucadia National reached a tentative deal to buy Reliance for nearly $300 million in Leucadia stock. Even given the tentative nature of the deal -- Leucadia insisted on having eight weeks to look at Reliance's books before inking any final agreement -- the rating agencies were held at bay. After all, Leucadia had the liquidity and financial flexibility to repay or refinance Reliance's debt.
Yet Reliance's stock and bond prices continued to plummet. Investors were taken aback by Reliance's $40 million underwriting loss in the first quarter. In addition, a sharp $30-plus drop since March, to the high 30s, in the price of the remaining eight million shares of Symbol Technologies owned by Reliance would all but negate any boost in net worth provided by the sale of Reliance Surety. And surely Symbol stock will remain under pressure as Reliance continues to liquidate a position that (with splits taken into consideration) once totaled 15 million shares. Another bothersome question: Why had Steinberg and other family members given Leucadia an option to buy 37 million of their shares at an effective price of $2.55 when the company was reporting a book value of nearly $9 a share?
The final hammer fell in mid-June when the key insurance rating agency A.M. Best finally pulled the plug on Reliance and downgraded its insurance operations from A-minus to B-plus-plus. In one fell swoop, Reliance's insurance units fell off the approved lists of major commercial brokers like Aon and Marsh & McLennan and thus lost their access to major corporate accounts. To nobody's surprise, a month later, Leucadia walked.
Reliance's condition had gone from serious to critical.
The company's parlous state is reflected in its stock, which has plummeted from 7 3/4 in late December to a recent quote of around 25 cents and which the company has made a mainstay of employees' 401(k) retirement plans. (The company, which has had large layoffs, had 6,050 full-time workers, as of last December 31.)
At that price, the once-proud company that in 1998 boasted a market value of nearly $2.2 billion, is worth less than the $36 million that Saul Steinberg's apartment fetched.
Much of the recent pressure on the stock came from frenzied selling by Steinberg and his relatives. From June 26 through 30, Steinberg dumped some 3.7 million of his 36 million shares, at prices ranging downward from $l.48 to 75 cents. Some 23.4 million of his shares are pledged as collateral on $14 million in loans from Provident Bank, Bear Stearns and Citicorp's Smith Barney unit, according to a recent SEC filing.
And at least one of Steinberg's creditors already has dumped pledged stock. Provident Bank sold 6.1 million shares between June 23 and July 24 to raise some $6 million. Provident is controlled by Cincinnati financier Carl Lindner, a friend of Steinberg's since the 'Eighties, when both were regulars at Mike Milken's infamous Predators' Balls.
Other relatives who have been selling their stock include Robert Steinberg, who is Saul's brother and the vice chairman of Reliance; Bruce Sokoloff, Saul's brother-in-law and Reliance's senior vice president for administration; and Linda Jurist, Saul's sister. Both "Bobby" and Linda Jurist likewise have pledged some six million Reliance shares to secure $10 million in loans from M&T Bank.
Reliance's debtholders have fared poorly, too. With the company unable to refinance its maturing debt, Reliance's publicly traded paper has collapsed in price. Its $291 million in 9% senior notes that are scheduled to come due at the end of November now change hands for some 30 cents on the dollar in the secondary market, while their junior counterparts, the 9 3/4 % notes of 2003, have sunk to 13 cents on the dollar. Two months ago, the bonds traded at 90 and 78 cents, respectively.
As for the $237.5 million in bank debt that was rescheduled to mature in two weeks, no official trading range has developed. But lenders would likely be willing to sell the paper at 60-70 cents on the dollar, according to market sources. The bank debt enjoys the advantage of having a claim on the net worth of Reliance's insurance subsidiaries. The public debt, however, is an obligation of the parent holding company, which relies on dividends from the insurance subsidiaries for nearly all of its sustenance. And state regulators are now pinching off that flow.
A debt default is now a possibility. At least, that's the obvious implication of both the depressed prices of the debt issues and their relegation to deep junkbond status. Creditor committees are already being formed quietly. At the very least, debt holders will be forced to sharply extend the maturity dates on Reliance's obligations and perhaps accept partial payment in stock warrants or some other contingent-value equity instrument.
In the meantime, Reliance Group Holdings is melting away. In recent weeks, it has sold a bunch of commercial lines of business, including directors' and officers' insurance, inland marine policies and national accounts claims-handling operations. In most cases, the buyers purchased only the renewal rights to those books of business, having little stomach for assuming any of Reliance's obligations on past policies. The proceeds from these sales were pitiful, say knowledgeable people at rating agencies: less than $100 million. The lines of business Reliance has retained are essentially "horrible junk," according to the chief executive of a medium-sized property/casualty company, who was shown the financials on several of the operations by Reliance's investment banker, Bear Stearns. Stuff like an auto-insurance operation for higher-risk drivers -- a big money loser since inception in 1996.
Reliance officials hope that its $8.3 billion in reserves for unpaid claims and future recoverables from other reinsurers will meet all future policy claims and eventually pay off at least some of the debt. Neither is a certainty, however.
"Reliance, as Steinberg ran it, has never been a particularly seaworthy vessel," comments David Schiff, who publishes the Schiff's Insurance Observer newsletter and has criticized Steinberg over the years. "The collapse of the company was the accumulation of years of too much debt, a lot of personal greed and poor insurance underwriting."
Indeed, Reliance always lugged too much debt, given the size of its capital base, the vicious cyclicality of the property/casualty market and the volatility of its investment portfolio. Steinberg was a leverage junkie. In fact, some $500 of Reliance's current $730 million in debt dates to 1982, when he borrowed to take the company private in a leveraged buyout financed by Mike Milken's Drexel Burnham. That debt, though refinanced in 1993, has been a fixture of the balance sheet ever since.
What ultimately proved so lethal to Reliance's finances was the company's structure. The bulk of the borrowings resided at the holding-company level, while the wherewithal to service and pay down obligations sat in the state-regulated insurance subsidiaries. In fact, some 95% of Reliance Group Holdings' capital and assets are in its Pennsylvania-based subsidiary, Reliance Insurance.
And this year, Pennsylvania insurance regulators turned stingy. Reliance Insurance was allowed to pay only $124 million in dividends (10% of its current statutory net worth) to its parent, less than half the $250 million handed over last year.
Little wonder. At year-end '99, Reliance Insurance failed to meet five risk-based financial standards established by the National Association of Insurance Commissioners, according to Reliance's latest 10-K filing with the SEC. Moreover, the Pennsylvania Insurance Department required Reliance to file a remediation plan and has been discussing the situation with the company ever since.
Steinberg actually used the big 1998 payment from the insurance operation to pare Reliance Group Holdings' debt by some $190 million. He could have chopped away considerably more by raising money in the equity market while Reliance's stock was hot. But he didn't. Such a move would have diluted further his family's stake in the company, which had declined from 77% in 1986 when he brought Reliance public again to around 43% in recent years.
His debt leverage gave him the additional heft to swing bigger investment positions for Reliance in junk bonds, real estate and his first love, the stock market. The investing side of the insurance business was what always attracted him anyway, according to people who know him. He was never much of an operator and largely disdained all the mind-numbing intricacies of policy underwriting and shifting actuarial assumptions.
Yet for all of Steinberg's derring-do as a raider in the 'Seventies and 'Eighties, he's had a mixed record as an investor. His claque at Reliance loves to point to his longtime 14% stake in Symbol Technologies, which, over the years, boosted Reliance's net worth by more than $600 million through market appreciation. And, his supporters contend, if pantywaist insurance regulators and Wall Street analysts had let Reliance hang on to large investment positions taken in the mid-'Nineties in the biotech supernova Human Genome Sciences and the Internet-company incubator CMGI, Reliance today would be rock-solid. But Steinberg had likewise suffered huge opportunity losses during the 'Eighties and 'Nineties by pouring upward of $700 million into "strategic investments" in Zenith National Insurance, a workers' compensation concern; and Frank B. Hall, an insurance brokerage. Both stakes have been liquidated in recent years at little or no gain, during the most ebullient bull market in U.S. history.
These days, Steinberg isn't smiling much.
At least a portion of Reliance's problems, critics assert, can be attributed to the greed of Steinberg and some members of his family. For one thing, Saul and his brother Bobby, who was Reliance's president before being bumped up to vice chairman last fall, took down more than $40 million in salary and bonuses over the past four years. In 1998, Saul hauled in $8.5 million and Bobby, $8.1 billion.
In contrast, insurance-industry veteran Maurice "Hank" Greenberg made just $6 million in 1998 for running the highly successful American International Group, which boasted a market value more than 400 times that of Reliance at the time.
At the same time, Reliance's lush dividend policy on its common shares provided the Steinberg family with annual income of around $16 million a year (Saul's share was approximately $12 million). The 32-cent-a-share annual dividend was eliminated in February. Shortly thereafter, Saul began to unload the apartment, furniture and art.
Reliance also provided Saul and other family members with lush perks. The corporate jet, for example, is a reconfigured Boeing 727, rather than the typical Gulfstream 4 or 5. The big plane boasts five bedrooms, numerous television monitors, silver and crystal service, a dedicated cooking and waiting staff and $9,000 cashmere blankets. "I like Saul a lot, but I'd have to say that he and the family did a lot to decapitalize this company over the years," insists a person close to Reliance, who was closely involved with the effort to rescue the company earlier this year.
But the biggest cloud hanging over Reliance is the possibility that its policy reserves are still grossly inadequate, despite the $330 million charge taken last year to bolster them. The doubters ask: Why else would Steinberg so readily agree to sell his shares to Leucadia at a quarter of book value? And why else would Leucadia pull out of the deal after just six weeks of going through Reliance's books?
Property/casualty insurance is a complex business. In effect, an insurer sells its product without fully finding out what its costs of goods sold will be for years to come. The reserves set aside to back up policy obligations often constitute an educated guess.
All sorts of factors can skew calculations. Jury liability awards have trended upward. New legislation and court decisions can lead to novel types of claims, such as those seen in recent years in the asbestos and environmental area. Job-related injuries or ailments can lead to years of financial pain for insurers. Frequently, problems leading to losses are discovered only years after any mishap.
A couple of industry observers note that Reliance's book of business grew far faster in recent years than the rest of the industry's, in an environment of Darwinian competition and rampant premium-cutting. Net written premium growth at Reliance rose an average of 12% over the past three years, well above the industry average of less than 3%, according to Keefe Bruyette & Woods insurance analyst Michael Paisan. "Reliance's growing that fast in this kind of market tells me they were living on the edge," Paisan observes. "Of course, when you're not taking in enough premiums on the risks you're insuring, your reserves will tend to be way off, too." The president of a major Midwestern property/casualty company likewise doubts the adequacy of Reliance's current reserves. His suspicions were piqued after Reliance year after year showed better underwriting results than his company, even though both had similar products and clientele. He had his actuaries compare the two companies' combined ratios in each product, going back some five years. Their astonishing finding: Reliance's ratio of estimated claims costs and overhead expenses to premium income ran some 10 percentage points below his operation's.
"This was not occurring, in my estimation, because Reliance was a lower-cost operator or had selected better risks than we had. I know their people and operations well. The only answer I can come up with is that they have been going light on their reserves," he says.
Indeed, former Reliance insurance employees say that there might have been some skimping on reserves because of the ferocious pressure the insurance subs were under to produce strong earnings and hefty upstream dividends.
On top of this, a new claims-budgeting system introduced at one of the major insurance units in 1997 slowed the immediate recognition of new claims. Actuarial assumptions and proper reserving suffered as a consequence.
Finally, Reliance's insurance operations relied more and more on "managing general agents," or third parties, to scare up new business. In doing so, Reliance in insurance parlance "gave away its pen" by allowing outsiders to do much of its underwriting, or pricing of risk. The outsiders' commissions were based on the volume of business generated, rather than on its profitability. The Unicover fiasco stemmed from a pool created by a managing general agent.
No one knows how big the potential reserve hole might be. But the securities markets certainly have rendered a judgment. A stock price of 25 cents implies that Reliance shareholders' equity of $1.1 billion is toast. Likewise, the collapse in the prices of Reliance bonds and bank debt indicates, perhaps, another $400 million or so of vaporized value. And the number could be larger.
A leading Wall Street securities analyst told Barron's the reserve deficiency could be $2 billion. At least that's what he and his associates determined after doing their annual reserve study of the industry, using two different actuarial methods. He refrained from putting the number out earlier this year only because his firm had dropped coverage of Reliance.
The prognosis for Reliance is likely grim, if reserve charges strip it of its net worth. A filing under Chapter 11 of the bankruptcy code isn't out of the question, especially if debtholders can't reach an acceptable settlement with Reliance.
Ultimately, the Pennsylvania's insurance regulators probably will write the final chapter. After all, some 95% of Reliance Group Holdings' assets and liabilities sit in its Pennsylvania-domiciled operating unit. The parent company's claimed net worth of $1.1 billion is just a lesser version-trimmed under Generally Accepted Accounting Principles that apply to Reliance Group Holdings-of the $1.3 billion of policyholders' capital and surplus in the regulated insurance subsidiaries.
The state regulators' paramount duty is to protect policyholders. They almost certainly would seize Reliance Insurance if they concluded that it couldn't meet its claims or if Reliance Holdings were to file for Chapter 11.
In any case, Reliance is writing very little new business these days and, instead, is mostly servicing claims on existing policies.
Steinberg still shows up at the midtown Manhattan headquarters of Reliance Group Holdings nearly every day. He typically works just three or four hours, according to associates, because his stamina has suffered since his stroke.
He hasn't been calling the shots at Reliance for some time anyway, despite his title of chairman. His old buddies and longtime Reliance directors, Bernard Schwartz of Loral Space & Communications and Globalstar, and George Baker, a former Chicago banker who became president and CEO of Reliance in February, are said to be the dominant players these days.
Steinberg isn't enjoying the lifestyle of the rich and famous any longer. He and Gayfryd are temporarily living in a modest three-bedroom apartment in a somewhat faded residential hotel, while they look for a small townhouse in the city.
Mostly likely, Steinberg's sale of the Park Avenue apartment and its furniture and art have left him financially flush, by most standards. But for how long? More than likely, Reliance's injured debtholders eventually will go after Steinberg's assets, claiming that his huge compensation packages and fat dividends constituted improper conveyance of company assets.
But don't cry for Saul. He'll still have a more financially secure retirement than will the thousands of his employees whose 401(k)s are stuffed with now nearly worthless company stock, generously contributed by Reliance. |
