Tireless in Seattle

Two years ago, 80-year-old Safeco Insurance Co. came dangerously close to shutting its doors for good. Earnings had plunged to just 9 cents per share, and the stock price had fallen to $22 from a 1998 peak of $56. Management decisions by its former chief, including a misguided acquisition and ventures into non-core businesses, conspired with an antiquated underwriting process and poor market conditions to nearly doom the Seattle-based company. The feeble property and casualty insurer suddenly was up for grabs, and none other than Warren Buffett was digging into his pockets. Then, a hometown boy who had resuscitated the fortunes of another large insurance company returned to breathe life back into the moribund company.

New CEO Mike McGavick didn’t take a kid glove approach to reviving Safeco. He cut the workforce by 10 percent; slashed 1,200 jobs; wrote off an unwise acquisition; pulled out of more than a dozen non-core large commercial insurance lines; declared a moratorium on new homeowners policies in 10 states; and sold off a profitable but debt-plagued commercial credit operation. He also assembled what analysts consider one of the best management teams in the insurance business-former Travelers CFO Christine Mead as finance chief, former Geico underwriting boss Mike LaRocco as president of Safeco’s personal lines division, and the former head of Accenture’s insurance practice, Yom Senegor, as CIO and director of strategic planning.

On Jan. 28, at a buoyant news conference announcing Safeco’s 2002 results, McGavick proclaimed the company alive and well. “The turnaround,” he said, “is complete.” Safeco reported a net income of $301.1 million, compared with a net loss of $989.2 million in 2001. Profits in the fourth quarter were five times what they were the previous year’s fourth quarter, $57.1 million compared to $8.6 million. “It was a long haul, but they’re finally back on track,” says Paul Latta, assistant director of research at Seattle-based investment bank McAdams Wright Ragen.

For McGavick, the turnaround has special meaning. “This company was here when Microsoft, Amazon.com and others here weren’t even imaginable,” he says. “There was no way we could let it fail.”

Stormy weather

In an industry where turnarounds are rare-analyst Michael A. Smith of Bear Stearns once equated turning around an insurance company to “parallel parking a battleship”-

McGavick succeeded by quickly crafting a rebound strategy and sticking to it. He also refused to gloss over the enormity of Safeco’s problems. “Everyone told him Safeco was a weak company, but he called it like it was-a very weak company,” says Cliff Gallant, vice president at New York-based equity research firm Keefe, Bruyette and Woods.

From his 22nd story office atop Safeco Tower, overlooking the neighborhood he grew up in and his alma mater, the University of Washington, McGavick reflects on the turnaround of Safeco, which sells auto, homeowners, small business and life insurance through independent agents in 45 states. A local institution-baseball’s Mariners play at Safeco Field-Safeco’s troubles emerged in the mid-’90s when former CEO Roger Eigsti sought to expand the company’s market share in the Midwest. In 1997, Eigsti paid $2.8 billion to acquire American States-too much money, analysts griped.

At the time, McGavick, a former insurance lobbyist and political campaign manager, was in charge of the commercial insurance division of CNA Financial. Known for his discipline and tenacity, McGavick revamped underwriting practices at the Chicago-based insurer, reviving the division and earning a reputation as a turnaround specialist. After ousting Eigsti in 2000 and fending off acquisitive overtures by Warren Buffett, Safeco’s exhausted board tapped McGavick for help. “I remember their profound sense of embarrassment,” he recalls. “This was a company with a great history and reputation. The board was really tired of producing results that were so out of character. They were as open to change as any organization I can imagine.”

McGavick is loath to attribute Safeco’s troubles entirely to the American States acquisition, which had good motives-more than 4,000 agents were to be added in the process. “The difficulties really began in the early ’90s, when the company opted not to modernize its underwriting practices,” McGavick says.

Other insurers had begun to use credit scoring as an underwriting tool, weeding out applicants based in part on credit history. But because Safeco did not use the tool, they wound up with the applicants other insurers rejected. “We were stuck with the bad risks,” says Marcy Hall, vice president of Kibble & Prentice, a Bellevue, Wash. agency representing Safeco.

Exacerbating the company’s poor underwriting practices was the softening property/casualty insurance market. Because Eigsti bought American States at the top of the underwriting cycle when prices had just begun to fall, Safeco had to reduce rates simply to retain market share. American States agents were told to hold onto the business at any price, a departure from underwriting discipline for Safeco, a conservative company with a white-shirts-only policy for male executives well into the ’90s.

In 1999, the low rates and high claim activity produced some $367 million in underwriting losses, half of it on American States paper. McGavick says prior management should have known in 1995 that something was amiss with the auto underwriting results. “But they were profitable and decided to plow those profits into the American States acquisition. In all the confusion, the hemorrhaging was obscured,” he says. “The company went from fabulous results to horrible.”

Under Eigsti, Safeco also had wandered from its roots as an insurer of small and midsize businesses and individuals and began underwriting large commercial risk policies such as directors’ & officers’ liability, lawyers’ professional liability and even medical malpractice. “Eigsti wanted Safeco to be a major national company like AIG,” says Gallant. “But the industry was going through cutthroat competition and these were lines of business and geographies that Safeco wasn’t familiar with. The strategy backfired.”

Standard & Poor’s reacted to the unsettling news by putting Safeco on credit watch and downgrading it from A-plus to AA-minus. A.M. Best retained Safeco’s A rating but changed it from a stable to negative outlook.

Steering the course

McGavick’s first decision was to reduce the dividend by 50 percent and redirect that capital-more than $95 million a year-toward the company’s growth. His second move was to write off $1.2 billion in goodwill derived from the American States acquisition. “He just basically unwound the mistake,” says Gallant.

McGavick then put Safeco Credit Co. on the block, announcing in July 2001 that GE Capital would acquire the profitable operation for an undisclosed sum. The sale helped cut Safeco’s short-term debt in half. “While the credit company contributed $20 million to earnings, it constituted fully half the debt on the balance sheet, roughly $1.5 billion in commercial paper,” McGavick notes. “Credit companies live on the spread they can create-what they can borrow at and lend at. Unfortunately, the ratings downgrades had compressed that spread and effectively undermined the entire operation.”

The CEO then began a series of layoffs, asset sales and consolidations to get expenses in line with industry leaders. More than 1,000 underperforming agencies were given goodbyes, leaving 7,000. Non-core lines of business were exited, as McGavick retained only products sold at low margins and focused on broad marketplaces-auto, homeowners, small business and life insurance. “Safeco was not about brilliant individual underwriters assessing risk as an art critic might assess a Monet,” he explains. “What we are is a team of disciplined underwriters looking at garden variety risks.”

Most important, McGavick brought in LaRocco to revitalize underwriting. LaRocco had senior management positions at Geico and Progressive. Both have a tiered approach to underwriting, using diverse rating factors, including credit scoring, to segment policy applicants into different risk tiers.

Whereas Safeco had three different pricing tiers for auto insurance in the past, it now has more than 15. It also has 1.5 million automobile policyholders, the most in the company’s history, adding up to more than $2 billion in revenues last year.

LaRocco was also charged with redeveloping Safeco’s homeowners insurance line. Like many insurers, Safeco was losing money on the business, which is vulnerable to capricious weather and uncertain liabilities. He developed a new homeowners product with narrower coverage terms and conditions, took aggressive rate actions in certain states and in 10 states declared a moratorium on the product altogether.

Latta notes that mild weather coupled with the new underwriting stance is paying off. “Fewer claims from storms and other natural disasters held Safeco’s costs to 93.5 cents for every dollar of premium last year written in homeowners,” he says. “I anticipate as results continue to improve, McGavick will reevaluate the moratorium.”

Perhaps the best news is Safeco’s ratings. Both Best and S&P recently upgraded Safeco to stable. And S&P reinstituted the company’s A-plus rating. But McGavick is not yet satisfied. He recently raised $329 million in capital to fund expansion activities, and has charged CIO Yenegor with developing state-of-the-art Web-based claims handling, agent interface and customer-facing IT projects. Independent agents will remain the company’s primary distribution channel, although like Progressive, Safeco expects to sell more insurance on the Internet. “We see a future where you buy a Safeco policy on the Internet, make payments online and service the policy online, but with an agent’s assistance as a trusted adviser,” McGavick says.

Five years from now, McGavick says he fully expects Safeco to be one of the top 10 most profitable insurance companies in America, and within a decade, one of the top five. At present, it is the 15th-largest. “To have started this decade with one of the poorest performances of any U.S. insurance company and to end it in the top five would be a great victory,” McGavick says. Even by the standard of a Bill Gates or Jeff Bezos.