Lindner’s Midas Touch Tarnished : Problems at Mission Insurance End AFC Chief’s String of Profits

NEW YORK â€”  One of the few things bond investors could count on, it always seemed, was finding good news in the financial reports of American Financial Corp., the insurance-based conglomerate run by Cincinnati financier Carl H. Lindner.

Lindner’s company seemed to be the closest thing to a sure thing on Wall Street. Fueled by the self-effacing financier’s skills at picking stocks for the corporate portfolio, American Financial had an impressive, virtually unbroken string of asset, revenue and profit increases extending all the way back to its founding in 1959.

Lindner’s family bought up all of the company’s public stock in 1981. Since then, the bondholders whose money provided most of AFC’s capital could rely on similarly steady growth in the company’s

ratio of profits to fixed charges--the cushion that ensures a supply of money to pay interest to bondholders--to 2.62 in 1983 from 1.55 in 1980.

That all ended with a vengeance last year. In 1984, AFC registered the first full-year loss in its history, a deficit of $45.4 million, contrasted to a profit the previous year of $167 million.

Decline Continued

This year, the decline has continued. AFC lost $55.8 million in the quarter ended Sept. 30, and $30.8 million over the first nine months of the year. According to government filings, the company’s earnings, once the source of such a generous cushion for bondholders, were insufficient to cover debt service by $59 million in the first nine months of this year. Last year, the shortfall was $66.7 million.

What is worse, all this red ink comes under circumstances that suggest that Lindner’s widely admired skill at buying companies at a fair price and turning them into reliable profit generators failed in a big way in 1983 and 1984. For that is when AFC established its significant holding in what has since become a cosmic black hole: Mission Insurance Group of Los Angeles.

Lindner has long had a reputation for patiently nurturing ailing acquisitions back to health, often by outlasting the economic cycles that put a misleading tarnish on fundamentally strong businesses. Says one executive who recently sold much of his stock in his money-losing company to AFC: “He’s biding his time, waiting for the business climate to change. The business has been on a downswing since 1975, but I think he’ll soon see an upswing.�

Adds Karl Eller, the chairman of Circle K Corp., of which AFC owns about 35% on a fully diluted basis: “He holds on through thick and thin. He has tremendous resources.�

These financial resources, which have as their foundation about $1.8 billion in assets held by AFC’s Great American Insurance Co., have made Lindner an important force in some key financial deals.

Mesa Petroleum’s T. Boone Pickens Jr., for instance, turned to Lindner in 1983 for backing for his takeover sally against Gulf Oil. The result was a hefty participation by Penn Central, in which Lindner was the largest shareholder, and ultimately a $47-million profit for Penn Central when Gulf fell into the hands of Chevron at a big premium.

Earlier in 1983, Lindner had approached Gulf & Western Chairman Martin S. Davis with a plan for a Penn Central-G&W; merger. The outcome of that was G&W;’s buy-out of Penn Central’s 9.4% stake for a profit estimated at between $56 million and $70 million.

There is some doubt that Mission Insurance’s problems can be solved by patience and forbearance. Considered a spectacular growth company from 1979 to 1982, the years in which AFC first bought into its stock, Mission’s health broke in 1983. This was partially the result of the collapse of the property and casualty lines that were its core business, but even more because of its ill-advised and inept entry into the business of reinsurance, or assuming risks that other insurers want to spread around.

Placed in Conservatorship

This October, when Mission had accumulated more than $169 million in negative net worth, the company was placed in conservatorship by the California Department of Insurance. AFC, which had invested $123 million in the company’s stock and added about $37.5 million in capital, wrote down its investment in the company to zero. AFC’s share of Mission’s losses over the 21 months ended Sept. 30 comes to $157.3 million--clearly the dominant factor in the parent’s unaccustomed flood of red ink.

Late last week, California insurance regulators reached a tentative agreement in which AFC would put up another $125 million in capital to support a reorganized Mission, comprising most of the company with the exception of its reinsurance liabilities. That would be enough, regulators hope, to make the stripped down Mission a viable property/casualty and workers-compensation insurer.

Regulators and California insurance executives have a good reason for wanting to see Mission back on its feet: If it fails, its liquidation would be the largest of any insurer in the state’s history, costing the statewide guarantee fund through which surviving insurers cover failed companies’ losses as much as $200 million.

Reputation Suffered

“Lindner’s reputation for being an astute businessman has definitely suffered in this industry,� says David L. McIntyre, president and chairman of Fremont Indemnity of Los Angeles.

Adds David O’Leary, insurance industry analyst for the investment firm of Fox-Pitt, Kelton Inc.: “I don’t know of any deal that Lindner’s been involved in that’s been this unsuccessful.�

Lindner’s reputation as a savvy investor is based almost entirely on AFC’s heretofore unquestioned investment success. Lindner is not one for cultivating a public image like other influential investors of the T. Boone Pickens stripe. He is known as much for his passion for privacy as his investment skills. He has never given a press interview; characteristically, American Financial declined to cooperate with the preparation of this story.

This reserve extends even to some of Lindner’s business contacts. “You see him, but you don’t see him that much,� says a businessman whose interest in a company was bought out recently by AFC. “He came in, he was courteous--curt, really--if he had a question he asked it but otherwise he stayed in the background. We had short dealings with him.�

Now 66, Lindner built American Financial after starting out in his family’s Ohio dairy. He established AFC in 1959 as a savings and loan company, later adding insurance units until the result was one of the 25 largest property and casualty insurers in the country.

Sophisticated Investor

Soon, Lindner acquired the reputation of being a sophisticated and somewhat fearsome equity investor. Many corporate managements found him to be a silent partner, but when he sensed the need for a change in direction the prospect of his merely taking sides could swing a proxy fight. Thus, Lindner’s support, along with that of some other powerful shareholders, helped a dissident Penn Central holder unseat former Chairman Richard Dicker in 1981.

Still, many executives consider AFC an asset as a major shareholder. One fan is Eller of Circle K, an operator of convenience food outlets whose directors include Lindner and his son Keith. Eller first met Lindner when the financier sold to Eller’s Combined Communications his Cincinnati Enquirer in 1971. That gave Lindner a sizable block of Combined stock; when Combined merged into Gannett in 1979, Lindner and Eller both became major shareholders of the larger company. Of the Lindners’ role in Circle K, Eller says, “They never interfere with the operations of the company,� although AFC stands ready to contribute financial analysis of any situation that Eller brings up.

Over the years, AFC’s financial habits have become almost predictable. One element was the allure of leverage; Lindner is a believer in the principle of using other people’s money to turn a profit for himself. As a result, American Financial’s balance sheet is a roster of complicated bonds, notes, subordinated debentures, and other such instruments, all designed to magnify the already considerable financial heft of the parent company’s $5.2-billion asset pool. Preferred stock and short- and long-term debt amounted to 86.3% of AFC’s total capital of $1.26 billion at the end of September, according to its third-quarter report to the Securities and Exchange Commission.

Believes in Leverage

As the company stated bluntly in its 1984 annual report to the SEC, “Management . . . has always believed in the use of leverage . . . to increase the return on its common shareholders equity.� Most of that debt--78% at the end of last year--is publicly issued debt, favored by Lindner for its longer terms and fixed rates.

But if the company is an enthusiastic issuer of debt, it is a much warier buyer of the same.

Most property and casualty insurers place the bulk of their assets in easily marketable tax-exempt bonds and other such debt securities; AFC, in contrast, has about 40% of its resources in common stocks and convertible securities and in privately placed debt with a limited market.

Similarly, while most insurers strive to diversify their portfolios as widely as possible, Lindner has never made a secret of his belief that concentrating AFC’s assets in a small number of issues is a virtue.

“This approach allows management to more closely monitor these companies and the industries in which they operate,� AFC stated in its latest annual report to federal regulators. “AFC’s concentration on a relatively small number of companies and industries may permit it to identify those investments with unusual growth potential.�

Six Core Companies

The core of this portfolio is six companies in which AFC is the largest single shareholder and whose finances the parent company accounts for on an equity basis, meaning it books each company’s profit or loss as its own in the same proportion as its stock ownership.

The star performer among this cadre is Penn Central, the old railroad company in which Lindner started investing shortly after its emergence from bankruptcy reorganization in 1978. Penn Central is now primarily in the energy and electronics businesses, AFC owns 28% and Lindner is the chairman. AFC’s other major investees and the percentage it owns of each are: United Brands (53% of the voting stock); Mission Insurance (49%); FMI Financial, an insurance, telecommunications and real estate company (28%); Circle K (10%), and Fisher Foods (37%).

Penn Central’s performance has been so good, as it happens, that it has masked some meager earnings at other investees. AFC paid a combined $657.7 million for its holdings in the six companies, of which slightly more than one-third, or $283.5 million, was spent on Penn Central. But of the holdings’ combined market value of $870.1 million at year-end 1984, well more than half represented the old railroad company ($504.3 million).

Penn Central was also the most profitable by any measure, with $170 million in 1984 earnings on $2.6 billion in revenues. At the other end of the scale, of course, was Mission, which lost $198 million last year and another $65 million through the first nine months of 1985, or to the eve of its takeover by California authorities.

Has Quick Reflexes

A portfolio of this nature requires an investor to be nimble, and Lindner has shown quick reflexes in unloading companies at a profit. In the last quarter of 1984, for example, he unloaded a sizable holding of Rapid-American, which had a $9.4-million loss last year, much of it an extraordinary charge on retirement of debt, for $110 million in short-term notes and $1 million in receivables. Along with the sale of a position in the liquidating Gulf Broadcast for $102.9 million, AFC made $11.5 million on those deals.

Just as AFC’s investees form something of a financial family, AFC is literally a family affair: Lindner’s three sons work for the company, and his two brothers, Robert and Richard, are directors. Robert is a company executive as well.

The family’s identification with the company became even closer in 1981, when Lindner took AFC private, vesting its equity ownership in his own hands and those of his brothers, sons, and grandchildren.

Financial documents filed with federal regulators disclose that AFC’s executives form an even larger family circle. The Lindners and other executives are skilled at creating independent businesses with a certain appeal for AFC. Thus, in 1984 a partnership comprising Lindner and his sons bought from AFC a purchase and lease-back contract involving 370 convenience stores owned by Circle K for a $23.6 million note, guaranteed by AFC. For “arranging the transaction,� AFC got warrants to buy 500,000 shares of Circle K at $30 each to add to the warrants for 1.8 million shares it got from the earlier sale of a company called UtoteM to Circle K. Eller says the deal was “on very competitive terms.�

Chartered River Barges

Then there are the river barges. In 1982, AFC says, it agreed to charter a number of such barges from people who included several officers and directors of AFC. The rate of $65 per day “may have been in excess of market rates� at the time, AFC says. Last year, the individuals who earned revenues from these deals included James E. Evans, AFC’s vice president and general counsel, who made $119,000; Robert C. Lintz, a vice president, $206,000; Sandra W. Heimann, another vice president, $225,000; and Robert A. Johnson, a director, vice president, and treasurer, who is Robert D. Lindner’s brother-in-law, $24,000.

AFC also charters a tugboat owned by its chairman. In 1984, Lindner’s revenues from that operation came to $1.3 million, or almost as much as the $1.9 million he got in salary from the company.

This apparent penchant for treating AFC resources as a privately owned pool of capital unnerved some California insurers who feared they might be left holding the bag, through the statewide industry guarantee association, for Mission’s liabilities if AFC managed to assemble its assets, and thus its potential for profits, in a new corporate shell.

Says Howard McConnell, a Kemper Insurance executive and chairman of the state insurance industry guarantee fund, to which operating insurers contribute to cover the liabilities of failed insurers: “The fund’s position is to make sure we are not tapped while there’s a nickel’s worth of AFC money left.�

Pleased by Plan

The state’s tentative rescue plan appears to keep that from happening. Norris Clark, chief of the department’s division of financial analysis in Los Angeles, says the regulators are treating AFC as the owner of Mission. “They are the controlling persons, and their’s is the only outside money we’re looking to right now.� Says McConnell: “We’re very pleased by the plan as we’ve heard it so far.�

Insurance industry professionals say that, although Mission boasted a silver-plated reputation on Wall Street and a similarly sterling reputation in the trade, its problems were visible by early 1984 to anyone who cared to look.

One problem was the generally mounting red ink of the property and casualty business generally. In that line, premium rates had failed to keep up with mounting policy losses. Says Fox-Pitt’s O’Leary, “Last year was the worst in the industry’s history, and they (Mission) did poorly with everyone else.� Indeed, AFC’s own insurance operations, most of them conducted under the name of Great American Insurance Co., had $266.7 million in underwriting losses last year--a sharp increase from the $185.9-million loss the year before--though they turned a $41-million profit, thanks to $307.7 million in investment income.

Insurers say Mission probably could have survived a couple of bad years; by late 1984 commercial insurers were instituting premium increases of about 20%, and another 60% increase was registered industrywide this year. “The swing in profitability over a period of three to 15 months is going to be massive,� O’Leary forecasts.

Reinsurance Problems

But Mission had another problem: Its reinsurance portfolio. Reinsurance is a process by which insurers shift part of their risk to other insurers, paying the assuming reinsurer a premium much as a car owner pays one to his or her own insurance carrier. Mission went heavily into the reinsurance business in the early 1980s, assembling pools of companies to assume reinsurance, setting rates, underwriting standards, and performing administrative services for the pool members.

According to lawsuits filed in New York by some members of these pools, Mission subsidiaries cut corners to ensure that the pools appeared profitable. One suit alleges that Pacific Reinsurance, a Mission unit, maintained loss reserves that were inadequate by a factor of 500%. Stuart Cotton, a lawyer for one pool member, says that Pacific also reinsured risks that pool members had never agreed to. In all, he says, Pacific was producing “an unrealistically better view of the results of the business to keep all the participants happy, keep them renewing.�

Mission units were also cutting premiums to the bone. “Anyone competing with them knew they were just undercutting premiums,� says Fremont Indemnity’s McIntyre. “You can charge 10% of the necessary premiums for only so long before the losses catch up with you.�

Pacific has denied doing anything improper and asserted that the pool members had the right to audit its books regularly and never exercised the right.

Nobody blames Lindner for the reinsurance problems, as he was a minority shareholder during the period in which they developed. But insurance executives question how his vaunted research skills failed to turn up Mission’s shortcomings--particularly as AFC is an insurer in many of the same lines.

Lindner has replaced the company’s chief executive, bringing in Raymond D. Johnson Jr., a transferee from AFC’s Republic Indemnity Co. of America, as president and chief executive. In trying to recapitalize Mission, he has also taken options that will allow him to increase his 50% stake to as much as 91% after the end of 1986. If the “new� Mission is still living, stripped of its reinsurance albatross and accumulating the millions of dollars in capital produced by higher premiums, Carl Lindner may have outlasted more than just another economic cycle.

PRINCIPAL HOLDINGS OF AMERICAN FINANCIAL CORP. In millions

Market value Stock owned of common on Company by AFC Cost Dec. 3, 1985 Penn Central Corp. 28% $283.5 $550 United Brands 53% $115.1 $192 Circle K Corp. 10% $70.5 $38 Mission Insurance Group 49.9% $123.3 $17.1 FMI Financial Corp. 28% $25.7 $39.2 Fisher Foods Inc. 37% $25.2 $20.2

Carrying value on Company Sept. 30,1985 Penn Central Corp. $408.8 United Brands $151.8 (at 12/31/84) Circle K Corp. $75.9 Mission Insurance Group 0 FMI Financial Corp. $28.4 Fisher Foods Inc. $24.2

Accounted for as an unconsolidated subsidiary as of Sept. 30, 1985; figures do not include 32.3% held by FMI financial. Lindner interests now control 85.4%.

Placed under conservatorship by California Dept. of Insurance in Oct., 1985; AFC investment written down to zero.

Carrying value is AFC acquisition cost plus equity in undistributed earnings.

Sources: AFC Form 10-K, Dec. 31, 1984, Form 10-Q, Sept. 30, 1985.

Source: AFC Annual report, 1984; Form 10-Q, Sept. 30, 1985