Insurance company hitting Zenith as workers' comp reform takes effect.

Who said you can't make money selling workers' compensation insurance in California?

Zenith National Insurance Corp., the state's third-largest workers' comp insurer, has posted five consecutive quarters of double-digit earnings increases while its stock has jumped more than 70 percent over the past year.

The company had a phenomenal 60 percent jump in premiums written in California during the first quarter--all the while operating in a market that has chased dozens of insurers away.

"If Zenith feels they can make money right now, they can accept more business," said Bob Farnham, a senior financial analyst with AM Best Co., the insurance rating service. "We think Zenith is one of the better-positioned carriers in California to take advantage of the improving market."

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Just last year the company was forced to tap a short-term line of credit to bolster its claims surplus. But since then. Zenith's stock has been on a tear, rising 73 percent in the past 52 weeks to close at $48.34 a share on June 23.

The stock gel a boost last month when Zenith said it would lower its rates by 10 percent starling July 1, a key, insurance renewal date for many businesses. Zenith's rate reduction is more than the 7 percent rate decline announced by the quasi-public State Compensation Insurance Fund, which insures about half of the businesses in California. Everest National Insurance Co., the state's second-largest carrier, announced a 7.5 percent rate cut.

Trend reversed

The rate reductions reverse a four-year trend of annual double-digit rate increases for workers' compensation insurance in California.

The County of Los Angeles, which is self-insured, paid $257.6 million in workers' compensation claims for its fiscal year ended June 2002, a 65 percent jump from 1999, according to a 2003 county grand jury report.

Insurance Commissioner John Garamendi has complained that insurers have not dropped rates far enough. He wants reductions of up to 20 percent, noting that California's Legislature adopted major reforms in April to bring skyrocketing premiums under control.

Stanley Zax, Zenith's outspoken chairman and president, dismisses any suggestion of reducing rates further until anticipated reductions show up in its system.

"You have to be able to separate the political puffery from the reality," he said. "More than half of the total costs of the workers' compensation system are health care related and health care costs are only increasing."

He suggested that because of that connection, businesses should expect only, a slight deceleration in rate hikes over the long run. Health care costs are projected to rise 12 percent this year, compared with 15 percent a year ago.

In addition, several of the key workers' compensation reforms will not become effective until January 1.

The remaining question is whether Zenith will lose some of the business it gained as competitors begin dropping their rates more aggressively.

One good sign: Zenith is showing renewed strength measured by a key financial metric known as the combined ratio, which fell to 90.7 percent in the first quarter, down from 97.5 percent in the like period a year earlier. That is, Zenith paid out 90.7 cents in claims for every dollar in premiums collected, compared with 97.5 cents in claims a year ago--meaning that even if rates drop, there is a built-in profit cushion.

Zenith's net income for the three months ended March 31 was $25.1 million, compared with $11.7 million for the like period a year earlier. Its property and casualty underwriting income nearly tripled to $21.8 million, while first quarter revenues rose 30 percent to $243.4 million from the year-ago period.

Share overhang

On the negative side, Fairfax Financial Holdings, Ltd., a Toronto financial services firm that is Zenith's largest shareholder, announced last week that it plans to reduce its ownership stake to 25 percent from 41 percent. The sale will add 3 million shares to the market float, on top of the 5 million shares already added by the company's recent 5.75 percent convertible senior note issuance. The added sales could act as a damper on the share price, taking the steam out of any further increases.

Still, Zenith has a large institutional following with a 9.6 percent stake owned by Gilder Gagnon Howe & Co., a New York brokerage firm; 8.1 percent by mutual fund provider Royce & Associates Inc.; and 5 percent by Barclays Global Investors.

Given the stock's strong showing it's hardly a surprise that Zax's salary and bonus jumped 22 percent last year to $3.3 million. Zenith also provides Zax with $5.2 million in term life insurance after the company eliminated a split-term life insurance plan in 2002. Zax owns 5.5 percent of the company's outstanding shares.

The company's directors, including Leon Panetta, the former White House chief of staff in the Clinton Administration, and Alan Rothenberg, a local banker, also are highly paid, with each receiving $62,000 a year and an additional $31,250 for each committee on which they serve.

Another tidbit gleaned from Zenith's April proxy filing is that Zax's daughter, who works as director of corporate communications for Zenith Insurance, earns an annual salary of $137,000.

Zenith National Insurance Corp.

Stock Prices

YEAR (Dec. 31)                 2003    2002

Revenue (millions)           $849.3   602.2
Total Expenses (millions)     752.7   603.5
Operating Income (millions)    96.7   (1.3)
Net Income (millions)            67   10.2
Earnings Per Share            $3.38   $0.54

Quarterly Premiums Earned (millions)

SUMMARY

Business: Workers' compensation insurer
Headquarters: Woodland Hills
Chairman: Stanley R. Zax
Market Cap: $925.4 million Dividend Yield: 2.4%
Total Liabilities: $1.74 billion P/E Ratio: 12.8
Long-Term Debt: $178.5 million