Minnesota Nice Meets Baltimore Brash.

When St. Paul acquired USF&G, it got more than it bargained for, including a severe culture clash. The company is hoping it can get oil and water to mix--and form a powerful bond.

Douglas W. Leatherdale, chairman and chief executive officer of St. Paul Cos., has a plan that has led the company through a major acquisition, the elimination of 5,550 jobs, the sale of its personal-lines business and a realignment of its primary insurance underwriting operations--all in the past two years.

As part of the plan, Leatherdale assembled a team of top executives that he says are the best and brightest from St. Paul and its most recent acquisition, USF&G Corp. To that mix, he added James Gustafson, who had been president and chief operating officer of General Re Corp., Stamford, Conn., as president and chief operating officer.

If the plan succeeds, Leatherdale anticipates that St. Paul will become one of the leading global commercial insurers, with a heavy emphasis on specialty products and niches. By acquiring USF&G, St. Paul achieved Leatherdale's goals for 2000 two years early. It received about $10 billion in revenue, with about $1 billion coming from non-U.S. sources, therefore positioning itself strongly in a consolidating marketplace and enhancing its likelihood of being a consolidator rather than a consolidatee.

But progress has not been without surprises and detours. The width of the chasm between St. Paul's conservative, introspective approach to business and USF&G's aggressive, outwardly focused strategies was greater than anyone expected, as was the conflict those differences would generate when it came time to eliminate jobs. No one foresaw that competing against the giants of the personal-lines market was so difficult that even the combined companies didn't stand a chance.

The Man With the Plan

Sitting behind his oversized desk with a panoramic view of St. Paul, Minn., behind him, Leatherdale spoke with the confidence and caginess of a man accustomed to planning his every move and every word. He is pleased with the overall outcome of acquiring USF&G, which St. Paul bought in April 1998 for $2.8 billion in a stock swap and assumption of about $400 million in debt and $300 million of capital securities. The merger moved St. Paul from the 16th-largest U.S. property/casualty insurer in 1997 to the 11th-largest in 1998 with $6 billion in net written premiums. In addition to its prominence in the medical-liability market, St. Paul moved into a position of leadership in reinsurance, surety and technology products.

Yet, Leatherdale said, "The most difficult part of the merger was taking two very different cultures and melding them together."

USF&G was aggressive because it had to be. Founded in 1896, the company had roots in Baltimore nearly as deep as St. Paul's ties to Minnesota. Then in the early 1990s, it suffered dire financial problems.

"The public never knew how close [USF&G] came to going under," Leatherdale said. "They tell stories that there were tunes they weren't sure if they could meet the payroll."

Under new management led by Norman Blake, USF&G kicked and clawed its way to survival, streamlining the organization and building on its market-focused culture.

"Whereas we prided ourselves on being quiet, they prided themselves on being well known," said Karen Himle, St. Paul's senior vice president for corporate affairs. "Years after they eliminated their Sugar Bowl sponsorship, employees still identified with that and being out there in the marketplace, whereas the St. Paul is used to our neighbors not knowing what we do."

Maybe the neighbors didn't know, but St. Paul was very aware of what its operations were. The company had a strong internal focus that surprised Gustafson when he arrived in January 1999.

"There was also a bit of doing things for the sake of process instead of for the end result," Gustafson said.

When Paul Liska, executive vice president and chief financial officer, joined St. Paul in 1997, he was annoyed by the amount of paper that crossed his desk. "You don't know how many reports I wrote across the top, 'Don't ever send me this report again,'" he said. "I get a lot less paper now."

By focusing so intently inward, St. Paul may have blinded itself to the needs of its clients and its agents, who found the company hard to do business with. USF&G, in contrast, was strongly focused on its clients. Its executives were held accountable for the performance of their business units, and they were used to taking drastic measures to reduce expenses.

Stephen Lilienthal, executive vice president for St. Paul's U.S. insurance operations, came from USF&G. "I run this like a real, live business," Lilienthal said. "I pay for your performance, and if you don't perform, you will not perform here."

Lilienthal acknowledges that his management style is aggressive, but he believes it's what shareholders expect. "I don't look at this as a religious or metaphysical experience," he said. "My job is only to bring shareholder value,"

Before buying USF&G, St. Paul spent a lot of time looking at the financial and market benefits of the acquisition--the neat fits of specialty areas, for example--and not much time looking at the vastly different cultures. Himle said the company should have found ways to smooth the transition as it blended the employees of the two organizations. "In the world of do-overs, that is one I would take," she said.

When the cultures collided, unfamiliarity led each side to ascribe characteristics to the other that weren't always accurate, slowing the process of learning from each other. But a year after coming together, St. Paul had new attributes gleaned from both sides, Leatherdale said.

The new St. Paul is more inclined to take risks than the old St. Paul, but less so than USF&G. The decision-making process is faster, and there's a higher tolerance for different ways of thinking and doing things. The new St. Paul is more performance oriented and outwardly focused.

The most notable example of the difference since the merger is the $20 million brand advertising campaign launched in September. St. Paul had never had a corporate advertising campaign in its 146 years of existence.

Bringing Down Expenses

One of the reasons St. Paul bought USF&G was the leverage that the acquisition could give the company in reducing expenses. During 1998, the newly combined corporation experienced an operating loss of $39.58 million from continuing operations. Between April 1998 and December 1999, St. Paul saved $260 million by eliminating 2,600 jobs made redundant or unnecessary by the merger.

"The human cost was the downside [of the acquisition]," Liska said. From a business standpoint, the layoffs had to be done, he said, and they "made us a stronger company."

From the day the acquisition was announced, St. Paul made a concentrated effort to let employees know what was going to happen and how they would be affected, Himle said.

The cuts began at the top. The managers in the top two tiers who were losing their jobs were notified within six weeks after the acquisition closed. Moving down St. Paul's organizational hierarchy, succeeding layoffs were announced every two weeks. The entire undertaking was completed within five months.

In an attempt to be fair and to keep the best talent, St. Paul used a formal selection process in which all employees had to interview for their jobs. The culture clash, however, added additional anxiety to an already anxious situation. "There was a lot of speculation about what kind of employee is going to get the job," Himle said. "If the competencies are equal, what are the cultural differences?"

Liska kept track of the layoffs in a thick binder with numerous charts of names and dollars. Knowing exactly where the company was in the process was critical to the program's success, he said. He tallied every month and knew to the person what was going on in each department.

Shedding Unprofitable Business

In addition to reducing fixed expenses, St. Paul needed to shed unprofitable business, particularly in the general commercial middle market. The acquisition of USF&G's book of business gave it the scale required to do that and still support the organization's extensive infrastructure and technology. By putting the two books of business together, "you can throw out the lousy parts of both and be all right," Liska said.

Market conditions have created the need to turn away business, Leatherdale said. a national broker told Leatherdale not to feel bad for the broker or the customer when he refused business. For every policy St. Paul turned down because of price, there were at least five or six other carriers that would take it.

The combined St. Paul and USF&G middle-market business started at $1.5 billion and dropped to $1.12 billion with a combined ratio of 125 by the end of 1998, Lilienthal said. Middle-market accounts range from $50,000 to $3 million in annual premium and have some degree of internal risk management.

Lilienthal expected St. Paul to have shed another $160 million to $170 million in middle-market business by the end of 1999. The company was losing about 30% of written premiums, but the loss ratio on the retained business is 10 points better than the business it turns down, Lilienthal said. "If I have a 10-point spread on business I keep and a 5% increase in price, I have something going," he said.

Lilienthal's goal is to bring the combined ratio to the low 100s, but it's going to take time. "If anybody tells you they can move a business from 125 combined ratio to 105 in two years, you go check them for drugs," he said. He's anticipating about 110 for this year.

A significant cause of bad business and large losses is bad underwriting decisions, Lilienthal said. As emphasis on specialty lines has grown, insurers have cherry-picked the best underwriters from the standard commercial lines. St. Paul is working to emphasize underwriter training and reinstill underwriting best practices, he said.

The St. Paul is also raising prices in all lines, although not the same percentage in all lines, Liska said.

No More Personal Lines

In addition to increasing its specialty commercial lines, St. Paul saw the USF&G acquisition as a way to enhance its presence in the personal-lines business. By buying USF&G, St. Paul increased its personal-lines business to $1.25 billion, but Leatherdale soon realized that was not enough bulk to compete with the heavyweights in that market. St. Paul's $1.25 billion represented a 1% share of the market.

"We did not anticipate that we would need to get rid of personal lines when we made the acquisition," Liska said. "We didn't anticipate it would get that bad that quick."

St. Paul focused on making the business profitable at end of 1998, which, along with the size of the combined operation, made it more attractive to potential buyers. Metropolitan Property & Casualty Insurance Co., which is based in Warwick, R.I., and uses the brand name MetLife Auto & Home, bought St. Paul's personal-lines business for about $600 million on Sept.. 30.

"It was not a hard decision," Leatherdale said. "Five or six companies with 50% to 60% of market share and thousands chasing the other 40%. We would never catch up. And we were under constant pressure to reduce our expense ratio to be competitive."

More Expense Reduction

The St. Paul transferred 1,700 employees to MetLife Auto & Home, but it still had to cut an additional $100 million of fixed expenses. "The price increases that we're getting are sporadic," Leatherdale said. "If revenues aren't there, you can't have expense growth. Margins are already squeezed because loss costs continue to go up and the pricing of your product isn't."

The company targeted 500 to 600 people who were indirectly associated with personal lines who would be cut. Then it estimated that it would need to eliminate another 1,000 positions. In the end, the total number of layoffs needed to reach the $100 million goal was 1,250.

When St. Paul announced the new cost-reduction program in August, it began a thorough analysis of every job in the company "We challenged people to step out of the box and say how am I going to do this differently," Liska said. Lilienthal has cut the number of employees in his group by more than 40% since the acquisition. "They didn't think we had a lot of fat, but they do now because nothing happened," he said. "We didn't lose any functionality."

After the August announcement about job cuts, the company was filled with tension for eight weeks, Leatherdale said. Then managers broke the bad news to the individual employees. "We took two days off to mourn," Leatherdale said. "Then we had a meeting to adopt where we were going."

Leatherdale said he didn't anticipate any more layoffs unless there was another major downturn in business.

At the End of the Day

Opinions vary about whether the acquisition of USF&G was a good move for St. Paul. Michael Schroeder, an insurance industry analyst with Wasmer, Schroeder & Co., Naples, Fla., said it's too soon to tell how much value St. Paul can extract through cost savings and synergies. With continued weak pricing in the property/casualty industry, the company may have been better off waiting until it could acquire USF&G at a lower price.

St. Paul paid less than many people think, said Bijan Moazami, property/casualty analyst for Friedman, Billings, Ramsey & Co., Arlington, Va. It paid for USF&G with stock, which afterward "went down the drain;' he said. "So they paid for it with currency that they knew full well was overvalued."

The stock plunge is another reason some people think the acquisition was a bad idea, but the stock would have dropped anyway with or without USF&G, Moazami said. Earnings in 1996 and 1997 were unsustainable because they included prior-year reserve releases of $446 million and $671 million, respectively, he said.

The-acquisition gave St. Paul size and dominant market share in certain lines, added new businesses and allowed cost savings, Moazami said. He highlighted the merger's impact on the standard commercial book of business. The merged business has a better combined ratio, and the company manages it actively, he said.

"The guy who does it, Steve Lilienthal, came from USF&G. [He's] an extremely smart guy and probably the most hated man at St. Paul because he's laid off so many people," Moazami said,

From a broker's viewpoint, however, the merger had a downside.

Vic Krauze, president and chief executive officer of Willis Corroon of Minnesota, said the acquisition slowed St. Paul's writing of new business. "It seemed it was a little harder to digest than they anticipated and required more expense cutting than they anticipated," he said.

Also, the fact that many of the people Willis had worked with in the past are no longer with St. Paul made it difficult to do business, he said. "Our objective is to get to know the new people and get things back to where they were," he said.

A Whole New World

Things at St. Paul will never be exactly the way they were. Gustafson said he tells employees, "if you're longing for the past, get over it, because we're not going back there."

Yet today's St. Paul Cos. is a mixture of old and new. Even the new headquarters, constructed with Minnesota granite and limestone in 1994, incorporates the advantages of modern architecture in ways that make it blend in with the historic churches, theaters and government buildings of downtown St. Paul.

Founded in 1853, St. Paul is older than the state of Minnesota or the city of St. Paul. All three were founded the same year, but the territory chartered the St. Paul Fire & Marine Insurance Co. first. Inside the venerable company's headquarters, contemporary paintings and sculptures grace the walls and halls. In a spirit reminiscent of traditional paternalistic insurance companies, St. Paul provides comprehensive employee benefits. Many of those benefits were cutting edge at the time they were begun and continue to be.

"We started talking about putting in a day-care center in the late 1980s before anybody cared about Working Mother magazine," Himle said. The center in St. Paul opened in 1991 and cares for 120 children. The center's exterior walls look like the new architecture, but the sharp edges are beveled so if children run into them, they won't be hurt.

Many of the company's offices outside St. Paul have onsite day care run by independent operators, and all employees have access to a national day-care network that will help find alternative day-care arrangements. For employees who want to adopt children, the company offers financial assistance. There is also a network for employees who need help in caring for elderly parents. An onsite fitness center, flex hours and compressed work week are other options for employees.

Currently St. Paul is looking into providing child care for sick children, Himle said. "We understand that the best and the brightest will work for companies that understand work and family issues, that support diversity in the workplace, that understand the flexibility that adult human beings need regardless of whether they have children, their age or their status," she said.

The Shape of Things to Come

When Leatherdale launched his plan for St. Paul in 1992, he had 20 years during which he learned the company's strengths and weaknesses. He came to St. Paul in 1972 as vice president of equity investments and was named president and chief operating officer in 1989 and chairman and chief executive officer in 1990. "He's the first St. Paul CEO who doesn't have an insurance background," Himle said. "He's an investment person, but he had a view of the business future for the company."

Two important aspects of that business future were niche marketing and rapid growth outside the United States. In 1992, the company had very little international presence. Over the next five to six years, company leaders decided which countries they wanted to be in, hired staffs and began building businesses around specialty products and risk management, an understanding that was rare in the rest of the world.

With that infrastructure in place, St. Paul in October began to restructure its primary insurance underwriting operations into three organizational components: global specialty products, U.S. operations and international operations.

A New View of the World

The global specialty products segment has worldwide responsibility for product development, strategic planning, pricing and risk selection for surety, medical services, ocean marine, technology, financial and professional services, public sector, oil and gas, and excess and surplus lines, plus a new unit, alternative risk transfer. U.S. operations and international operations segments are responsible for distribution of all commercial and specialty commercial products.

Gustafson said the realignment had five goals:

* to continue focusing on specialty businesses that are the bedrock of the company;

* to turn around underwriting results in the more undifferentiated lines of commercial insurance;

* to make it easier for U.S. brokers and agents to do business with the company;

* to organize in a way that provides a platform to grow; and

* to evolve from being a U.S. company to a U.S. company with some international operations to a global company.

The new alignment is designed to move new products to market more quickly, Gustafson said. When each vertically organized product line had to do everything--develop products, introduce them, get them to market, price them and manage distant operations--some of the resources needed for product evolution or new product development were consumed in other ways, said Michael Miller, St. Paul global practice leader.

St. Paul expects that quickly moving products to market will keep its agents and brokers happy. That was not the case before the realignment.

Reaching the Market

Almost all of St. Paul's U.S. production comes from independent agents and brokers. So when the agents and brokers said the company was hard to do business with, St. Paul began to listen. Under the old configuration, specialty businesses were responsible for their own sales and distribution, almost as if they were stand-alone businesses. "We were vertically integrated to the center of the earth," Lilienthal said. "It was a significant competitive disadvantage."

Consequently, an agent who wanted to work with different business segments had to contact different St. Paul offices, and sometimes just finding out whom to contact was difficult. At the same time, individual business segments might have no idea what other St. Paul products an agent sold and, therefore, might make decisions that were good for their segment but not necessarily good in the aggregate for St. Paul.

"We underleveraged the franchise value of an agent to our company," Lilienthal said.

Agents had to know exactly where to go to do business with each specialty; said Krauze of Willis. Moreover, each specialty had different risk strategies that agents needed to understand.

With the realignment, seven regional presidents across the United States will manage the distribution and operational strategies for all business segments of the company within their defined territories. An important part of that management will be coordinated planning in which representatives of appropriate business segments will meet jointly with an agent instead of meeting separately, as had been the case.

Selling Online

Although St. Paul remains firmly committed to independent agents, Lilienthal believes that there will be opportunities to sell certain small commercial products over the Internet. The company's Geo Vera operation already sells earthquake insurance online to California homeowners.

"It's not merely that the Internet can help reduce costs;" Lilienthal said. "Customers are telling us how they want to buy insurance, and they're pushing us to reduce our cost structure and leverage the money we're spending on technology"

We spend hundreds of millions of dollars on technology and if all we do is automate manual transactions, we've achieved nothing, he said.

Focusing on the Core

As Leatherdale moves St. Paul toward his goal of being a leading global commercial insurer with emphasis on specialty products and niches, there is speculation about what will happen to parts of the company that fall outside those parameters.

Leatherdale acknowledged that St. Paul always would have a piece of the middle-market commercial business. He also wants to be one of the top 10 reinsurers in the world. St. Paul ranked 21st among global reinsurers based on 1998 gross premiums, according to A.M. Best Co.

St. Paul wrote about $1 billion in reinsurance in 1999. Leatherdale wants to double that amount and change the mix from 60% domestic, 40% international to a 50-50 balance. He would also like more casualty and less property business.

He said the company would reach its reinsurance goals through organic growth and acquisitions. "I would look for things that are a little bit different and would give us a little different client base, particularly outside the United States," he said.

He also wants to make acquisitions in primary insurance, but he said they would be "bolt-on" acquisitions, more in the nature of a new product or a piece of a company than a major merger like USF&G.

The future of some of St. Paul's other operations is less certain, particularly its nonstandard auto business, which includes Titan Insurance Co. and Victoria Fire & Casualty Co; its life company, F&G Life; and its asset-management segment, the John Nuveen Co. When asked about his plans for nonstandard auto and F&G Life, Leatherdale smiled mischievously and said, "If I answered that directly, I'd have to issue a press release this afternoon:" Both businesses are profitable, he said, but they're both small players in their respective industries.

Analysts are less evasive. Moazami predicted that St. Paul would sell both the nonstandard auto and F&G Life as soon as it could. He also predicted that the company would sell John Nuveen if it could find a tax-efficient way to do it. "The valuation of John Nuveen kind of disappears within the valuation of the St. Paul Cos.," he said.

Leatherdale said Nuveen contributes a substantial amount of earnings to St. Paul and takes very little management time. "We paid $9 million for it in 1974, and it has a market cap today well in excess of $1 billion on the New York Stock Exchange," he said.

To Sell or Be Sold

Another question up for grabs is whether St. Paul itself might be acquired. "They're all takeover candidates as long as the bite's not too large to swallow," said Schroeder of Wasmer, Schroeder & Co. As recently enacted financial services reform legislation removes Glass-Steagall barriers, "the St. Paul Cos. might be attractive to a larger financial-services concern like American Express rather than another insurance company," Schroeder said. "But that doesn't mean they wouldn't appeal to another insurance company."

Leatherdale agreed that St. Paul could be a takeover candidate, but he said there was little a company could do to protect itself. "The only two things that matter are did you make Wall Street's consensus estimate for this quarter and did your stock go up," he said. "And that's no guarantee."

St. Paul's board of directors and its management are committed to remaining an independent company, Gustafson said. "Somebody asked me if I lost sleep about [being a takeover candidate], and I said I can't figure out what my not sleeping would do to help," he said.

Five Years From Now

Leatherdale intends to keep his plan in place. If he was way, five years from now, St. Paul will look very much the same as it does today, only bigger and itable. He also plans to maintain the company's strong balance sheet.

"At the end of the day, we sell a promise "You can only sell that if you have the fit to back it up."

                              Combined Ratio
         Loss Ratio Expense Ratio
1994        72.5        32.0      104.5
1995        72.2        31.1      103.3
1996        73.2        31.9      105.1
1997        71.1        32.7      103.8
1998        82.1        34.1      116.2
1999 [*]    74.5        32.9      107.4
(*.)First six months of 1999
Source: St. Paul Cos.
                         1998 Investment Portfolio
Fixed Maturities                 77%
Equities                          4%
Real Estate and Mortgage Loans    5%
Venture Capital                   2%
Short-Term and Other Investments 12%
Source: St. Paul Cos.
                         1998 Premium Distribution
Commercial Lines       37%
Personal Insurance [*] 22%
Specialty Commercial   20%
International           5%
Reinsurance            16%
(*.)Personal lines sold to MetLife Auto & Home in 1999
Source: St. Paul Cos.

A Brand New Campaign

When someone mentions the St. Paul Cos., what image comes to mind? In the past few years, anecdotal evidence has indicated that people who recognized the name pictured an old, stable insurance company--but nothing unique. In 1996, St. Paul set out to change that image.

The first step was hiring Bruce Martin from a company well known for its brand: Proctor & Gamble. Three years later, St. Paul rolled Out a $20 million advertising campaign aimed at establishing its brand. The fact that the campaign is under way illustrates the new St. Paul mentality, achieved through the merger of St. Paul and USF&G, said Karen Himle, St. Paul's senior vice president for corporate affairs. "If it weren't for the acquisition, we probably would still be talking about it," Himle said.

A brand is a company's personality. A lot of insurance communications tend to talk about financial strength and claims service, but those are attributes rather than a brand personality, said Martin, who is St. Paul's vice president for corporate marketing. They're not differentiating factors, because all companies must have them.

Last year, St. Paul spent about $500,000 on advertising related to its acquisition of USF&G, but until this effort the company hadn't had a national advertising campaign since its founding in 1853. The closest the company had ever come to having a distinguishable identity was after the 1871 Chicago fire, Himle said. St. Paul was the only company that was able to pay every claim, dollar for dollar, without going belly up, because the owners of the company put some of their own money on the table to satisfy claims. At the beginning of the 20th century, St. Paul became known as the "dollar-for-dollar company."

To develop St. Paul's 21st-century identity, company officials examined its history and values, supported by its attributes, to determine what differentiates the company. They settled on trust. The ads are designed to communicate that "this company is trustworthy; they're serious about what they do and they take their commitments very, very seriously," Martin said.

Using those concepts, national marketing communications agency Campbell Mithun Esty created two 30-second television spots and five black-and-white print ads. The TV ads kicked off Sept. 27 on Monday Night Football and also are broadcast on CNN's "Headline News" and CNBC's "Marketwatch." The print ads appear in Time, Newsweek, US. News, Forbes, Fortune, The Wall Street Journal, Money, Black Enterprise and Hispanic Business. The print ads also are used in direct mailings to agents and brokers.

The most emotive ad-seems-to be the ad that kicked off the campaign. In the TV version, a young girl stands unflinchingly while a 4,500pound rhinoceros races toward her. At the end, the rhino comes to a dramatic stop inches from the girl, then stands still as she gives the beast a kiss. A voiceover says, "Is there an insurance company where a 146-year history proves your trust is not misplaced? Without question. The St. Paul."

Another TV ad, featuring a matador and a bull, says, "Is there an insurance company that believes the most important thing they cover is the risk you didn't think of? Without question. The St. Paul." The point of the ad is to build the consumer's trust that the "coverage that has been written is developed by people who know your business and your industry better than anybody else," Martin said.

The campaign's target audience includes independent agents and brokers, risk managers and other corporate executives. Demographically, that group consists of well-educated, high-income men between the ages of 35 and 60, Martin said. "But we do hit female and multicultural audiences proportional to the percentage they make up of our overall audience," he said.

Martin expects that with creative updates the campaign will run forever. "This is not a one-time branding campaign," he said. "This is an investment. It's like a small acquisition. We want to feed it, build it over time."

If effective, a brand enables a company to justify a small premium increase, because there's something that makes the company different in the consumer's mind, Martin said.

Right now, Internet advertising is not a high priority for St. Paul. Pricing is inconsistent and banner headlines, which comprise the bulk of Internet advertising, don't provide a lot of opportunity to do brand selling, Martin said. "We might have chased the Internet piece a little faster if we still had the personal-lines business," he said.

St. Paul at a Glance

The St. Paul Cos. is a group of companies providing property-liability, life insurance and reinsurance products worldwide. St. Paul is the 11th-largest property/casualty insurance company in the United States, based on 1998 net premiums written, and the 21st-largest global reinsurance company, based on 1998 gross premiums written, according to A.M. Best data.

Chairman and CEO: Douglas W. Leatherdale

President and Chief Operating Officer: James E. Gustafson

Established: 1853 by Alexander Wilkin, secretary of the Territory of Minnesota, to serve locals who had become frustrated with slow service from faraway insurers

Number of Employees: 11,000

Agents: 3,300 independent agents and brokers

Offices: 200 offices around the world, three-fourths of which are in the United States

Companies: St. Paul Fire & Marine Insurance Co., St. Paul International Underwriting, St. Paul Re, F&G Life and The John Nuveen Co.

Financials: For the first nine months of 1999, St. Paul Cos. posted a jump in net income to $695.5 million, or $2.85 a share, from a loss of $11.4 million, or 9 cents a share, a year earlier. Operating earnings for the first nine months totaled $621.3 million, from $407.8 million a year earlier.

For the first half of 1999, the company had net premiums written of $2.87 billion and policyholders' surplus of $4.21 billion, according to A.M. Best Co. data.

New York Stock Exchange Listing: SPC 

Growing Abroad

In 1992, the St. Paul Cos.' international presence included a small business in the United Kingdom and a microscopic business in Spain. Today, the company has offices in 14 countries outside of the United States. In 1992, St. Paul wrote less than $100 million in business abroad. Expectations for 1999 include more than $600 million written in business outside the United States, and the goal for 2000 is $800 million.

What Happened?

The big push began in 1994 to identify the right markets, hire the right people to work there, define the markets' needs in areas where St. Paul had expertise and develop products to meet those needs. As those pieces began to fall into place, they paved the way for the realignment of St. Paul's primary insurance operations that created, along with two other organizational components, the global specialty products segment in 1999. That segment now is responsible for worldwide product development, strategic planning, pricing and risk selection for each of the St. Paul's specialties.

"Our international strategy is to build these markets one line of business at a time and one country at a time," said Kent Urness, St. Paul global practice leader for medical services, ocean marine and technology.

Unlike many companies, St. Paul didn't look to expand internationally by capitalizing on operations its domestic clients had abroad. Instead, the company found indigenous business in the markets it selected. Potential clients hadto be commercial industrial specialty companies with a minimum amount of size, Urness said. They also had to be located in a country that did not have onerous regulatory restrictions. "We looked first where we could write liability coverage, because it's easier to differentiate yourself on the liability side than on the property side," Urness said.

St. Paul does business in Australia, Brazil, Ireland, Canada, the United Kingdom, France, Germany, the Netherlands, Argentina, Spain, Mexico, South Africa, Botswana and Lesotho. From its office Brazil Australia, the company will look for business in Newzealand, Hong Kong and other areas of opportunity in Southeast Asia, Urness said. "This area cannot be supported from United States or Europe," he said. "With the help desk, for example, you need somebody there during their working hours."

The realignment has enabled staff increases in each line of business in each office. Administrative resources--such as counting, finance and information technology--are centralized in London and other base cities, so people on location in London various countries can concentrate on business development, accounts, claims and risk management, Urness said. "We're doing risk management, and the rest of the world is miles hind in that," he said.

International distribution is done mostly through independent brokers, Urness said. International brokers such as Marsh & McLennan and Willis have a strong presence abroad, but there are also local brokers. Occasionally, a company will insist on working without a broker, but "if there is a way to do it with a broker, that is our first, second and third choice," Urness said.

Eventually, St. Paul wants each of its international offices to be a $50 million business, but a more important target is that each office will be profitable in its fourth year, Urness said. "If people ask when we are going to make money on international, I respond, 'We are making huge investments in setting up new operations around the world,'" he said. "But if you look at countries where we have had an operation for three four years--the United Kingdom, Spain and Ireland, for example--we have met or exceeded our fourth-year profitability goals."

A New Direction

As part of the realignment, St. Paul added a new unit, alternative risk transfer, to the global specialty products segment. Alternative risk transfer is risk-assumption arrangements that are not necessarily traditional insurance structures and could include earnings protection, mergers and acquisitions protection, financial-support guarantees and residual value protection, said Michael Miller, St. Paul's global practice leader for financial and professional services, public sector services, oil and gas, excess and surplus lines and alternative risk transfer.

These are business risks that are outside the traditional liability and property risks and that traditional products haven't touched, Miller said. Residual value, for example, has become a risk, particularly since the advent of the car-leasing business. At the beginning of a lease, an estimate is established for what the value of the car will be at the end of the lease, but that estimate may not be accurate. A residual-value product protects against the difference in predicted residual value and actual residual value.

Another example of an alternative risk transfer is a product guaranteeing financial remuneration if a forest plot purchased by a paper manufacturer doesn't produce as much paper as expected.

Guarantees and agreements on valuations are critical to these kinds of special products, Miller said. It is also critical to St. Paul that the client is a significant participant in the risk. "They assume part of the risk and work with us--through mitigation techniques--to limit risk exposure," he said.

Many alternative risk-transfer arrangements are global arrangements, but Miller anticipates the business in the United States is only a fraction of what it will be in the future. It's the first new revenue stream to come along in the United States in a long time, he said.

Alternative risk transfer also represents the convergence of financial services and insurance services. "Many of our competitors [in this line] are not insurance companies," Miller said.

Two-Pronged Claims Approach

Once upon a time, when margins of profitability were high, the St. Paul Cos. serviced every claim the same way. But times have changed, margins have changed and customer expectations have changed, giving rise to St. Paul's two-pronged approach. It's a business model the company has been building for several years and has pushed since the merger of St. Paul and USF&G Corp. in 1998.

It's a model that works well in the United States in terms of the company's commercial organization and its differentiation on the specialty side, said Michael Conroy, St. Paul's executive vice president and chief administrative officer.

The idea is to divide claims into two categories based on the complexity of the claim. It's nearly impossible for a company to differentiate itself based on how it adjusts fundamental property, auto physical damage and some workers' compensation claims, Conroy said. Price is very important to those customers, so you give them an efficient claims-handling process with a lot of centralization, and you keep expenses down, Conroy said. "You can't survive in this marketplace if you're providing services you don't get paid for," he said.

For filing those claims, St. Paul promotes the toll-free number at its central reception center in Tampa, Fla. Also, last year the company introduced an online filing service for workers' comp, automobile, general liability, property and medical liability claims. So far, the majority of claims reported via the Internet have been workers' comp claims, but St. Paul expects more customers to want that access in the future, Conroy said.

The second category of St. Paul's business model for claims includes service-driven workers' comp, complex property, other general liability, auto bodily injury and professional liability claims. Those types of claims require expertise and possibly legal representation, so they are referred to one of St. Paul's national general adjusters. They also have the support of a group that manages legal exposure from claims. "We refer to it as CLEM," Conroy said, for Claims Legal Exposure Management.

CLEM personnel are trial attorneys who previously worked in private law firms. They provide legal oversight, trial strategy and negotiation strategy, and they approve the defense attorneys selected to represent St. Paul's clients.

Conroy admitted that compensation for this group is expensive, but he said the ability to reduce overpayments made it worth the cost. What a company pays out in indemnity dollars is by far the largest portion of its loss costs and, therefore, presents the best opportunity for improvement, he said. It is possible to measure what a company should have paid for a claim vs. what it actually paid, he said.

Also in the service-oriented category, Conroy said he hoped to improve Internet access for customers who want to inquire about the status of their claims. A problem with that kind of service is the lack of a common industry platform, he said. "If you're an agent or a large commercial insured and you deal with more than one company, you may have to go through more than one portal," he said. "We need to allow the customer to come through a common portal."

After the merger with USF&G, the two companies had to be converted to a single-claim system; Conroy said the conversion wasn't difficult. "Everybody has to know we're going to look at claims-handling processes and pick the best," he said. "One of the things we do well here--and we learned it from our mistakes--is merger and acquisition. We consider that a core competency."

Some of the domestic claims-handling strategies can be applied globally, but there are differences in laws and customs, Conroy said. Claims managers abroad have to develop their own systems, he said.