Progressive's chairman draws fire for gains

THE BALTIMORE SUN

Since Cleveland financier Alfred Lerner became a major investor and chairman of Progressive Corp. in 1988, the auto insurer's stock price has tripled.

"He's a winner," says Alan C. "Ace" Greenberg, chairman of Bear, Stearns & Co., Mr. Lerner's longtime investment banker. "The guy wins and stockholders win."

But it's Mr. Lerner's own big winnings at Progressive -- known for its shrewd underwriting of policies for high-risk drivers -- that have drawn the fire of other Progressive stockholders. They say Mr. Lerner has enriched himself through his role as the company's chief financial strategist, including an unusual money-management contract that has generated $105 million in fees for a Lerner-led firm.

From 1989 to 1991, Progressive Partners, a firm 50 percent-owned by Mr. Lerner, received a total of $50.9 million for managing Progressive's $2.6 billion investment portfolio, despite Progressive's seemingly unspectacular investment results.

This year, after critics questioned the size of those payments at a time when Progressive was laying off hundreds of employees, Progressive paid another $54.6 million to buy out the remainder of the Lerner firm's lucrative 10-year money-management contract, struck in 1988.

"A lot of people think the company was taken to the cleaners" by agreeing to make such big payments, concedes Peter Lewis, Progressive's chief executive officer, who negotiated the money-management deal with Mr. Lerner to get him to help Progressive. "People have said to me: 'You're being taken advantage of.' "

Mr. Lewis defends Mr. Lerner's role, saying he has shaped Progressive's financial strategy in ways that have reaped hundreds of millions of dollars in benefits. For example, Progressive has bought back 10 million of its shares, one-third of the total, over the past few years at prices $300 million below the current market. "I think it was a good deal -- I think time will vindicate it," Mr. Lewis says; he even compares Mr. Lerner to basketball star Michael Jordan.

For his part, Mr. Lerner declines to discuss the details of hi investing strategy or how his returns generated such hefty fees. "I think we have delivered to the shareholders very respectable appreciation during the period of our involvement," he says. "I don't think it begins and ends with it being a lot of money."

Mr. Lewis acquired Progressive in 1965 for $4 million and built it into the leading insurer of drivers who have had accidents or gotten speeding tickets. However, Mr. Lewis' weakness in investing came to the fore after the 1987 stock market crash, when he fired his investment staff and sold all Progressive's stocks at the market's bottom, taking a $44 million loss.

Like Mr. Lewis, Mr. Lerner is a self-made Cleveland tycoon who built his fortune, estimated at $465 million, by investing in banks and real estate. In 1987, the two men teamed up to buy 9.6 percent ofCleveland bank Ameritrust Co., which bought back the stock at a profit. Mr. Lerner is chairman and 9.5 percent owner of MNC Financial Inc., parent of Maryland National Bank, and chairman and 11 percent owner of MBNA Corp., MNC's former credit-card subsidiary.

To entice Mr. Lerner to help Progressive, Mr. Lewis offered him the chance to invest $75 million in the insurer on very favorable terms. Mr. Lerner got a bond that paid interest at the prime rate and is convertible into three million Progressive shares at $25 a share, about where the stock was then trading. The option gave Mr. Lerner an equity stake nearly as large as Mr. Lewis', who owns 3.6 million shares but has been selling stock over the years.

The value of Mr. Lerner's 20-year stock option was the subject of controversy. Progressive's investment banker at the time, Morgan Stanley & Co., said it would cost Progressive's shareholders tens of millions of dollars; Bear Stearns, Mr. Lerner's banker, said it was "fair" to Progressive shareholders.

Bear Stearns soon won the role as lead underwriter of two Progressive bond issues totaling $300 million before the end of 1988. And Mr. Lerner quickly hired a former Bear Stearns investment banker, Michael Murr, to run Progressive Partners day-to-day.

The payouts on the investment contract raised eyebrows once they began being reported in Progressive's annual proxy statements. Progressive Partners received $16.6 million in money-management fees in 1989, $14.7 million in 1990, and $19.6 million in 1991. No one will specify the formula that led to the payouts; but more than half represented incentive pay for beating a preset target return or yield.

The annual payouts amounted to about 1 percent of Progressive's portfolio, or triple the average for property-casualty insurers, according to William Bitterli, an analyst at Northington Partners Inc. in Avon, Conn. "Generally, [Progressive] investors said that's really high." Among holders that complained: Alliance Capital Management L.P., which owned 1.3 million shares at midyear.

The money-management contract "turned out to be more expensive than anybody anticipated," Mr. Lewis says. "Whenever you make a deal and have formulas, you don't know how it's going to work out." Terminating the contract early and putting the Progressive Partners investing staff on Progressive Corp.'s payroll will save $13 million annually through 1998, Progressive says.

Others aren't so upbeat. "A lot of people would say he [Mr. Lewis] paid way too much, and it was inappropriate and unnecessary; but that wouldn't change Peter's mind," says Cleveland accountant James B. Wolf Jr., a former director of Cleveland-based Progressive.

The big payouts to the Lerner-led firm may have reflected shrewd negotiating by Mr. Lerner, because Progressive investment performance since 1988 hasn't been remarkable. Indeed, Progressive reduced the maturity of its bond and mortgage portfolio, reducing its returns at a time when interest rates were declining.

"Arguably, they shouldn't get much compensation because they've carried a lot of short-term investments in an environment where rates were going down," says Jeff Everett, an insurance analyst at Templeton, Galbraith & Hansberger Ltd., which has sold 2.7 million of its 3.4 million Progressive shares since 1990.

Mr. Murr, the Progressive Partners executive, says the maturity was shortened in order to reduce the investment risk, because Progressive Corp. was taking on financial risk by buying back its stock.

However, Progressive departed from its policy of avoiding risk when it took a chance on a new stock issue in January 1991, investing $49.5 million -- equal to 22 percent of its entire stock portfolio -- in 2.2 million shares of MBNA, the credit-card company that was sold in an initial public offering by Mr. Lerner's MNC Financial. That offering was co-managed by Bear Stearns.

Progressive acquired the shares at a time when MNC, whose stock had fallen by 90 percent, desperately needed the proceeds of the MBNA offering in order to stave off a financial crisis. Although the price of MBNA stock has since soared by 78 percent, some shareholders criticized the Progressive investment. "That was an egregious conflict of interest," says Templeton's Mr. Everett. (Nonetheless, Mr. Everett says Mr. Lerner's overall impact on Progressive "has been positive.") Mr. Lewis says he didn't see any conflict, and was only sorry Progressive couldn't have bought more stock.

Mr. Lewis says Mr. Lerner's advice has been worth every penny. "Having Al and Progressive Partners to manage our investments and capital structure, having a buddy to talk to about problems -- I don't know what that's worth, but probably hundreds of millions of dollars." He adds, "I'd do it all over again."

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