Hit hard by high risk ventures out west, Covenant Group returns to native business. (company profile)

HIT HARD BY HIGH RISK VENTURES OUT WEST COVENANT GROUP RETURNS TO NATIVE BUSINESS

The Covenant Group is relieved to be coming back to New England after a tumultuous sojourn doing business on the West Coast. It's coming back a little battered, but it has renewed hope for its traditional lines of auto and homeowners insurance in the six-state region.

In recent years, the company was doing business in California, plus a little bit in Texas and Alaska. This was in a category it called "Special Risks," which included some of the most volatile property casualty markets. If you're looking for Covenant's shirt, it's lost. Look in Alaska where it insured the aircraft of bush pilots. Consider California mud slides and some of juries of the Golden State, where Covenant wrote homeowners policies.

The story is told in the records of A.M. Best, which assesses the financial strength of insurance companies. Covenant's report card from Best has fallen from an A to a C, the lowest letter grade Best confers. (The next step down is Best's refusal to confer a grade.) From 1981 to 1984, Covenant Mutual reports to regulators show it lost a total of $15 million, $12.5 million of it in 1984. Covenant's surplus decreased for three years running, falling by 41% in 1984 from $27.4 million to $16.1 million. Yet, even in the early '80s while the company was losing ground, it continued to increase its volume of business.

By 1985, the years of red ink had brought Covenant Mutual to the point that more liquidity was needed, even though it had given up the whole "Special Risks" program and was trying to wind down the business. The answer it found was to sell some stock to outside investors and to borrow capital through an elaborate transaction involving its Employee Stock Ownership Plan.

While Covenant Mutual is owned by its policyholders, it owned 98% of the stock of Covenant Corp., a downstream holding company. The remainder was held by Covenant Corp.'s Employee Stock Ownership Plan. Covenant Corp. in turn owns all of Covenant Insurance Co., which does Covenant's traditional New England insurance business.

In July of last year, Covenant Corp. sold the majority of its stock to its ESOP and to the clients of Connecticut investment adviser, Philo Smith, who had joined the Covenant board two months before. Smith purchased 18% of the Covenant Corp. stock for $5.7 million, and the company's employee stock option plan (ESOP) bought another 31% for $10 million.

The ESOP already owned 2% of Covenant Corp. To finance the additional stock purchase, the ESOP borrowed $10 million from Covenant Corp., which had borrowed the funds from Connecticut Bank and Trust. The Covenant loan is to be repaid over a seven-year period. The transaction was structured so …