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SEATTLE-SAFECO Corp.'s $2.8 billion acquisition of Indianapolis-based American States Financial Corp., announced last week, will create the 12th largest property/casualty insurer in the United States.

The acquisition will give SAFECO its desired stake in small to medium-sized commercial business and extend its geographic strength from the West to the Midwest.

Fort Wayne, Ind.-based Lincoln National Corp., which now owns 83.3% of American States' common stock, will use the proceeds of the sale to focus on life insurance and its other asset accumulation businesses.

Combined, SAFECO and American States had 1996 revenues of $5.9 billion. The deal is expected to close by the end of September.

For American States' policyholders, the sale will be neutral to positive, as they could benefit from SAFECO's expertise in commercial lines.

SAFECO is not getting a bargain, analysts say. The $2.8 billion SAFECO plans to pay for American States, which amounts to more than two times book value, is a "full price" and one that could raise the stakes on future deals, analysts warn. But they also note that unlike some other deals, American States is a strong, well-managed company with no significant problems.

There is relatively little overlap in their operations, which means SAFECO will not be able to introduce significant economies of scale. But, in addition to extending its geographic reach, the deal will enable SAFECO to almost double its sales force. There is an overlap of only about 800 agents between American States' 4,800 agents and SAFECO's 4,200.

The deal is a case of "one plus one equals three," said George Yonker, SAFECO's vp-finance. It "will enable us to achieve the three strategic goals," he said. They are to:

Expand and diversify geographically.

Diversify product line.

Become a "premier" independent insurance agency company.

"SAFECO is probably already the premier personal lines independent insurance agency company, and American States is certainly a premier small commercial independent insurance company," said Mr. Yonker.

"When you combine those two, it gives us a lot of synergies that should be beneficial both to our agents and to their customers, which should enhance our ability to grow and grow with profit," he said.

Although the deal is not expected to impact earnings per share in 1998, it should mean a 7% boost in 1999, an 11% increase in 2000 and about 15% in 2001, and "that should continue to increase as well as we go forward," he said.

Mr. Yonker noted commercial business now represents about 25% of SAFECO's total business, and 20% of that is small commercial business. Plans call for moving SAFECO's small commercial business to American States. "We think that they have better systems and better support for that type of operation," said Mr. Yonker.

SAFECO's medium to large commercial business will be retained at its Seattle headquarters.

American States' policyholders "have a more experienced management team in charge of their company, with a better record, so they should be better off in the long run," commented Russell R. Miller, chairman of Russell Miller Corporate Finance Inc., a San Francisco-based insurance industry specialty banker. "Usually that translates into lower operating expense and eventually lower premiums to the policyholders," he added.

Analysts praise the deal as beneficial to both SAFECO and Lincoln National.

The industry is overcapitalized and commercial lines is a mature business, so "it makes a lot of sense strategically for SAFECO to think about ways to increase its presence and market share," said John Hall, senior insurance analyst with Alex. Brown & Sons in Baltimore.

"From the point of view of Lincoln, you have company that did not have a lot of synergies between property/casualty and its growing life and asset accumulation business, a company that was suffering earnings volatility from its property/casualty business and that was affecting the overall valuation of the enterprise," said Mr. Hall.

Others agree the deal makes strategic sense. "For SAFECO, strategically, it's exactly what they wanted, more commercial business and more Midwestern," said Gary Ransom, an analyst with Conning & Co. in Hartford, Conn. "For Lincoln, they got a great price, a price that was higher than most people would have anticipated."

"I think it's a good fit, maybe a better fit with SAFECO than almost any other company" because of their similar cultures, said Gloria Vogel, senior vp at Advest Inc. in New York.

One reason SAFECO paid as high a price as it did for American States was that many others were interested, too, including USF&G Corp., Travelers Property Casualty Corp., Liberty Mutual Insurance Co. and the Hartford Group Inc. A spokeswoman for Hartford would say only the insurer had "considered the business opportunity presented by American States" while spokesmen for the remaining insurers had no comment.

"I think American States is an excellent operation, and I'm not surprised there were so many parties interested in being considered as suitors," said John L. Ward of the Cincinnati-based Ward Financial Group.

"They're a good performer. They have good relations with a number of the independent agencies. And they have a good, balanced book of business. And all those adjectives I just used about American States I would apply equally to SAFECO. And for that reason, I think it's an excellent acquisition and combination." The price paid is "well justified," Mr. Ward added.

Ms. Vogel agreed. "It's rare to see a company of that ilk being put on the market, and perhaps that accounts for the large number of bidders and the quality of those bidders and the high price that was paid."

"I think this is the kind of business it's almost impossible to build these days without a significant amount of expense, and it was just worth more to SAFECO than it was to other companies," said Craig Elkind, a director at rating agency Standard & Poor's Corp. in New York.

Rating agencies including S&P, Moody's Investors Service and A.M. Best Co. have all placed SAFECO's ratings under review for possible downgrades citing the debt that will be incurred as a result of the deal.

Best notes that SAFECO, in addition to paying $2.8 billion for American States, will assume $300 million of debt.

Initially SAFECO will finance the deal with $2.5 billion of short and intermediate bank debt and a $600 million extraordinary dividend from the SAFECO Insurance Cos.

"We see this as a good strategic opportunity for the company. . .albeit an aggressively financed one," commented Alan Murray, vp and senior credit officer at Moody's Insurance Group.

Mr. Yonker said: "As you know, you get what you pay for, and we believe we paid a fair value for American States. It's a well-managed and well-positioned company. This merger is going to really enhance SAFECO's long-term revenue and earnings growth."

However, Michael Smith, an analyst with Salomon Bros. in New York, questioned SAFECO's earnings per share projections. "In order for those numbers to work. . .many things have to go right. Nothing's permitted to go wrong," he said.

Michael Lewis, senior insurance analyst at Dillon Read & Co. in New York, agreed. "A lot has to go right to produce those kinds of results, and the margin for error, I guess, is relatively thin when you're paying what appears to be over two times book," he said.

But Mr. Yonker said, "We were very conservative in our estimate in what we felt we could do."