Auto Club’s Stakes In Other Businesses Leading to Friction
By KATE BERRY
Staff Reporter
In an age of rising corporate scrutiny, the Automobile Club of Southern California is a throwback.
As a mutual benefit corporation, its members own the organization, theoretically. But other than the annual renewal bills that land in the mail, members have little information about the club’s finances, its executive pay structure or its entrepreneurial activities.
That’s created friction not unlike what has occurred at two other similarly structured entities: AARP and the New York Stock Exchange.
“One of the things we’ve been upset about is their secrecy,” said Carl Olson, a finance professor at California National University who ran unsuccessfully for a board seat and later sued the Auto Club.
“They’re classified as a nonprofit, but that does not mean they don’t make a profit,” he continued. “It means they don’t distribute the profits as dividends to their members. They give it back to themselves and no one really knows what they’re doing with the money and how much they’re paying themselves.”
Like a for-profit conglomerate, the Auto Club has been moving in recent years toward owning the products and services it sells to its members. Critics maintain that peddling Auto Club-owned travel packages, collision repair and other services to its members compromises the club’s fiduciary responsibility.
But Thomas McKernan, the Auto Club’s president and chief executive, said he doesn’t see any conflict.
“One of our core competencies that members rely on us for is sifting through whole lots of things, putting our brand on it and providing it to them,” said McKernan, whose salary is not disclosed. “They trust us to do that whether it’s a hotel that’s approved, or a garage that we hang our sign on, or a body shop that our standards have been applied to.”
Steering members wrong?
The most recent example of what critics say are conflicts flared in December, when Attorney General Bill Lockyer filed a $50 million lawsuit against Caliber Collision Centers of Irvine and six subsidiaries. Lockyer claims that the centers committed widespread fraud by over-billing customers for services and parts.
The Auto Club had been referring members to Caliber for years. The club’s insurance arm bought a 19 percent stake for $30 million in 2001.
An article in the January/February 2003 issue of the Auto Club’s Westways magazine recommended the 50 “top-ranking” body shops in Southern California to its members. The list included five Caliber locations.
The article, titled “In Your Best Interest,” disclosed that the Interinsurance Exchange owned a minority interest in Caliber. But it didn’t say that the Auto Club owns the exchange, and it failed to mention that the state Bureau of Automotive Repair filed an administrative enforcement action against Caliber in 2001, resulting in a five-day suspension and three years’ probation for a Caliber shop in Costa Mesa. (The Costa Mesa shop was not recommended in the article.)
Other BAR enforcement actions were filed against 12 Caliber locations in early 2003, prior to the article’s publication.
A call to Westways Editor in Chief Jim Lehrer was returned by Auto Club spokeswoman Carol Thorp, who said the magazine was aware of the accusations but had not heard any complaints from its own members.
“Since the article was basically reporting what members had to say about Caliber, there was no reason to change it,” she said.
Thorp added that the Auto Club has “yet to find any evidence of what is being charged in the lawsuit as far as our members are concerned. If any of these things were happening, we would not use Caliber. We are not seeing it. If the courts say this is happening, we’re going to have to decide what to do.”
Olson has demanded numerous actions by the Auto Club to address the state charges and determine whether members were overcharged. He said he has not received any response to his letters.
Auto Club Chief Financial Officer John Boyle said the club was justified in giving Caliber the high marks. He said extensive audits of 30 percent of their repair shops found no evidence of over-billing.
The Auto Club has also come under criticism for failing to disclose its $100 million purchase of the Pleasant Holidays travel agency in 1999. (The trade publication Travel Weekly reported the transaction two years later.) Pleasant Holidays sends 400,000 people to Hawaii each year, and some critics have charged the problem with the club’s dual role a conflict in the first place is compounded by non-disclosure.
“We don’t really see it as an issue,” McKernan said, adding that members expect the club to vet a product or service. He did not elaborate on why he doesn’t see a conflict with the club’s hidden ownership.
“The problem is they don’t really let their members know what their policies are and what they’re all about,” said Todd Silberman, who founded Lifeco Services, one the nation’s five largest travel agencies, and who recently started Better World Club of Portland, Ore. as an alternative to AAA. The for-profit company, with 10,000 members, offers towing and travel services in Southern California.
Silberman devotes a section of his company’s Web site to criticism of AAA’s national policies. (The Automobile Club of Southern California is the largest of 77 affiliates of AAA, once known as the American Automobile Association.) “There are issues that come up for mass transit, gas taxes and roads but if those issues conflict at all with automobile drivers, they’re against it,” he said.
‘Not under my watch’
Unlike the NYSE, which ended up ousting Chairman Richard Grasso last year when his contract became a symbol of conflict for the self-regulatory body, the Auto Club has only closed ranks as criticism mounted.
Several activists, including Olson, have tried unsuccessfully to get elected to the club’s board. Rather than risk a possible shake-up, the organization held a vote last year in which its 5.3 million members in Southern California agreed to have the 12-member board appointed rather than elected.
McKernan has a bare-knuckles defense for the club’s actions.
“The club is not going to get into trouble under my watch,” he said. “It’s ethical, it does the right thing, it is an institution in Southern California.”
The quintessential insider, McKernan has worked his entire professional career at the Auto Club, where he started behind a service desk in Pasadena, fielding questions about travel and Department of Motor Vehicles services.
He is director at several local companies, including money management firm Payden & Rygel whose founder, Joan Payden, also sits on the Auto Club board.
In another brush with board cross-membership a major corporate governance issue nationwide McKernan sat on the board of Coast Federal Bank until stepping down in 1997. Coast’s chief executive until 1998, Ray Martin, now sits on the Auto Club board.
McKernan became chief financial officer at the Auto Club in 1985 and then enrolled in the doctorate program in business at the Peter F. Drucker Graduate School of Management in Claremont. By 1991, he was named president and chief executive.
During McKernan’s tenure, the Auto Club, based in Los Angeles but run from a glimmering Costa Mesa campus, has expanded at rapid rate. Its for-profit insurance arm has nearly doubled in the past eight years and now writes personal auto insurance in Texas and New Mexico as well as Southern California.
The club has also amassed a $286 million reserve, known as a “membership protection fund,” that could be distributed to members in the unlikely event that the group dissolves. But despite that money, Auto Club members have no ownership stake, Thorp said. The fund is used to expand its lines of business and to keep dues low, she said.
As a mutual benefit corporation, the Auto Club is taxed but retains nonprofit status because it does not issue stock or dividends, said Denise Azimi, a spokeswoman for the Franchise Tax Board. It is also restricted from raising capital.
The organization has crafted an unusual growth strategy to purchase other auto clubs and have its for-profit insurance arm own services sold to members.
During McKernan’s tenure, the Auto Club has acquired clubs in Texas, New Mexico and Hawaii, adding 1.3 million members to the rolls. It also has an affiliation with the Auto Club of Northern New England. “We have to get a larger scale to keep pricing competitive,” McKernan said.
The club has sold 2 percent stakes in Pleasant Holidays to Auto Club South and to the national AAA organization. It also reaps millions by selling its travel services to other auto clubs around the country.
The impetus to move into the car repair business came in 2001 after Allstate Corp. bought Sterling Collision Centers and restricted that service to its own customers. McKernan feared further consolidation would shut his customers, the members, out of the industry. “That’s why we have control over some content,” he said.
The Auto Club does release some financial information. It employs 8,500 people and is the sixth-largest personal auto insurer with a lobbying arm in Sacramento. In 2002, it reported $1.1 billion in revenues, up slightly from 2001. Of that, $434 million came from travel services, $300 million from insurance and $289 million from membership dues.
And at least in terms of automobile insurance, members have appeared to benefit from McKernan’s stewardship.
Once considered one of the most expensive insurers in the state, the club maintains that its rates have risen roughly 10 percent since 2000, about half of the increase of its competitors. The Auto Club now ranks among the lowest-cost insurers behind Mercury Insurance Group of Los Angeles, according to McKernan.
Ken Tappan, an analyst at AM Best Company, agrees. He estimates that AAA insures about 22 percent of its 5 million members. “The Auto Club is highly competitive,” Tappan said. “They went from being one of the highest-priced insurance companies in the ’80s to one of the lowest today.”
