AmTrust goes private as it seeks to reverse decline

Private equity firm Stone Point Capital, the Karfunkel Family, and the CEO of AmTrust Financial Services Barry Zyskind are acquiring the insurer in a transaction valued at approximately $2.7 billion.

The deal will see the investors acquiring the approximately 45 percent of the company's issued and outstanding common shares that the Karfunkel-Zyskind family and certain of its affiliates and related parties do not presently own or control.

"I believe that this transaction represents an exciting step forward for AmTrust, our employees, and the agents, brokers, partners, and customers we serve,” said Zyskind. “As a private enterprise, we will be able to focus on long-term decisions, without the emphasis on short-term results."

Going private will allow AmTrust to address its current challenges without public company pressures, aided by Stone Point’s extensive insurance expertise and relationships, according to KBW analysts.

AmTrust offers specialty property/casualty insurance products, including workers' compensation, commercial automobile, general liability and extended service and warranty coverage through its primary insurance subsidiaries.

Problems started when the insurer caused concerns among stakeholders after it  delayed its 2016 consolidated financial statements and said that the company's 2014 and 2015 financial reports would be restated.

Shareholder rights law firm Robbins Arroyo filed a class action complaint against AmTrust. In the filing, the law firm accused AmTrust officials of falsely attesting to the accuracy of the financial statements, to the disclosure of any material changes to the company's internal controls over financial reporting, and to the disclosure of all fraud.

The New York-based insurer posted a net loss of $174.7 million for the third quarter of 2017 compared to a net income of $80.7 million in the same period a year ago. The combined ratio deteriorated to 134.4 percent from 93.2 percent over the period.

The net loss included an increase in prior years’ loss reserves by $326.9 million, driven primarily by increases in reserves for its programme business and for the 2013 through 2016 accident years.

This adverse development was driven primarily by long-tailed, terminated programmes in AmTrust's Specialty Program segment, the company explained. AmTrust has also “significantly re-underwritten and re-priced” many of its active, ongoing programmes to help ensure profitability and results in-line with expectations.

The reserve increases were ceded to the Adverse Development Cover (ADC) purchased by AmTrust in June 2017. However, AM Best noted in a Nov. 6, 2017 statement, that “the actions raise questions about the potential future movement of reserves for these accident years (which would not be covered by the ADC, as that cover is being exhausted by these actions) and about price adequacy and underwriting practices for the current and more recent accident years.

AmTrust may want to change its reinsurance programme after going private and reduce the cession volumes. KBW noted that Zyskind said in the third quarter 2017 conference call that he expects AmTrust to “relook at some of our reinsurance and maybe slowly start taking back some of that premium.”

Maiden Holdings gets dragged in

This could have negative consequences for Bermuda-based Maiden Holdings.

AmTrust's current quota share with Maiden expires on July 1, 2019. Assuming no material change, AmTrust cessions would constitute about 70 percent of Maiden’s 2018 and 2019 net earned premiums, KBW explained. A significant quota share reduction would therefore likely pressure Maiden’s fixed expense base and could lead some cedants to worry about its overall viability.

KBW analysts noted that Maiden’s AmTrust reinsurance segment typically produces a lower combined ratio than its Diversified Reinsurance segment, so less AmTrust-sourced business would imply a higher overall combined ratio, especially if Stone Point’s potential contributions improve AmTrust’s underwriting performance.

However, recent data shows that Maiden’s AmTrust reinsurance segment’s combined ratio deteriorated to 131.1 percent in the fourth quarter of 2017 from 108.1 percent in the same period of 2016. The segment experienced adverse loss development of $139.0 million due primarily to workers' compensation and general liability lines of business and, to a lesser extent, commercial auto liability.

At the same time, Maiden’s Diversified Reinsurance Segment improved its combined ratio to 108.7 percent in the fourth quarter of 2017 from 128.3 percent in the same period of 2016.

A similar trend was reflected in the full 2017 results, where the Maiden’s AmTrust Reinsurance segment produced a combined ratio of 110.8 percent compared to 98.4 percent in 2016. Meanwhile Maiden’s Diversified Reinsurance Segment improved the combined ratio to 107.1 percent from 109.4 percent.

Positive developments

AmTrust stresses that its small commercial business and specialty risk and extended

warranty segments continued to perform well in 2017 and years prior despite emerging loss experience beyond its prior indications. These operations represent approximately 80 percent of gross written premium, the company noted.

“In the aggregate, even with the effect of the adverse development allocated to its contributing segments, our overall book of business continues to be very profitable while taking action to reduce the effect of the under-performing Specialty Program book of business,” the company said.

In 2017, AmTrust entered a number of deals to bolster its capital base and strengthen the balance sheet.  In May 2017, the insurer completed a $300 million capital raise through a private placement to support its insurance units.

In addition to the capital increase, AmTrust started to divest assets.

AmTrust sold assets that carried high capital charges, including equity in National General Holdings, and the sold of underwriting and claims systems to National General in September 2017 for around $200 million.

Furthermore, AmTrust decided to sell a portion of its US fee businesses to Madison Dearborn Partners, a deal that was well received by AM Best in November.

The sale of the fee businesses is expected to significantly improve the equity position and balance sheet strength of AmTrust upon completion of the transaction, AM Best noted. In addition to gross cash proceeds of $950 million, approximately $482 million of goodwill and intangible assets associated with the businesses being sold will be removed from AmTrust’s balance sheet, as those businesses are deconsolidated.

AmTrust has, meanwhile, closed the transfer of a 51 percent equity interest in its US-based fee businesses to private equity firm Madison Dearborn Partners.

"This transaction close marks a significant milestone in our efforts to unlock value and build a stronger capital base for AmTrust, while positioning both AmTrust and the US fee companies for continued, profitable growth," Zyskind commented.

The transfer of the equity interest of the US fee business to Madison Dearborn Partners will generate around $1.2 billion of capital.

Separately, the company expanded its executive staff in the finance, accounting, audit and actuarial disciplines to bring additional expertise to these critical business areas, AM Best added. In June 2017, AmTrust for example appointed Adam Karkowsky as chief financial officer.

The company has been working to resolve the material weaknesses in financial controls identified in the year-end 2016 audit and has regained current filer status with the Securities and Exchange Commission, AM Best noted.

But the agency warned that it expected AmTrust’s reported financial results for 2017 to deteriorate from prior years’ results. It also raised concerns about uncertainty regarding future changes in loss reserves and current year pricing and underwriting actions.

There may be quite some more work to do on the operational side of the business, KBW analysts suggested.

“We think AmTrust needs to focus on fixing its financial controls weaknesses, monitoring its pricing and reserve adequacy,” KBW analysts said in a January research note.

While maintaining appropriate financial strength ratings, AmTrust needs to retain and bolster its distribution network, build out the management infrastructure to a level appropriate to a global multi-line P&C insurer. This needs to happen all against the backdrop of what will probably be a persistently soft workers’ compensation market throughout 2018 and probably 2019, according to KBW.

“We think that this task list will be much easier to accomplish without the pressures and scrutiny of being a public company, and Stone Point’s extensive insurance expertise and relationships should be enormously helpful,” KBW noted.