Tower Group International Ltd. got its start insuring corner groceries and dry-cleaning shops in New York before embarking on a global expansion through a series of acquisitions.
Now it may be forced to return to its roots.
After announcing on Monday a much-larger-than-expected charge to boost its reserves, Tower's ratings were downgraded and its share price plummeted. Amid a market rally paced by financial stocks, its shares rose 9.4% on Thursday but are down 47% this week.
Tower's investment bankers are exploring strategic alternatives, including a possible sale of the company to a "runoff" firm, according to people familiar with the matter. Such a firm pays claims and manages the investments backing them but doesn't sell new policies. Analysts said another option is for the company to focus again on small businesses, cars and homes, because buyers of these policies are less mindful of financial-strength ratings than bigger firms.
Tower's travails illustrate the pitfalls of building an insurer through deals, as some of the company's problems can be traced to a relatively small acquisition it made in 2009, analysts said. And it comes as consulting firm Deloitte is predicting an increase in mergers-and-acquisitions activity in the insurance sector, in part because other growth opportunities are limited.
Through a spokesman, Tower's founder, Michael H. Lee, declined to comment.
Mr. Lee, 55 years old, was an attorney when he launched Tower in 1990 with $2 million in capital, according to Tower's website. He told Investor's Business Daily in 2005 that he initially targeted tiny businesses as customers because "not many big players want to compete there," he said.
"His zest for the business was always there," said Jay Levy, president of Morstan General Agency in Manhasset, N.Y., who has arranged many policies for small businesses with Tower.
Tower became more ambitious after an initial public offering in 2004 that raised $116 million. In the 2004 annual report,
Is there really a difference between an IT company (like Oracle) versus an insurance company when it decides for internal growth versus external ?
I do not fault Tower for doing acquisitions. Sometimes ceos sometimes like to make deals for the sake of increasing their power but I have not heard arguments indicating that this is the case here.
Tower has been making a profit in the past; if Tower could just recapitalize its reserves, it could return to a more normal stock behavior.
When an IT company makes a bad acquisition, they can dump it and move on. When an insurance company makes a bad acquisition, the negative consequences last much, much longer and can infect the rest of the business. The gift that keeps on giving.
From 2005 to this year, Tower acquired six companies or units of them. It expanded geographically, took on bigger customers and even began selling policies to other insurers. Tower moved into the top 50 of U.S. insurers, with $1.76 billion of premiums in 2012, according to Fitch Ratings.
After a merger in March, Tower moved its headquarters to Bermuda. The deal triggered a customary review by its outside auditors of its internal financial controls, according to an August regulatory filing. This, in turn, led to the hiring of an independent actuarial firm to review loss reserves.
On Monday, Tower said it would need to add about $365 million to boost its reserves. The move will reduce Tower's statutory capital, or the difference between assets and liabilities under state statutes, by about one-third, according to analysts at FBR Capital Markets.
That and a separate $215 million noncash charge prompted ratings downgrades below the A-minus level that analysts have said will make it difficult for Tower to win new corporate business. Many insurance brokers, agents and corporate buyers won't buy coverage from insurers rated below A-minus by ratings firm A.M. Best Co. In downgrading Tower units, Best noted the insurer has "adequate" capitalization. One of Tower's deals during its expansion was the $107 million acquisition of insurer Specialty Underwriters' Alliance. Based in Chicago, it targeted niches of the business world, selling workers' compensation, and liability and property insurance to tow-truck operators, contractors and others. In announcing the deal, Tower said those customers require "highly specialized knowledge due to their unique risk characteristics."
Tower's need to boost reserves "primarily emanates from business acquired" in the Specialty deal, according to Fitch, which also downgraded Tower. The insurer said the boost involves workers' compensation, commercial auto and various liability policies, and stems from the emergence of losses as well as "changes in judgment, including actuarial factors" used in assessing reserves.
Courtney Smith, Specialty's chairman at the time of the deal, said: "They had their actuaries, we had our actuaries, we agreed on a price, and they bought it." He said he left within six months of the deal's closing, so "what they did, they did. I didn't have anything to do with it."
Boris Lukan, a principal responsible for the insurance M&A practice for Deloitte Consulting in the U.S., said a key part of any deal has to be "a careful assessment" of the buyer's ability to integrate the new company and manage the risk it will take on.
Tower, which maintained a big footprint in New York City, also got socked last year with $80.1 million in losses from superstorm Sandy. For the year, it posted a net loss of $28.2 million, compared with a profit of $60.5 million in 2011.
New York's Department of Financial Services has been investigating handling of Sandy claims by Tower and some other insurers, citing complaints such as claims denied over the phone with no adjuster visit, it said in February. Mr. Lee said in a conference call with analysts this spring that any allegations "do not constitute a pattern or practice of Tower."
Mr. Lee appears to have caught one break lately. On Sept. 23, Tower said in a filing that he received a margin call that required him to sell more than 1.2 million shares of company stock, at more than $10 a share. Tower shares closed Thursday at $4.08.
There it is, for all of you former SUAI shareholders who are still here. I warned you about Courtney in 2009, so you have no business participating in any of the lawsuits over the recent drop in TWGP stock price.