Tesla among masters of 'very challenging' insurance carrier shell game

An insurance company that briefly came to prominence in the global financial crisis is among a handful of carriers poised for reinvention under a type of deal structure that offers some of the benefits of traditional insurance M&A without one of the key risks.

The acquisition of dormant insurance companies as clean shells, such as Tesla Inc.'s purchase in January of the entity formerly known as Balboa Insurance Co. from Bank of America Corp., offers buyers a solution to bring new products to market or enter new geographies more rapidly than starting a carrier from scratch.

This optionality, however, comes at a price in a market where demand may outpace supply. New entrants to insurance like Tesla and longstanding players such as CNA Financial Corp. continue to see value in acquiring one of the finite numbers of carriers that possess a combination of active state licenses, a business in run-off and an owner with the ability and willingness to shield acquirers from any remaining legacy liabilities.

Bank of America gained control of Balboa through its otherwise ill-fated 2008 purchase of mortgage lender Countrywide Financial Corp. At the time, Balboa ranked among the leading providers of lender-placed hazard and automobile collateral protection insurance, which allows loan servicers the ability to maintain coverage on homes and vehicles in the event of a lapse due to nonpayment on the borrower's voluntary policy.

This business grew substantially as home loan delinquencies and defaults spiked, resulting in highly favorable underwriting profitability for the carriers but sparking controversy among consumer advocates and certain regulators in the process. The cumulative net underwriting gain achieved by Balboa and its affiliates in 2008 and 2009 ranked seventh-highest among all U.S. property and casualty groups through that stretch.

Balboa later transferred nearly all of its liabilities to QBE Insurance Corp. in 2011 via a 100% quota-share reinsurance agreement as part of a transaction that effectively facilitated the company's exit from the market.

While 100% quota shares and loss portfolio transfers can be timed to coincide with stock purchase agreements to create clean shells, the Balboa sale is one of several recent divestitures involving targets that maintained no meaningful premium writings or insurance reserves for several years. Either way, the structures address one of the leading drawbacks associated with transactions involving active insurance carrier targets: adverse and unexpected outcomes associated with pre-acquisition liabilities. They do not necessarily fully absolve the acquirer of counterparty risk, however.

Speed to market

Tesla, in acquiring Balboa and two affiliates, has accelerated its strategy of growing a business to offer insurance to its automobile customers, given concerns about the affordability and availability of coverage for its vehicles. The electric vehicle maker entered auto insurance by relying on the paper of unaffiliated carriers, including Markel Corp.'s State National Insurance Co. Inc.

In the last four months, S&P Global Market Intelligence has obtained product filings for the insurer or its affiliates to launch the Tesla auto insurance program in Oregon, Virginia, New Jersey and Nevada. Balboa has been renamed Tesla Insurance Co.; the other two group members, previously Meritplan Insurance Co. and Newport Insurance Co., are now known as Tesla Property & Casualty Inc. and Tesla General Insurance Inc.

CNA, in contrast, has no immediate plans for the shell it is buying.

"Due to the lack of acceptable shell insurance companies with financially sound parent companies on the market at any given point in time and the length of time required to complete a shell acquisition, CNA believes that a 50-state licensed shell of the caliber of the Domestic Insurer may not become available in the future," said CNA's Continental Casualty Co. in a Form A associated with its proposed acquisition of Aetna Insurance Co. of Connecticut from CVS Health Corp.

Speaking during a May 25 public hearing, according to a recently released transcript, CNA Senior Vice President, Deputy General Counsel and Corporate Secretary Stathy Darcy described the market for acquiring such an entity as "very challenging and competitive." As a result, Darcy explained, "it would be good to have something on the shelf to utilize in the future" for such hypothetical activities as the entry of new lines of business or an intercompany reorganization to realize capital efficiencies. Aetna Insurance Co. is licensed to write a range of coverages in all 50 states and the District of Columbia, which would confer substantial flexibility for CNA's future pursuits.

Acquisitions of U.S. shell companies by Bermuda reinsurers have also been a driver of transaction activity over the years, and The Carlyle Group Inc.-linked Fortitude Reinsurance Co. Ltd. was among the latest to pursue that approach. Fortitude Re bought distinct U.S. P&C and life shells in the first half of 2022: Plans' Liability Insurance Co. and the former RX Life Insurance Co., now Fortitude US Reinsurance Co..

Inexpensive but not cheap

Clean shells often sell for total consideration that includes statutory surplus at closing plus an agreed-upon amount for each of the target's active licenses. Continental Casualty agreed to pay consideration of $200,000 apiece for Aetna Insurance Co.'s 51 licenses plus the amount of the target's capital and surplus at the time of closing; it amounted to just over $6.0 million as of March 31, suggesting a total deal value of $16.2 million. Deal values for the other aforementioned transactions are not available.

Per-license consideration in shell deals appears to be on the rise, though there are several variables involved and our information is limited to transactions where we were able to obtain copies of Form As and/or stock purchase agreements.

Forza Insurance Holdings LLC agreed in February to a transaction that includes payment of $200,000 per authorized state for the acquisition of Southern Pilot Insurance Co. from QBE. The predecessor to Sentry Insurance Co. agreed to pay QBE subsidiaries $175,000 per state in which Unigard Insurance Co., now Dairyland American Insurance Co., and Southern Fire & Casualty Co., now Point Insurance Co., were authorized in a series of 2020 transactions. In a deal that closed at the start of 2022, Ambac Financial Group Inc.'s Everspan Insurance Co. said it would pay $112,000, apiece, for the licenses of 21st Century Pacific Insurance Co. The portion of consideration linked to the licenses of Centurion Casualty Co. in a UnitedHealth Group Inc. subsidiary's 2019 acquisition of the company from Wells Fargo & Co. was roughly $140,000, apiece. At the start of the previous decade, a Deere & Co. subsidiary agreed to a deal that valued the target's 41 state licenses at $107,500, apiece.

Scarcity value may be the cause of higher prices. Out of a U.S. P&C universe of more than 2,600 individual entities, there were 24 prospective shell companies that meet the following selected parameters: less than $5,000 in both gross and net premiums written in 2021, losses and loss adjustment expenses of below $10 million and licenses to conduct business in more than 40 U.S. states and territories. Nine of those 24 companies are either subject to pending M&A agreements or had been sold in the past year. And not all of the remaining 15 fit the profile of a carrier that is readily saleable.

There are other dormant carriers with larger balance sheets that could be converted into a clean shell, but the execution of transactions requires a seller that is willing to engage in such a restructuring and to part ways with something that may not be easy to replace.