Ailing workers' comp writer due for downsizing post-sponsored demutualization

Amid the longest sustained stretch of calendar-year underwriting profitability for private workers' compensation insurers in at least a generation, a recently entered M&A agreement offers a reminder that the high tide has not lifted all boats.

Michigan Commercial Insurance Mutual, a monoline workers' comp writer known as MCIM that operates in six Midwest and Southeast states, will barely resemble its current form upon completion of a proposed demutualization and sale process that follows a challenging 2023. While private workers' comp writers nationally produced a calendar-year combined ratio of below 90% for a heretofore unfathomable seventh consecutive year, MCIM recorded its highest combined ratio excluding policyholder dividends in 22 years at 133.5%.

Among workers' comp-focused stand-alone P&C entities and P&C groups with 2023 workers' comp direct premiums written of at least $1 million and excluding state funds, MCIM's workers' comp-specific combined ratio of 133.8% was surpassed by only two carriers: Previsor Insurance Co. and First Benefits Insurance Mutual Inc. It was 48 percentage points higher than the overall industry's workers' comp combined ratio, excluding state funds.

MCIM is facing additional regulatory attention as its 2023 results failed the so-called risk-based capital, or RBC, trend test, with an authorized control level RBC ratio of between 200% and 300% in tandem with a calendar-year combined ratio in excess of 120%. Documents posted by the Michigan Department of Insurance and Financial Services indicate that MCIM has agreed to a novel transaction with Wilmington, Del.-based Freedom Advantage Insurance Co. that would essentially result in the survival of the company, but the loss of its identity, board, management, and much of its in-force business.

Regulatory attention

Terms of the transaction call for MCIM to engage in a subscription rights demutualization where it will issue 400,000 shares of stock valued at $10 apiece. Policyholders will receive subscription rights to purchase up to 49.9% of the shares as Freedom Advantage intends to acquire at least 50.1% so as to obtain control of the converted insurer.

After closing and taking control, Freedom Advantage said it intends to rename MCIM as I-Que Insurance Co. and refocus the company on underwriting profitability. The go-forward business plan contemplates what Freedom Advantage described as a significant reduction in premium volume to be achieved by the exit of certain volatile and unprofitable business lines as well as the re-underwriting of the remaining business to ensure compliance with underwriting guidelines. MCIM's officers and directors will be replaced with a roster largely consisting of Freedom Advantage executives and board members.

Freedom Advantage previously wrote workers' comp business but its portfolio was placed into runoff in 2021, according to its most recent annual statement. Assumed New York homeowners business constituted all of its $2.7 million in net premiums written in 2023.

MCIM posted a net underwriting loss of $8.5 million in 2023 as compared with a loss of $1.1 million in 2022 with net earned premiums falling by 13.8% at the same time incurred losses and loss adjustment expenses increased by 11.9% amid unfavorable reserve development for prior accident years.

"The company faced rigorous rate decreases in the states in which we write business, and the company's marketing efforts fell short in terms of projections for growth in the overall book of business," MCIM said in the management's discussion and analysis section of its 2023 annual statement.

Additionally, the $4.1 million in adverse prior-year reserve development posted by MCIM, which largely pertained to accident years 2018 through 2022, represented the company's highest such tally in a calendar year since 2001. And it stood in stark contrast to overall industry trends where 2023 marked the seventh consecutive year of favorable prior-year development in an aggregate amount in excess of $5.73 billion.

MCIM's resulting net loss of nearly $5.6 million, in combination with negative changes in net unrealized capital gains and losses as well as nonadmitted assets, caused the company's total adjusted capital to plunge to less than $9.9 million from $17.7 million. In turn, its authorized control level RBC was more than halved on a year-over-year basis to 208.4% from 418.4%. MCIM's surplus declined further in the first quarter of 2024 to a level that, all else being equal, implied an RBC ratio within the company action level at an estimated 191%.

A novel deal structure

Challenging times for a number of small and regional P&C insurers have triggered a wave of consolidation and business model restructurings during the past two years. This has led to outcomes for certain impacted carriers that include the following: the emergence of investment platforms such as Mutual Capital Group Inc. and the Bain Capital LP-backed The Mutual Group to provide additional operational and financial flexibility to mutuals and mutual insurance holding companies; the virtual overnight disappearance of Wisconsin town mutuals; conversions of mutuals into the more flexible mutual insurance holding company framework; mutual company affiliations to enhance diversity of business lines and/or geographies; and the significant paring back in the scope of operations.

The Freedom Advantage/MCIM arrangement proposes the combination of a new corporate structure and operating retrenchment through a transaction architecture not often seen.

What we might describe as a sponsored subscription rights demutualization combines elements of more commonly used deal structures: a subscription rights demutualization where policyholders have the ability to invest in the equity of the converted insurer or sponsored demutualizations, where a conversion occurs so as to facilitate an insurer's sale to a third party.

Numerous niche P&C writers, including in the workers' comp space, have conducted traditional subscription rights demutualizations in conjunction with initial public offerings of the newly created holding company's common stock. That includes ICC Holdings, which recently agreed to sell to Mutual Capital Group, just over seven years after demutualizing and going public. Sponsored demutualizations have been a prominent feature in the consolidation of the medical professional liability market, though the most notable recent example arguably occurred in the life industry: a 2022 demutualization sponsored by the Caisse de dépôt et placement du Québec and Ontario Teachers' Pension Plan Board-backed Constellation Insurance Holdings Inc. involving the mutual insurance holding company parent of the former Ohio National Life Insurance Co., now AuguStar Life Insurance Co.

A more comparable application of the sort of structure intended to effect MCIM's conversion and sale occurred in 2016 when AmTrust Financial Services Inc. acquired the newly formed parent of the stock successor to commercial auto insurer ARI Mutual Insurance Co. Under the terms of that deal, ARI Mutual policyholders were given the opportunity to acquire shares of the then-publicly traded AmTrust at a discount to their market value.

ARI Mutual was more than double MCIM's size at the time its transaction was first revealed, and it had a more significant presence in its largest market. MCIM ranked as the No. 44 workers' comp writer in 2023 in Florida, its largest state, with share of 0.38%. AmTrust (largely through its Technology Insurance Co. Inc. subsidiary) and American Financial Group Inc. ranked No. 1 and 2, respectively, in the Sunshine State with shares of 12.6% and 9.0%.

The unique MCIM transaction does not represent Freedom Advantage's lone effort to grow inorganically. The company disclosed in its annual statement that it expected to wrap up negotiations to merge with an unnamed Maine-domiciled company before the end of the second quarter.

At least one Maine-domiciled company, runoff workers' comp insurer Great Falls Insurance Co., indicated in its annual statement that it was under contract to be sold.