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Insurance deal target received rare 'excessive' reserve opinion prior to sale

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Insurance deal target received rare 'excessive' reserve opinion prior to sale

Potential loss reserve deficiencies rank among the most prominent real and perceived risk factors to M&A transactions in the property and casualty industry. But the target of one recently completed deal seems to have had the opposite problem.

The independent auditor for Direct Auto Insurance Co., which sold to Nodak Insurance Co. parent NI Holdings Inc. on Sept. 5, opined that the company's carried loss and loss adjustment expense, or LAE, reserves of nearly $37.4 million as of year-end 2017 made a "redundant or excessive provision" for its unpaid obligations. The carried reserves were $5.9 million above the amount Pinnacle Actuarial Resources Inc. actuary Joseph Herbers considered necessary to fall within the high end of his range of estimates he deemed to be "reasonable."

Direct Auto was one of only five individual P&C entities to receive an opinion for their independent actuaries of redundant or excessive reserves in 2017. The combined estimated net redundancy of the other four companies, U.S. Insurance Co. of America and three separate members of the BrickStreet Mutual Insurance Co. reinsurance pool, was less than $1.3 million.

"Management's philosophy is to set a conservative case reserve when the accident is reported," the company said in its 2017 annual statement. " ... This philosophy has worked well as the company has had favorable loss development in each of the past five years."

Direct Auto's favorable development of reserves for prior accident years totaled $5.5 million in 2017 as originally reported by the company on Schedule P of its annual statement. It was the fourth straight year in which the company generated favorable development in excess of $5 million. The amount of favorable development has exceeded 56% of the company's prior-year-end policyholders' surplus throughout that stretch. The company's independent auditor later revised the amount of incurred losses and LAE attributable to insured events in prior accident years to more than $10.7 million.

Direct Auto's surplus increased to nearly $16 million from $12.1 million as originally reported as a result of the auditor's reduction of unpaid losses in the $5.9 million amount of the redundancy estimated by Herbers, net of a $2 million adjustment to the provision for federal income taxes.

The company writes nonstandard auto insurance through independent agents in its home state of Illinois. NI Holdings, which is best known for underwriting private-passenger auto, homeowners, farmowners, commercial and crop insurance coverages through the North Dakota-centric Nodak, pitched the $17 million acquisition as a way to improve business line and geographic diversity. Subsidiary Primero Insurance Co. writes nonstandard auto business in Nevada, Arizona, North Dakota and South Dakota. The overall group generated 6.4% of its nearly $54 million in direct premiums earned from its nonstandard auto segment.

Direct Auto was among the 16 individual P&C entities to receive something other than a "reasonable" designation from its independent actuary in 2017 out of 2,440 companies for which opinions were rendered. In two instances, actuaries opined that companies' carried reserves were inadequate. No opinion was rendered in five cases. Four companies received qualified opinions, which generally reflected technical limitations associated with the scope of the applicable actuary's review.

For General Security National Insurance Co., a qualified opinion resulted from the appointed actuary's inability to evaluate the company's fully reinsured gross reserves pertaining to the 1969 accident year. The independent actuary for National Insurance Co. of Wisconsin Inc. issued a qualified opinion as he did not evaluate the company's active life and premium deficiency reserves pertaining to the long-term care business.

Herbers previously issued a redundant or excessive opinion to Direct Auto in 2015, finding that the company's carried reserves at that time were $971,000 above the high end of his range of reasonableness.

Among other entities that received redundant or excessive opinions in prior years and for which S&P Global Market Intelligence has received the applicable statement of actuarial opinion, the last estimated redundancy to be larger on a net basis than the $5.9 million Herbers found for Direct Auto in 2017 was $7.2 million for Dallas-based Security National Insurance Co. (TX) in 2014. Huggins Actuarial Service Inc. actuary Ronald Kuehn that year said three separate AmTrust Financial Services Inc. subsidiaries, including Security National, carried reserves that were above the maximum range of reasonable estimates.