Valiant Insurance Group is the U.S. specialty insurance arm ofBermuda-based Ariel Holdings.

Southfield, Mich.-based First Mercury Corporation, whoseoperations include excess and surplus lines insurers and producers,said its principal insurance company--First Mercury InsuranceCompany--inked a definitive agreement to acquire Valiant for anamount equal to its anticipated tangible book value at closing.

A fourth-quarter closing is expected.

In a written announcement, Richard H. Smith, chairman, presidentand chief executive officer of First Mercury, said, "For some time,we have been evaluating opportunities to enter the admittedmarket."

He added, "Valiant provides us with an attractive opportunity togain admitted licensing [and] expand our resources in professionaland management liability and selected specialty casualtyunderwriting classes, while adding marine underwriting capabilitiesto take advantage of improving market conditions in this line."

Edward LaFramboise, vice president of finance for First Mercury,explained that none of the group's insurance operations directlywrites any admitted business currently, although one insurancecompany--First Mercury Casualty Company--is admitted in 15 states.At this point, that company is only providing intercompanyreinsurance, he said.

Ted Camp, executive vice president and chief underwritingofficer, elaborated on the deal's benefits beyond a 47-statefully-licensed operational admitted platform that Valiant brings tothe table. In a phone interview, he said Valiant also bringsseveral experienced underwriting teams with good reputations, "arobust New York presence," and a book of business that is "a goodfit and similar to that of First Mercury."

Gary Dubois, president and chief executive officer of Valiant,agreed that the books are similar but complementary. "There arebroad areas of comfort, and in certain cases, areas of expertisethat we share," but Valiant focuses on slightly differentsubsegments than those historically targeted by First Mercury, hetold NU.

"Valiant is very excited and enthusiastic about the prospects ofbecoming associated with the First Mercury organization on agoing-forward basis," he said. While acknowledging Valiant'sappreciation for Ariel's support in getting the startup runningover the last three years, he said "the ability to become part ofthe First Mercury organization allows [Valiant] to move on to thenext phase of development."

He said, "We share a common vision to become an organizationthat is perceived as a best-in-class provider of specialty linescommercial insurance," noting First Mercury's long-standingcommitment to specialty lines--a commitment that has spanned morethe 37 years, according to First Mercury.

George Rivaz, CEO of Ariel Holdings, explained the decision tosell Valiant in an e-mail to NU. "Valiant has faced softmarket headwinds from commencement, and as a result itscontribution to the Ariel group has fallen short of initialexpectations," he said.

"Furthermore, the timing of the market upturn, which would benecessary for Valiant to deliver strong positive returns oncapital, remains uncertain," he said.

"In light of this, the Ariel Holdings board concluded thatextraction of our capital, rather than further investment needed tosupport growth of Valiant's business, was the appropriatecourse."

He said Ariel was pleased to find, in First Mercury, an ownerthat can provide Valiant with "an important incremental strategicplatform" and one that is willing to make the investment Valiantwill need to fulfill its potential.

First Mercury's Mr. Camp said the deal "expands our lines ofbusiness into marine and management liability, [which] we'recurrently very interested in," noting that First Mercury onlywrites a very small amount of management liability business at thispoint.

"This also gives us a much bigger footprint in the professionalliability arena," Mr. Camp said, noting that interest in thatsegment led First Mercury to hire a professional lines underwritingteam a year-and-a-half ago. "This gives us some immediate scale" inthe professional liability segment, he said.

In addition to professional, management liability and marinelines, First Mercury said it will retain the primary and excesscasualty segments of Valiant's existing underwriting platform andthe experienced underwriting teams producing these classes.

As for the business First Mercury will not retain, Mr. Camp saidthat will be decided on an account-by-account basis. For example,programs underwritten by third-party administrators in the Valiantbook are unlikely to be kept, he said, noting that this business isnot consistent with First Mercury's strategy of underwriting itsbusiness directly.

There are also certain accounts that really didn't fit withinValiant's stated strategy of focusing on smaller and midsizeaccounts, he added.

First Mercury Financial ranked as the 22^nd largestwriter of excess and surplus lines business in 2009 with $292.1million in direct E&S premiums, according to a recent listing of top E&S writers published by NationalUnderwriter. See related article for a full ranking of E&Sinsurers complied by Highline Data (www.highlinedata.com), part ofThe National Underwriter Company.

On a GAAP basis, total gross premiums for the group were $344.4million in 2009, representing a 7 percent increase over 2008. FirstMercury attributed the jump to an assumed retroactive reinsurancetransaction (a loss portfolio transfer for claims in theself-insured retention of a large homebuilder, resulting in 25million to the insurance operation).

First Mercury reported another 7 percent increase infirst-quarter 2010, also citing an assumed reinsurance deal.

Early this year, First Mercury paid out a special dividend andalso reduced its workforce by 13 percent, while restating itscommitment to grow its top line.

"As we moved through year-end renewals, it became obvious...thatno market change was coming in the near future," Mr. Smithexplained during a year-end conference call, reporting that themanagement team and board of directors agreed on a restructuringthat "resulted in the right-sizing of [the] capital base, staffinglevels [and] underwriting assets" in order to "improve results inthe current stagnant market conditions, and...to be even betterprepared for a change in future conditions."

He said 40 percent of the staff reductions were in corporate,while the balance was spread across the underwritingoperations--with the most notable cuts coming in a propertydivision.

While the dividend payout was designed to align capital withmarket opportunity, Moody's cited "incremental pressure on thecompany's capital adequacy and financial flexibility" as reasonsfor changing the outlook of First Mercury's "Baa2" financialstrength rating to negative following the Valiant acquisitionannouncement last week.

Moody's analyst Enrico Leo said the pressures are "a result ofthe expansion into larger size and higher-risk business lines" in aweak pricing environment.

Asked about differences in terms of account sizes, Valiant's Mr.Dubois said "it's probably a fair statement that we do have more ofa focus at the larger end of the middle-market segment, but I don'tbelieve it's a dramatic difference" from the account sizes targetedby First Mercury.

In addition to risk-taking insurers First Mercury InsuranceCompany (an E&S insurer) and First Mercury Casualty Company(admitted in 15 states), First Mercury group has severaldistribution subsidiaries: CoverX Corporation, First MercuryEmerald Insurance Services and American Management Corporation.

All of the operations focus on niche and underserved segments,such as the security industry, which is targeted by CoverX.

First Mercury's website further describes CoverX as an E&Sniche underwriting platform with a small-account focus in areaslike specialty casualty, professional lines and hospitality. Incontrast, First Mercury Emerald--a wholesale broker--has alarger-account focus, targeting more complex risks.

American Management Corporation, a managing general agency, hasa specialty focus on fuel-related businesses including servicestations, repair garages and fuel marketers.

New York-based Valiant started operations in 2007 whenBermuda-based Ariel purchased the company as a shell to serve asits platform for a U.S. specialty insurance business.

Ariel is one of the Class of 2005 Bermuda companies set up with$1 billion in capital from private equity investors in the wake ofHurricanes Katrina, Rita and Wilma to capitalize on opportunitiesin the property-catastrophe reinsurance market. But even in itsearly days, founder Don Kramer had a vision of growing beyond theshort-tail reinsurance lines, and later diversified the companywith Valiant and with the acquisition of Atrium Underwriters inLondon in 2007 as well.

In March, Mr. Kramerstepped down as CEO, retaining the role of non-executivechairman for Ariel Holdings.

Mr. Rivaz, who succeeded Mr. Kramer, said diversification goalsremain intact.

"We are committed to building value in our business, and aim todo so by focusing our capital and resources on lines of businessthat deliver attractive returns over time for the risks assumed,"he said.

"Diversification of our profit streams remains an important partof our strategy, and continues to develop from the combination ofAriel Re property catastrophe and marine reinsurance, our Lloyd'sbusiness, and credit and surety reinsurance written in our Zurichbranch."

Noting his belief that Ariel Re and Atrium "are well positionedto deliver attractive returns both currently and for the longterm," he said Ariel will "keep evaluating additional opportunitiesand hope to identify more that fit our criteria."

Through May 31, 2010, gross written premiums for Valiant wereapproximately $34 million, First Mercury said, adding that in the12 months following the closing of the transaction, First Mercuryanticipates that Valiant will write approximately $50-to-$60million of gross written premiums.

According to Highline Data, Valiant wrote $54 million in grosspremiums in total on a statutory basis in 2009.

Mr. Dubois confirmed that Valiant plans to continue to grow andpossibly remain on track with prior plans to expand officesthroughout the country, but will reassess the specific geographiclocations as it aligns with an U.S. partner that has an existingbranch network.

Moody's said outsized growth could prompt a ratings downgradeover the near-to-medium term. On a positive note, commenting onFirst Mercury's strengths, the New York-based rating agency saidits rating reflects an established position in providing generalliability insurance for the security industry and strong profitmargins in core business, among other things.

But strengths are offset by a focus on medium-tail casualtybusiness with uncertain reserve adequacy, Moody's said.

With respect to growth, First Mercury said it intends to retainonly about 33 percent of Valiant's anticipated gross writtenpremiums, while reinsuring the rest--remaining consistent with apast practice to use reinsurance on newer area of business.

Under the terms of the agreement, Ariel has agreed to provideFirst Mercury with full protection related to the runoff ofValiant's net loss and loss adjustment expense reserves andunearned premium reserves reflected on the closing date balancesheet.

The transaction is subject to customary closing conditions andregulatory approvals.

Looking ahead, Mr. LaFramboise said there could be moreacquisitions in First Mercury's future. "We have a stated growthand diversification strategy...and we always have a pipeline ofopportunities that we're working," he said.

"We would probably be a lot more likely to be more interested indistribution than balance sheet acquisitions, but we will evaluatethe opportunities as they come before us," he added.

Explaining the preference for distribution opportunities, hesaid they don't come with the legacy issue of the balance sheet. Inthe Valiant situation, he noted that Valiant has a very smallamount of net exposure. In addition, "we're getting very attractiveprotection from a high-credit quality seller, so that we're not atall uncomfortable with that situation," he said.

First Mercury does not expect the Valiant deal to have amaterial effect on 2010 earnings and expects the transaction to bemodestly accretive to earnings in 2011.

Related article:

For more on Valiant's early history and product focus, seerelated article, "ExperiencedTeam On Board At Valiant Insurance," in which Mr. Dubois andValiant Vice President Scott Bayer describe the company's goals andphilosophy.