California insurance regulators have been able to shore up amutual California homeowner's insurer weakened by the housing bustthrough a complex mutual-to-stock conversation.

The demutualization was California's first since 1997 and itsfirst P&C demutualization since 1985, according to RobertHogeboom, an insurance regulatory lawyer at Barger & Wolen inLos Angeles.

Hogeboom and his partner Dennis Quinn worked 15 months on thedeal to covert Merced Mutual Insurance Company based in Atwater toa stock insurer.

The company was then acquired by United Heritage Financial Groupof Meridian, Idaho. The deal became effective April 1.

A key component of the deal was that it allowed regulators tokeep the company in California.

“For the deal to be attractive to both Merced members andUnited Heritage, the members had to receive from United Heritagemore cash for their equity in Merced than the statute would allowMerced to pay,” Hogeboom he said. “In this case, the money camefrom a third party, leaving the capital and surplus in Merced.”

In most demutualization deals, the surviving company is leftwith a reduced surplus, Hogeboom explained.

Under the deal, Merced converted to a stock company and 94percent of the stock was acquired by United Heritage for about $7.5million. A small group of policyholders retain the remainder of thestock.

The remaining 1,200 policyholders get a certificate which yieldsthem 3.5 percent a year, plus a lump-sum payoff within 10 yearsupon approval of the commissioner, Hogeboom said.

Hogeboom said Merced was having problems because the recessionand housing bust that started in 2007 prompted a number offoreclosures of homes it insured.

Hogeboom estimated that, since 2008, Merced lost about a thirdto 40 percent of its business due to the recession, “which causedforeclosures [and] automatically resulted in cancellation of theinsurance.

“The company decided that, in order to survive, it needed apartner, and the best avenue to get a partner and more capital wasto demutualize and then partner through the acquisition with theUnited Heritage Group,” according to Hogeboom and Dennis L.Johnson, president and CEO of United Heritage holding company.

Merced wanted to find a company that had a mutual background anda specialty in auto in order to expand their offerings and reducetheir reliance on homeowners.

“When you can offer both, you can sell both at a lower rate,”Hogeboom said. “They were getting hurt because they couldn't offerauto, and they didn't have the resources or the expertise to startan auto company de novo,” Hogeboom said.

The deal involved a lengthy approval process with the CaliforniaDepartment of Insurance, including a public hearing on theapplication and a special meeting of the policyholders to approvethe plan.

Johnson said Merced agreed to the deal with UnitedHeritage because it wanted to “partner with a well-capitalizedinsurance group that shared Merced's mutual insurance companyculture and possessed expertise in underwriting autoinsurance.”

Johnson said it is in the process of establishing a system tosell auto and packaged products, “which is expected to complementMerced's existing homeowners' line to further serve California'sCentral Valley.”

United Heritage is an insurance holding company that owns 100%of the common stock of three insurance companies: United HeritageLife Insurance Company, United Heritage Property & CasualtyCompany, and Sublimity Insurance Company.

United Heritage Life Insurance Company, offers life insurance,fixed annuities and group insurance products in 38 states andWashington, D.C.

United Heritage Property & Casualty offers property andcasualty insurance in four western states and Sublimity InsuranceCompany offers auto insurance in three western states and is basedin Sublimity, Oregon.