Last week, James River secured an adverse development cover (ADC) that puts the insurer in a better place to address its remaining challenges and gives it a shot at an exit for shareholders in the medium term if it can execute over the next couple of years.
The ADC announcement confirmed this publication’s report last month that James River had engaged with the legacy market to seek fresh protection for its core business that would sit in excess of the deal it secured from Stone Ridge’s Longtail Re in July, with the need for a significant charge to be taken to get there.
James River also – as this publication had anticipated – declared the strategic review closed, and indicated to investors it would look to chart an independent path forward.
In response, the company’s stock has plunged to $4.63 per share, down 29% in the past five days and nearly 80% from where it went public.
Let’s take a step back. James River and its management team have been living through a serious hangover over the past few years, since J Adam Abram handed the CEO role over to Frank D’Orazio after a period of mismanagement. (He remained as chairman until summer last year – in a move that likely restricted the room for maneuver of the new management team.)
That period has seen its reputation as a solid E&S insurer battered as its results suffered following a series of misadventures beyond its core business, including a disastrous Uber relationship and a poorly executed foray into casualty reinsurance.
Over time, these portfolios generated hundreds of millions of dollars of adverse development, and a succession of pieces of bad news that ultimately pushed the board to initiate a strategic review, and launch a subsequent full sale process.
In response to the charges, the company placed the Uber book and its casualty reinsurance business into runoff, before offloading the legacy exposures, leaving it with its core E&S business.
That said, the rot found in the Uber and casualty reinsurance reserves had spread to even the core E&S unit. This publication reported the range of estimates of reserve deficiency in the E&S book stretching from $200mn at the optimistic end to $400mn at the pessimistic.
When it put in place the Longtail Re, this publication said that the company was playing for time with another legacy deal. This time with an extra tranche of protection, the company has at least a shot at avoiding further adverse development.
Companies fighting for their lives will repeatedly express confidence in reserves that do not deserve confidence. But Enstar’s willingness to take a bigger common equity stake as part of the deal is a strong hint that its view of ultimate claims on the book is just inside the limit.
Given Enstar’s pedigree in estimating claims development that view deserves respect, opening up the possibility that James River has done enough to put its reserving challenges behind it.
Gallatin’s willingness to convert some of its stake from the preference shares where it has much greater downside protection to common equity where it can capture upside is another indication that a sophisticated institution thinks James River has reached its nadir.
Even with Enstar’s imprimatur, and Gallatin’s display of confidence, D’Orazio will still have a major challenge convincing investors that its past mistakes have truly been walled off.
There is also an overhang from the ongoing litigation with Fleming. The latest update in the saga was a few weeks ago, when Fleming submitted an amended complaint with additional allegations to bolster its claims of fraud and misrepresentation in the $277mn sale of JRG Re to Fleming.
In July, Fleming filed a lawsuit against James River, company CEO Frank D’Orazio and group CFO Sarah Doran, alleging securities fraud, common-law fraud and breach of contract.
Additionally, the carrier needs to get through a messy fourth quarter and the hit that its book value will take from the Enstar ADC.
The resilience of the go-forward business
On the other hand, the company has managed to keep the go-forward E&S book in place in a market that is bullish on E&S, and has drawn some equity in to bolster its balance sheet.
Given the degree of performance challenges, it has been no mean feat to prevent widespread staff defections and persuade the wholesale brokers to keep the business flowing in. That points to resilience in the go-forward business.
If James River can convince investors that its reserves are okay, then a $1bn E&S company would be a very attractive target in this market.
Of course, that will require quiet multi-year delivery on results, with a particular emphasis on proving the reserving issues are a thing of the past. And it will ultimately require skillful marketing to potential acquirers given its recent past.
AM Best pegged the US surplus lines market as surpassing the $100bn premium threshold for the first time in 2023, producing $115.6bn in direct written premium. International insurance groups and standard lines insurers that have no E&S business, or which are underweight, could see James River as a viable platform to gain access to the non-standard market.
Speaking of the ratings agency, it has chosen to keep James River at a viable rating for this long, and transactions like the Enstar deal are typically stress-tested with AM Best before being agreed. So likely the E&S insurer still has road to run with the ratings agency.
The stock has been pounded in recent days reflecting the evaporation of bid speculation, the dilution to shareholders, the book value hit from the charge, and potentially further erosion of management credibility.
Pro forma for the Enstar charge, the E&S insurer could be trading at as little as around 60% of tangible book.
Management has also proven that even through the darkest of days, it can hold a team together and persuade the brokers to feed its go-forward business.
To some that will sound like an opportunity, for others just another falling insurer knife.
It all ultimately turns on how bad the reserves are, and whether James River’s ADC wall is high enough to keep the floodwaters out.
We will likely not know the answer for a number of years. But it has its best chances of survival for some time.