He added, "Valiant provides us with an attractive opportunity to gain admitted licensing [and] expand our resources in professional and management liability and selected specialty casualty underwriting classes, while adding marine underwriting capabilities to 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 directly writes any admitted business currently, although one insurance company--First Mercury Casualty Company--is admitted in 15 states. At this point, that company is only providing intercompany reinsurance, he said.

Ted Camp, executive vice president and chief underwriting officer, elaborated on the deal's benefits beyond a 47-state fully-licensed operational admitted platform that Valiant brings to the table. In a phone interview, he said Valiant also brings several experienced underwriting teams with good reputations, "a robust New York presence," and a book of business that is "a good fit 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 are broad areas of comfort, and in certain cases, areas of expertise that we share," but Valiant focuses on slightly different subsegments than those historically targeted by First Mercury, he told NU.

"Valiant is very excited and enthusiastic about the prospects of becoming associated with the First Mercury organization on a going-forward basis," he said. While acknowledging Valiant's appreciation for Ariel's support in getting the startup running over the last three years, he said "the ability to become part of the First Mercury organization allows [Valiant] to move on to the next phase of development."

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

George Rivaz, CEO of Ariel Holdings, explained the decision to sell Valiant in an e-mail to NU. "Valiant has faced soft market headwinds from commencement, and as a result its contribution to the Ariel group has fallen short of initial expectations," he said.

"Furthermore, the timing of the market upturn, which would be necessary for Valiant to deliver strong positive returns on capital, remains uncertain," he said.

"In light of this, the Ariel Holdings board concluded that extraction of our capital, rather than further investment needed to support growth of Valiant's business, was the appropriate course."

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

First Mercury's Mr. Camp said the deal "expands our lines of business into marine and management liability, [which] we're currently very interested in," noting that First Mercury only writes a very small amount of management liability business at this point.

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

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

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

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

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

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

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

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

"As we moved through year-end renewals, it became obvious...that no market change was coming in the near future," Mr. Smith explained during a year-end conference call, reporting that the management team and board of directors agreed on a restructuring that "resulted in the right-sizing of [the] capital base, staffing levels [and] underwriting assets" in order to "improve results in the current stagnant market conditions, and...to be even better prepared for a change in future conditions."

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

While the dividend payout was designed to align capital with market opportunity, Moody's cited "incremental pressure on the company's capital adequacy and financial flexibility" as reasons for changing the outlook of First Mercury's "Baa2" financial strength rating to negative following the Valiant acquisition announcement last week.

Moody's analyst Enrico Leo said the pressures are "a result of the expansion into larger size and higher-risk business lines" in a weak 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 of a focus at the larger end of the middle-market segment, but I don't believe it's a dramatic difference" from the account sizes targeted by First Mercury.

In addition to risk-taking insurers First Mercury Insurance Company (an E&S insurer) and First Mercury Casualty Company (admitted in 15 states), First Mercury group has several distribution subsidiaries: CoverX Corporation, First Mercury Emerald 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&S niche underwriting platform with a small-account focus in areas like specialty casualty, professional lines and hospitality. In contrast, First Mercury Emerald--a wholesale broker--has a larger-account focus, targeting more complex risks.

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

New York-based Valiant started operations in 2007 when Bermuda-based Ariel purchased the company as a shell to serve as its 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 of Hurricanes Katrina, Rita and Wilma to capitalize on opportunities in the property-catastrophe reinsurance market. But even in its early days, founder Don Kramer had a vision of growing beyond the short-tail reinsurance lines, and later diversified the company with Valiant and with the acquisition of Atrium Underwriters in London in 2007 as well.

In March, Mr. Kramer stepped down as CEO, retaining the role of non-executive chairman for Ariel Holdings.

Mr. Rivaz, who succeeded Mr. Kramer, said diversification goals remain intact.

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

"Diversification of our profit streams remains an important part of our strategy, and continues to develop from the combination of Ariel Re property catastrophe and marine reinsurance, our Lloyd's business, and credit and surety reinsurance written in our Zurich branch."

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

Through May 31, 2010, gross written premiums for Valiant were approximately $34 million, First Mercury said, adding that in the 12 months following the closing of the transaction, First Mercury anticipates that Valiant will write approximately $50-to-$60 million of gross written premiums.

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

Mr. Dubois confirmed that Valiant plans to continue to grow and possibly remain on track with prior plans to expand offices throughout the country, but will reassess the specific geographic locations as it aligns with an U.S. partner that has an existing branch network.

Moody's said outsized growth could prompt a ratings downgrade over the near-to-medium term. On a positive note, commenting on First Mercury's strengths, the New York-based rating agency said its rating reflects an established position in providing general liability insurance for the security industry and strong profit margins in core business, among other things.

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

With respect to growth, First Mercury said it intends to retain only about 33 percent of Valiant's anticipated gross written premiums, while reinsuring the rest--remaining consistent with a past practice to use reinsurance on newer area of business.

Under the terms of the agreement, Ariel has agreed to provide First Mercury with full protection related to the runoff of Valiant's net loss and loss adjustment expense reserves and unearned premium reserves reflected on the closing date balance sheet.

The transaction is subject to customary closing conditions and regulatory approvals.

Looking ahead, Mr. LaFramboise said there could be more acquisitions in First Mercury's future. "We have a stated growth and diversification strategy...and we always have a pipeline of opportunities that we're working," he said.

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

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

First Mercury does not expect the Valiant deal to have a material effect on 2010 earnings and expects the transaction to be modestly accretive to earnings in 2011.

Related article:

For more on Valiant's early history and product focus, see related article, "Experienced Team On Board At Valiant Insurance," in which Mr. Dubois and Valiant Vice President Scott Bayer describe the company's goals and philosophy.