Tower Group: A Look Back At Errors Made by David Merkel, CFA of Aleph Blog

I try to run an ethical blog here, so when I make mistakes, I admit them.  In this case, I don’t think the errors make a lot of difference to the investment decision, but I will confess to being wrong on  details in my last post.  I made the statement:

Though there are no financing contingencies to this deal, ACP Re can walk away with no penalty if it merely wants to do so.

That’s wrong.  ACP Re can walk away of its own accord if there is a material adverse change, and under some conditions, they would receive a breakup fee.  As such, it is not a “free look.”  But it is one-sided in this sense: if the reserves are too low, ACP Re can declare a material adverse change.  If they are fair or high, ACP will happily do the merger and enjoy the profits.

On the delay of the 10-K, which is more than a month late, I repeat that most of the figures in the balance sheet are easy to calculate.  I was trained as an actuary, albeit a life actuary, though I was an insurance buy-side analyst for 4.5 years.  The difficult question with any P&C insurer is whether the reserves are correct, and even actuaries inside a company are never fully sure of the reserves.  That’s why reserves at P&C insurers are usually set conservatively, even though GAAP says to use best estimate.  It is not a bad thing to bend GAAP accounting to be conservative, and be slow in recognizing income.

My experience with insurers that are tardy with their financials is that it is wise to steer clear.  Aggressive insurance management teams tend to go through a string of corrections before the financials are set right.

Between 1998-2000, I used to do arbitrage on small deals.  On net, I did fair with it, but the deals where I lost, you could feel a kind of “sag” where you would not ordinarily expect it.  Good arb deals show strength after an initial period of selling by those that do not want to hang around for the arb.

Now, I don’t think my reasoning is depressing the stock price, but it is interesting that the stock price keeps heading lower, and slowly.  I have a saying that slow moves tend to persist, while fast moves tend to mean-revert.

I don’t have any inside information, but this situation feels bad.  Ordinarily with takeovers, the bid for stock is far more firm.

Full disclosure: No positions in any of the companies mentioned