Agents Should be Unaffected by Pending Sale of Merchants Group

November 2, 2006

Merchants Group, Inc. in Buffalo, N.Y., which sells property casualty insurance through Merchants Insurance Co. of New Hampshire, has agreed to be bought by American European Group, Inc, a private insurance holding company.

The cash acquisition price is valued at $33 a share or $70.8 million. The sale is subject to both shareholder and regulator approval and is expected to close sometime in the first quarter of 2007.

The buyer, AEG, also owns Rutgers Casualty out of New Jersey. Another of its subsidiaries, Kentucky National Insurance Co., is in runoff.

Neither Merchants Group nor Merchants NH, with approximately $50 million worth of property casualty business, has any assets or employees. The business operations have been managed by Merchants Mutual for years and will continue to be for the “foreseeable future,” according to Robert Zak, chief executive officer and president of Merchants Mutual.

Merchants NH, a stock-based company domiciled in New Hampshire, reported net income of $3.8 million and shareholders equity of $77 million as of June 30, 2006.

Merchants Mutual Insurance Co., which writes about $150 million in business and owns 12 percent of Merchants Group, is not affected by the sale and agents writing for it should see no change, Zak told Insurance Journal. The sale will also not impact Merchants Mutual’s 200 employees in Buffalo, he said.

“We view this favorably,” he said. “There will be no disruption in our business.”

If under its new ownership, Merchants NH should pursue a change in its operational relationship in the future, Zak said Merchants Mutual would quickly find replacement products for agents’ accounts placed with Merchants NH.

Generally, Merchants Mutual handles standard business while Merchants NH is a preferred account vehicle.

After the announcement, A.M. Best and Fitch announced ratings actions affecting Merchants NH.

The A.M. Best and Fitch ratings of Merchants Mutual Insurance Co. were not affected.

A.M. Best placed the financial strength rating (FSR) of A- (Excellent) and the issuer credit rating (ICR) of “a-” of Merchants NH under review with negative implications.

Fitch Ratings changed the Rating Watch status on the ‘BBB-‘ Insurer Financial Strength (IFS) rating of Merchants NH to Negative from Evolving.

A.M. Best said its rating will remain under review pending the close of the transaction, at which time it said it expects to downgrade the FSR and ICR due to concerns regarding execution risk.

A.M. Best’s view is that AEG’s management team will face “significant execution risk in managing and retaining Merchants NH’s existing book of casualty business.” Merchants NH’s existing servicing agreement with Merchants Mutual Insurance Co., which owns just under 12 percent of MGI, is not set to expire until year-end 2007. Furthermore, A.M. Best noted, Merchants NH’s current ratings reflect the benefits of being owned and managed by Merchants Mutual, which has been providing the company with infrastructure, including underwriting and claims handling systems.

Fitch Ratings has changed the Rating Watch status on the ‘BBB-‘ Insurer Financial Strength (IFS) rating of Merchants NH to Negative from Evolving.

Fitch said it intends to meet with AEG management to discuss its intentions for Merchants NH on a go forward basis in addition to its financing of this transaction. If Fitch believes AEG will not significantly alter Merchants NH’s risk profile, it is likely Merchants NH can maintain its current stand alone ‘BBB-‘ IFS rating.

However, Fitch said that it if believes that Merchants NH will be altered in such a way that increases its risk profile, it would likely downgrade Merchants NH’s IFS rating below the secure level two to three notches to the ‘BB’ IFS rating category.

Fitch noted that the only public rating it has on the buyer, AEG, is a ‘BBq’ IFS rating on Rutgers Casualty Insurance Co. AEG’s other insurance subsidiary, Kentucky National Insurance Co., is currently in run-off and not rated by Fitch.

Last Nov. 30, Stephen C. June, resigned as CEO from Merchants Group, Inc. as well as from positions as chief operating officer and executive vice president at Merchants NH.

Merchants Mutual and Merchants NH — which together form Merchants Insurance Group —sell property and casualty insurance in the northeastern, mid-Atlantic, and midwestern states. The companies are represented by approximately 670 independent insurance agents.

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