Failure of Novae-Chaucer Deal Reflects Investment Vagaries

LONDON, Apr 06, 2009 (A. M. Best via COMTEX) -- ZALOF | Quote | Chart | News | PowerRating -- The decision by Novae Group plc to seek a merger with fellow Lloyd?s insurer Chaucer Holdings plc made a lot of sense to Matthew Fosh, Novae?s chief executive.

?You had two businesses that are relatively small compared to their peers and, put together, would have made a serious-sized business,? Fosh said in an interview in his London office. For a start, he said, a combined operation would have needed less capital than two separate entities.

?In a business where scale matters, it would have given us scale,? Fosh said. ?We?d have had more trading power in the market. We would have been writing bigger lines and been able to more efficiently buy reinsurance.?

A merger also would have created synergies, in the form of ?old-fashioned cost savings,? Fosh said.

But the deal did not go through, and that failure says much about the complex pushes and pulls exerted by the investment markets.

Investment Maneuvers

Chaucer (LSE: CHU) became a feasible target, Fosh said, as a result of a ?bit of a hiccup? in the investment sector in the third quarter of 2008. The resultant losses drove down Chaucer?s share price. Weakness in Novae?s own shares, Fosh said, had previously meant that it was ?not really in a position to approach anybody.?

Chaucer?s problems pushed its share price down ?to a similar rating to ours, and it made a potential merger of equals possible,? Fosh said. ?We approached them, and they listened.?

But the due diligence begun by Novae in late January and early February 2009, Fosh said, suggested a liking by Chaucer for higher-risk investments. And some of these investments, notably holdings in hedge funds, were difficult to get out of quickly, Fosh said. Chaucer learned this lesson when it started to de-risk its portfolio, he said.

Novae did not want to see these investments effectively move to its own balance sheet, Fosh said.

Differences between the two companies had their roots in investment strategies, Fosh suggested. While Chaucer had taken aggressive investment positions over the previous year or two, he said, Novae has always been ?painfully cautious.? Novae?s investment thinking, he said, has led it toward such safe assets as cash and treasury bonds.

Chaucer?s more expansive approach toward the investment markets had produced good returns from 2005 to 2007, Fosh said. The problems came in 2008, he added.

Apart from Chaucer?s investment profile, Fosh said, the two businesses would have been a strong fit. Chaucer?s underwriting and reserving were good, and the social vibes were solid, he said. The board would have contained representatives of each company. The merger ?was deliverable,? Fosh said.

Novae, which manages Syndicate 2007, focuses on big and specialized accounts and has a Lloyd?s capacity of 360 million pounds (392.6 million euros). The group also provides commercial lines cover in the United Kingdom and continental Europe through Novae Insurance.

Chaucer is strong in such lines as energy, property, marine and the U.K. auto market. Chaucer had a 2008 pretax loss of 26.2 million pounds, down from a pretax profit of 89.4 million pounds in 2007 (BestWire, March 10, 2009).

Novae Group plc had a 2008 pretax profit of 40.2 million pounds, down from a pretax profit of 41 million pounds in 2007.

Novae?s interest in Chaucer became public very early. Chaucer, which was in the process of raising capital, announced -? quite properly, Fosh said ? that it was being courted. Novae quickly made its interest known (BestWire, Jan. 29, 2009). Novae confirmed it was in talks that might, or might not, lead to a deal. Chaucer?s decision to seek capital was related to its investment reverses, Fosh suggested.

There was no reason for Novae to be coy about its position. ?It would have taken the market about two and a half nanoseconds to work out who it was,? he said, noting that Novae?s move ?elicited two or three? other expressions of interest in Chaucer.

The failure to link up with Chaucer has not curbed Novae?s appetite for expansion. ?Chaucer was a very good possibility, but not the only one,? Fosh said. ?There are other possibilities and we look at them all the time.?

One option is to seek other acquisitions, Fosh said. Another is to continue a policy established over the past three or four years and recruit underwriting teams from other insurers. Fosh described this as ?organic growth with a bit of a turbo.?

Any acquisitions strategy Novae pursues, Fosh said, will be tempered a by a more realistic attitude to debt than has applied across the market in recent years. The current generation, he said, came to the conclusion that a high level of debt, deemed necessary for expansion, was fine. ?It ain?t,? Fosh said.

Debt brings risk, Fosh said. ?We have an appetite for doing deals, but we do believe that you?ve got to be pretty cautious.?

Novae Insurance Co. Ltd. has a current Best?s Financial Strength Rating of A- (Excellent). Lloyd?s and Syndicate 2007 each currently has a rating of A (Excellent).

(By Robert O'Connor, London editor: Robert.OConnor@ambest.com)

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