June 11 (Bloomberg) -- D.E. Shaw & Co., the fourth-largest hedge fund manager, agreed to buy property and casualty insurer James River Group Inc. for about $575 million and will fold it into a holding company with a new reinsurance unit.

James River stockholders will receive $34.50 a share, 1.9 percent below Friday's closing price, the insurer said today in a statement. D.E. Shaw will create and fund a Bermuda-based reinsurance company to nearly double to $450 million the capital available for James River to back policies, the Chapel Hill, North Carolina-based company said today in a regulatory filing.

``Since Shaw is a significant owner of insurance stocks, they could see this as one of those little diamonds in the rough,'' Geoffrey Bobroff, an independent money-management consultant in East Greenwich, Rhode Island, said in an interview. ``Shaw may be able to expand its franchise more nationally with little effort.''

D.E. Shaw's proposed acquisition comes about two weeks after hedge fund manager David Einhorn raised almost $195 million by selling shares of reinsurer Greenlight Capital Re Ltd. in an initial public offering. Reinsurance prices more than doubled after Hurricanes Katrina, Rita and Wilma caused insured damages of $57.9 billion in 2005. Reinsurance is coverage for insurers.

Investors including Berkshire Hathaway Inc. Chairman Warren Buffett and hedge fund manager Einhorn invest insurance premiums until they pay claims.

Oversees $30 Billion

New York-based D.E. Shaw uses computer programs to find discrepancies in prices among securities. It also invests in distressed debt and makes bets on broad economic trends using stocks, bonds, currencies and commodities. It was founded in 1988 by David E. Shaw, a former Columbia University computer science professor. It oversees about $30 billion in investment capital. Lehman Bros. Holdings Inc. bought a 20 percent stake in March.

D.E. Shaw's investment will ``permit us to selectively retain more premium and risk than we currently are able to keep on our balance sheet,'' James River said in the filing.

Under the terms of the merger agreement, James River will actively solicit other proposals until Aug. 5, the statement said. If the merger agreement is terminated during the review period, D.E. Shaw affiliates will receive a fee of about $7.2 million. Investors holding approximately 45 percent of the outstanding common shares of James River have agreed to vote in favor of the D.E. Shaw deal, the statement said.

`Investment Capability'

``They can take advantage of D.E. Shaw's investment capability,'' said Elizabeth Malone, an analyst with KeyBanc Capital Markets Inc. in New York. ``In Bermuda you pay a significantly lower tax on profit and investment returns.''

James River Chief Financial Officer Michael Oaks said the company ``hasn't really played out the business plan'' for the Bermuda reinsurer and its impact on the company's taxes.

Malone lowered her rating on James River today to ``hold'' from ``buy'' because she said she didn't expect other bidders to emerge.

James River sold stock at $18 a share in an initial public offering in August 2005, two weeks before Katrina. Shares declined $1.09, or 3.1 percent to $34.09 in Nasdaq Stock Market trading today. The company was founded in 2002.

While property and casualty insurance prices have declined as insurers lower rates to gain market share, companies such as James River that provide coverage to small businesses can maintain profit margins, said Cliff Gallant, an analyst with Keefe, Bruyette & Woods Inc. in New York.

`Less Competition'

``There's less competition in small accounts and that's who their target customer is,'' said Gallant, who has a ``market perform'' rating on James River. ``They believe the company can grow and they might be able to take it public again.''

James River's first-quarter net income rose 49 percent to $10.1 million as the company's premium revenue climbed 25 percent to $60.2 million. James River sells workers' compensation and excess casualty policies.

D.E. Shaw held a 1.5 percent stake in Everest Re Group Ltd., a Bermuda-based property and casualty reinsurer, as of March 31, according to filings with the U.S. Securities and Exchange Commission.

The investment firm's insurance-industry holdings also included a 0.6 percent stake in Richmond, Virginia-based Genworth Financial Inc., the insurer spun off by General Electric Co. Genworth first sold shares publicly in 2004, and General Electric sold its stake in 2006. D.E. Shaw also has holdings in MGIC Investment Corp., a Milwaukee-based provider of U.S. mortgage insurance; and Philadelphia-based Radian Group Inc., another mortgage insurer that's merging with MGIC.

There are more than 9,000 hedge funds with $1.57 trillion in assets, according to Chicago-based Hedge Fund Research Inc.

J.P. Morgan Securities Inc. is advising James River's board, and Wachovia Capital Markets LLC is the adviser for D.E. Shaw.

D.E. Shaw spokeswoman Kari Elassal declined to comment.

To contact the reporter on this story: Erik Holm in New York at eholm2@bloomberg.net.; Jenny Strasburg in New York at jstrasburg@bloomberg.net;

Last Updated: June 11, 2007 18:10 EDT