Harleysville Buyout Highlights Directors’ Potential Conflicts at Insurer

Harleysville Mutual Insurance Co. directors may draw scrutiny for potential conflicts of interest when customers are asked to approve the sale of the company and its Nasdaq-listed subsidiary, Harleysville Group Inc. (HGIC), to Nationwide Mutual Insurance Co.

Michael Browne is chief executive officer of each Harleysville company, and most of the directors serve on both boards. Directors last week approved the companies’ sale on terms that give the publicly traded firm more than twice the valuation of its parent.

All nine directors of Harleysville Mutual own stock in the other company. Among them are two people who, according to the general counsel, comprised a special committee to assess the deal because they aren’t on the Harleysville Group board. Those two will realize about a $1.35 million gain on their stock if the sale to Nationwide is completed, according to data compiled by Bloomberg. None of the nine has an economic stake in the mutual beyond the role of policyholder.

“It doesn’t sound like arm’s length,” said Robert Hunter, a former Texas insurance commissioner and the director of insurance for the Consumer Federation of America. “Unless there’s a very rigorous study by the regulating state with a good report, it’s probably going to end up in court.”

Browne owns about 557,000 options in the publicly traded firm, all of which were under water before Bloomberg News reported the talks with Nationwide on Sept. 23. If the sale is completed, they’re worth more than $14 million. His shares and restricted stock would be worth at least $11 million.

Pennsylvania Law

Robert Kauffman, general counsel of the Harleysville, Pennsylvania-based insurers, said the policyholders will benefit because they will become affiliated with Nationwide, a larger company with a better financial-strength rating. He added that under Pennsylvania law, a mutual company’s board must balance the interests of policyholders, employees, and other stakeholders rather than maximize economic value as a stock company incorporated in Delaware would.

The members of the committee of Harleysville Mutual directors that blessed the deal include Nicholas DeBenedictis, CEO of Aqua America Inc., a Bryn Mawr, Pennsylvania-based water utility. He had 28,707 shares of Harleysville Group stock, according to an April regulatory filing. The stake would be worth about $1 million more on completion of the deal than on Sept. 22. DeBenedictis didn’t return a call seeking comment.

The directors don’t have a conflict of interest, Kauffman said. Under Pennsylvania law, stock ownership in another company does not “in and of itself” mean the director has a conflict, he said.

Missing Fords

Harleysville traces its roots to 1915 when the disappearance of Ford sedans prompted a local man to organize an association to protect against auto theft. The company first sold stock in Harleysville Group to the public in 1986.

In the deal with Columbus, Ohio-based Nationwide, also policyholder-owned, the public shareholders who own about 47 percent of Harleysville Group get $60 a share in cash, or 137 percent more than its stock price on Sept. 22.

It also values Harleysville Group at more than $1.6 billion, or more than twice company’s book value under U.S. Generally Accepted Accounting Principles. The book value was $781.7 million as of June 30, or about $28.81 per share. The company’s net worth is about $711 million under the accounting rules used by state insurance regulators.

$840 Million

Holders of restricted stock and options, including Browne, will get a payout of about $80 million for those securities, Nationwide said. That’s almost 10 percent of the $840 million the buyer is paying to Harleysville Group equity holders.

“Policyholders literally get nothing, and management gets about $70 million to $80 million,” said Jason Adkins, founder of Boston-based law firm Adkins Kelston & Zavez PC, which has brought suits against mutuals on behalf of policyholders. “That clearly, clearly is not appropriate. Policyholders should be compensated.”

Adkins represented policyholders of Allied Mutual Insurance Co. and claimed in a suit that company assets were improperly transferred to Allied Group Inc. The case was settled in 2005 for at least $100 million, according to Nationwide, which acquired the Allied insurers.

Policyholders of the mutual company will see their interests and the firm’s $892 million of net worth combined with that of Nationwide’s, with no payout -- a transaction similar to a stock merger of equals. Nationwide’s financial strength rating of A+ from A.M. Best Co. is a level higher than Harleysville Mutual’s.

‘No Worse Off’

Griffin Financial Group LLC, a Pennsylvania-based investment bank, gave Harleysville Mutual an opinion that the deal was fair. Policyholders are “no worse off, and arguably better off because they’re members of a stronger, more highly-rated company than they are today,” said Jeffrey Waldron, a Griffin senior managing director.

“Nationwide is better diversified nationally, both in product and in catastrophe exposure,” said Joe Case, a spokesman for the buyer. “Harleysville policyholders will also benefit from Nationwide’s more complete line of products and its national service support.”

The Nationwide takeover requires approval by a majority of Harleysville Mutual policyholders who cast a vote. Harleysville Group shareholders and Nationwide policyholders must also approve the deal for it to be completed.

Rosanne Placey, a spokeswoman for the Pennsylvania Insurance Department, said the companies haven’t yet submitted their filings to the regulator related to the deal, and she declined to comment further.

To contact the reporters on this story: Zachary R. Mider in New York at zmider1@bloomberg.net; Andrew Frye in New York at afrye@bloomberg.net.

To contact the editor responsible for this story: Jennifer Sondag at jsondag@bloomberg.net; Dan Kraut at dkraut2@bloomberg.net

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