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As a strategic endgame, property and casualty insurer Tower Group International, Inc. (TWGP - Analyst Report) has sought an alliance with ACP Re Ltd., a Bermuda-based reinsurance company.

The deal, valued at $172.1 million, will see Tower Group’s shareholders getting $3.00 in cash for each share held.

Tower Group went into trouble recently after it faced a huge reserve shortfall. The company had miscalculated the magnitude of reserve required for policies related to workers’ compensation, commercial liability and commercial auto.  While the company had faced reserve deficiency, the industry witnessed a higher favorable reserve development for the first nine months of 2013 helped by positive pricing momentum, a gradually improving economy and a relatively benign loss cost trends.

Coming back to the deal, as part of the merger agreement, AmTrust Financial Services, Inc.  (AFSI - Snapshot Report), (whose founder established a trust, which is the controlling stake holder in ACP Re) will buy Tower Group's renewal rights and the assets in its commercial lines business, for about $125 million.

The deal is expected to see light by the summer of 2014 and is contingent on customary approvals from the insurance regulator.

The deal also carries some termination rights. If Tower Group backs out of the deal it will have to pay ACP Re for certain of its transaction expenses, subject to a cap of $2 million, along with a termination fee of $8.18 million. Tower Group has sought consultation from J.P. Morgan Securities LLC of JPMorgan Chase & Co. (JPM - Analyst Report) and from BofA Merrill Lynch of Bank of America Corporation (BAC - Analyst Report).

Post merger, Tower Group will be the surviving entity gaining the status of a wholly owned subsidiary of ACP Re.

It comes as a great surprise to us that a company that was so hale and hearty till last year had to resort to a merger to save itself. While on the surface the company seemed to be doing well, reserve inadequacy had spelt trouble for the company for quite some time now.  The company undertook remedial measures to improve its financial position and reduce expenses like, selling of stakes in Canopius Group Ltd.; reducing workforce by about 10% and dissolution of the scheduled acquisition of ASRe from Fairfax Financial Holdings. However, they did not bear fruit. Tower Group currently carries a Zacks Rank #5 (Strong Sell).

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