As I spoke with my source on the telephone my jaw literally dropped—-between my day job as a CPA and passion as a hobbyist investor I thought I had seen the sleaziest of the sleazy in characters like Angelo Mozilo, John Mack, Ed Liddy, Hank Greenberg etc but those guys have nothing on the management team of Canadian insurer Kingsway Financial Services Inc. Once again I was also reminded that while stories like the Balloon Boy and White House Party crashers dominate the news, the best stories in my opinion come from the world of finance and are generally under reported by the media. First some background courtesy of Yahoo Finance:
Kingsway Financial Services Inc., through its subsidiaries, provides property and casualty insurance to individuals and businesses in the United States and Canada. It primarily offers non-standard automobile and trucking insurance. The companys non-standard automobile insurance covers drivers who do not qualify for standard automobile insurance coverage because of their payment history, driving record, place of residence, age, vehicle type, or other factors; and trucking insurance cover liability, accident benefits, physical damage, cargo, and comprehensive general liability under a package program. It also provides standard automobile insurance; commercial automobile insurance; commercial and personal property coverages; motorcycle insurance; residential wind insurance coverage; construction defect claims; and other specialty coverages, such as customs, bail, and surety bonds. In addition, the company purchases reinsurance from third parties.
The Yahoo profile typically derives from the first footnote to the annual financial statements issued by the company. Not included of course is a short financial history which in Kingsway’s case we define as beginning in 2005 when this huge company began to implode racked by bad underwriting and investment decisions. In this case the shareholders tried to get management to right the ship led by activist investor Joseph Stilwell whose group owns over 10% of Kingsway. Mr Stilwell also could answer to the title bagholder as I’ll explain a bit later.
In Kingsway’s case the problems are massive and well documented. Over the past year several of the Board of Directors have resigned as has the Chief Financial Officer and Kingsway’s unresponsive CEO W. Shaun Jackson. Insurer specialized AM Best and the other ratings agencies have been steadily downgrading the company which also appears to be in violation of certain debt covenants. One particular operating company, Lincoln General Insurance Company, which underwrote commercial truck insurance in Pennsylvania was particularly unprofitable to the detriment of the entire organization.
When an insurer decides to abandon a previously served market the process, called “run-off” is not a quick proposition. An insurer’s book of business contains polices that expire throughout the course of a year, sometimes even longer and those policies must be honored. Additionally many state DOI’s provide that such operation wind downs be done “orderly” and thus can take years to accomplish. For an insolvent insurer needing quick action the process is of little help and it was that situation of too little too late that Kingsway found itself in with its subsidiary Lincoln General. Let’s hear what management decided to do from their own mouths from a shareholder conference call held November 6, 2009 courtesy of Seeking Alpha (please don’t shoot me if I go over the 400 word limit):
Thanks, Dan. I believe we are at the turning point in Kingsway’s transformation. Since last quarter’s call, we have taken action that will allow us to put the legacy of poor historical business strategies behind us. We can now concentrate our attention on rebuilding the strength and performance of the group. On last quarter’s call, I provided an update on the considerable process we made in executing the transformation plan we announced in February of this year. I outlined what we were doing on all four fronts. All of which I’ll touch on again this morning. The four were, restoring financial stability, managing the run-off of Lincoln, strengthening relationships with regulators and rating agencies, being sure we have the right people in the right role.
I want to start with Lincoln this time. Because of the actions they have taken recently to dispose off Kingsway interests in and control all Lincoln. Of the $128.8 million loss from run-off and discontinued businesses posted in the third quarter, it should be noted that $95.5 million is directly attributable to Lincoln with an additional $23.6 million write-down related to the disposition totaling $119.1 million.
The call continues:
……I announced the appointment of senior run-off experts from the Rockwell Financial Advisory team to the Lincoln Management team on board. They created the run-off plans for Lincoln and took on the mandate of executing it. We said that we can continue to support the run-off and that we would be prepared to provide an additional contribution of $10 million maximum should that become necessary. Despite the amount of management time and energy that has been spent from Lincoln, there has continued to be uncertainty about the state of the business.
Late in the third quarter, Rockwell and its outside experts quantified additional areas of exposure. We determined that for the good of the Kingsway group of companies as well as Lincoln, we simply couldn’t sustain the risk of potentially having to put more money into Lincoln beyond what we had already committed nor could we risk default on the Kingsway’s public debt indentures. We decided to act immediately to dispose of all ownership in Lincon’s parent Walshire Insurance Company. We acted to protect the interest of both Lincoln and the Kingsway Group of companies including shareholders, creditors, policyholders and employees.
Let me be clear, the purpose of this transaction is not in any way to trying to avoid any existing obligations of Kingsway, we will continue to honor our obligations with respect to Lincoln to do so we must maintain the financial viability of the publicly held trading company overall. It is possible that Lincolns continuing negative performance could have triggered a default in the Kingsway public debt indentures that scenario would have jeopardize Kingsway’s ability to continue to support all of our insurance subsidiaries and meet obligations to policy holders including Lincoln’s.
So far so good right? The team figured out a way to shed Lincoln in very short order and the CEO was clear, “not in any way to trying to avoid any existing obligations of Kingsway, we will continue to honor our obligations with respect to Lincoln”. So what plan did these highly paid financial consultants at Rockwell devise for the insolvent Lincoln? I’ll let Kingsway’s CEO Colin Simpson continue the explanation:
As previously disclosed, Kingsway ceased to control Lincoln as of October 19, but expects to continue to support the Lincoln run off to announce transition services agreement. That times action removed Lincolns from Kingsway’s consolidating group balance sheet, thereby removing the rest of the group or potential future adverse development of Lincoln. We have disposed off our interest by donating the shares of Walshire which owner (sic) Lincoln shares to charity.
Of course to the stock analyst listening in all this sounded too good to be true and for good reason. It didn’t make sense. For instance the CEO disclosed the consultants identified “additional areas of exposure” which necessitated the quick disposal as well as the amount of the Q3 write-off of Lincoln. If those additional exposures were completely captured in the write-off and Kingsway would be standing behind Lincoln’s run-off plan and the write-off didn’t bankrupt Kingsway then why get rid of Lincoln? Alternatively was the entire exposure truly captured or did Kingsway truly intend to stand behind their financial obligations with respect to Lincoln? The questions from the analysts kept hammering on those topics as we skip to page 7 of the conference call (CC) transcript for the CEO Simpson’s bottom line:
Tom Mackinnon – Scotia Capital
And just to get this straight, with respect to what’s happened, Rockwell seems signal that there could be an area of potential exposure. Then you said you had to act quickly, so you sold it off to charity and then as a result, you’ve eliminated any kind of residual adverse development obligations with respect to Lincoln as a result of doing so. Is that the way we should look at that?
(Inaudible) we had sales it gets to…
Tom Mackinnon – Scotia Capital
Well yes, whatever, but it’s gone?
What we basically did early…
Tom Mackinnon – Scotia Capital
(Inaudible), you tossed it.
Yeah. Early in the month, we recognized that there was going to be some further development in the numbers of Lincoln and at that point, we took the determination, we can no longer take the risk of the financial implications of that on the group and also on the basis of the risk under certain circumstances, we could have breached our debt covenants. And on that basis, we had to react quickly in order to resolve the issue and remove the risk from the group to protect the rest of our operating companies and as I have clearly stated, it also protects our ability in the future to support Lincoln by providing the services as they need to carry other operations on [arms length] agreement.
Tom Mackinnon – Scotia Capital
So, essentially if you hadn’t gifted this ownership through Walshire to charity, then you could have been on the hook for further adverse development if it was to develop?
Yeah, it could be on the adverse development and we could have also triggered and opened our public debt indentures and (inaudible) are subjected to debt indentures and Lincoln had voluntary submitted itself or been placed into supervision, rehabilitation or liquidation, Kingsley would have been in default. And Kingsley repayment obligations under those public debt would have been accelerated and become immediately due and payable and that was the risk that we’re trying to prevent.
Tom Mackinnon – Scotia Capital
Well this was a costless solution, just given the fact that there is no booking impact as a result of what you’re telling us from the Lincoln book at the end of the third quarter was effectively zilch.
Predictably CEO Simpson no longer wanted to discuss the specifics as we continue:
Yeah, I think it would be inappropriate for us to discuss all of our detail on this forum.
Shortly after the conference call Mr Stilwell was “encouraged” enough to buy another 100,000 shares @ 3.12 a share in an investment decision that would prove disastrous, at least over the short-term as the Pennsylvania DOI didn’t buy into Simpson’s bullshit with respect to Lincoln General.
The Pennsylvania Insurance Department will take legal action against Kingsway Financial Services, Inc. and its wholly-owned subsidiary Kingsway America, Inc. to unwind certain transactions and ensure that Kingsway retains its legal obligations as the ultimate controlling entity of Lincoln General Insurance Company, Commissioner Joel Ario said today.
Lincoln General, a Pennsylvania insurance company specializing in commercial insurance for the trucking industry, has been experiencing financial difficulties. The department has been in discussions with Lincoln General and Kingsway concerning Lincoln General’s financial condition and Kingsway’s responsibilities as the ultimate controlling corporation for Lincoln General.
Rather than continuing these discussions, Kingsway unilaterally sought to divest itself of its responsibilities under state law by improperly removing Lincoln General as a member of the Kingsway consolidated group of companies. It did this by attempting to dispose of its entire interest in Lincoln General by donating 100 percent of the stock of Lincoln General’s immediate parent to 20 different charitable organizations. Each charity received five percent of the parent’s stock plus a check in the amount of $20,000 as an inducement to accept the shares.
“Pennsylvania’s insurance holding company laws require Insurance Department approval of a change of control of a Pennsylvania-domestic insurer,” said Commissioner Ario. “That did not occur. Instead, Kingsway sought to dispose of its control of Lincoln General without having another entity as the controlling shareholder. We are taking legal action to unwind this set of sham transactions.
“In addition, we will be reaching out to the charities which have been unwitting participants in this transaction and will work with them to avoid any repercussions. We are hopeful to resolve this by the end of the year.”
Here we are at year end with no resolution. Curious to know the details I made my way over to the Pennsylvania DOI website and found the DOI complaint and the answer to Kingsway’s counter-claim. In the original complaint we find a classic bum’s rush and get a good idea how low a major bagholder is willing to go to salvage their investment. Remember the “additional areas of exposure” turned up by the consultants? So does the Pennsylvania DOI:
18. In the early Fall of 2009, Lincoln General undertook a claim-by-claim review to ascertain the adequacy of its reserves.
19. Although Lincoln General’s claims review was not yet complete, without Lincoln General and the Department’s knowledge, Kingsway unilaterally decided to divest its entire interest in Lincoln General.
20. Rather than consulting with the Department about its options with respect to Lincoln General, Kingsway came up with the following scheme to divest its interest in Lincoln General.
21. Based upon information and belief, on or about October 16,2009, Kingsway contacted at least 20 different and unsuspecting charities to inquire whether someone would be present at the charities’ offices on Monday, October 19, 2009 to accept a donation. At that time, Kingsway refused to provide any information to the charities about the donation or its intended purpose.
22. Based upon information and belief, the following Monday, October 19, 2009, purported Kingsway messengers visited, in person, each of the charities named in paragraph 12 above and presented each with a stock certificate representing 226,112.55 shares of Walshire’s stock, along with a check from Kingsway in the amount of $20,000, as inducement for accepting the shares. When combined, the stock certificates represented 100 percent of the total shares of Walshire stock.
23. Based upon information and belief, after receiving the donation, a representative of each charitable organization was required to sign a gift receipt and have their photograph taken with the stock certificate as acknowledgement of receipt of the donation.
24. Based upon information and belief, at least one charity that was initially approached questioned the donation and was immediately eliminated from the receipt list, and the messenger instructed to move on to another unsuspecting charity.
25. By the end of the day on October 19,2009, the 20 charities set forthabove in paragraph 12 above had become unwitting participants in Kingsway’s scheme to divest its interest in Lincoln General (the “transaction”). True and correct copies of a sample stock certificate issued to the charities involved, the $20,000 check, and the gift receipt required to be signed by the charities are attached hereto as Exhibit B.
26. Based upon information and belief, Kingsway did not provide for an orderly transition of Lincoln General to its new ownership, effectively abandoning Lincoln General.
So now we circle back to that November 6, 2009 investor conference call the good folks at Seeking Alpha were kind enough to publish. This is what CEO Simpson said in the conference call about the Pennsylvania DOI:
The charities have all been sold and the shares are likely to be worthless and the shares cannot be returned to Kingsway. We are currently in on ongoing discussions with Pennsylvania Insurance Department and Rockwell regarding the transaction and so we are unable to provide more detail with this time.
But Simpson did provide more detail and withheld salient information. Entries were made to Kingsway’s financial records that indicated the exit from Lincoln was clean and all the potential liabilities were either booked or disclosed. At the time he made those representations in the conference call he knew the Pennsylvania DOI would not approve the exit from Lincoln as we continue from the original complaint:
28. Upon learning of Kingsway’s scheme to divest its interest in Lincoln General, on October 20, 2009, Deputy Commissioner Johnson sent a letter to Colin Simpson, President and CEO of Kingsway, informing of the illegality of the transaction pursuant to the Act. A true and correct copy of Deputy Commissioner Johnson’s October 20, 2009 letter is attached as Exhibit C.
That’s right ladies and gentlemen what we have here in my opinion has crossed the line from the sleazery of making 20 different charities Lincoln General bagholders to a first class case of criminal securities fraud. In an indication as to whom may have instigated this scheme we look no further than good ol’ bagholding Joseph Stillwell who signed the Walshire stock certificates that conveyed ownership in Lincoln General. Could it be there was another purpose in Stillwell’s purchase of those additional 100,000 shares after the November 6 CC? You betcha there is but news that the PA DOI would be fighting the Lincoln divestiture broke before the pump and dump could get into full swing.
And remember those pesky debt covenants that came up in the conference call? An American based company would be required to post that agreement on the EDGAR database at the SEC. Foreign companies have no similar requirements as the smoke continues to rise from the burning house known as Kingsway Financial Services:
Given Kingsway’s representation to the Department that the debt covenants were instrumental in Kingsway’ s decision to implement the transaction, the Department has made repeated requests since October 28,2009 to Kingsway’s counsel for copies of the debt covenants. To date, Kingsway has not provided copies of the debt covenants to the Department.
And the charities that were force-fed the stock in a bums rush? It seems most many no longer want either the stock in Lincoln General or the $20,000 inducement Kingsway paid for them to take it as they realized they were duped:
Please find enclosed the following items:
- Walshire Associates stock certificate donated to us on Monday, October 19.2009
- Our check for $20,000.00 payable to Kingsway Financial Services Inc.
- Copy of Kingsway Financial Services Inc. check to us for $20,000.00
- Copy of our signed receipt of gift.
- Copy of a letter dated October 26, 2009 from Stephen J. Johnson, Deputy Insurance Commissioner of Pennsylvania.
We were not aware at the time of receiving this gift of the history of the shares, or the intent in making this gift. Given the substance of the letter, we do not have the desire or the resources to become a party to a regulatory dispute of this nature.
Kingsway of course is having none of it and for whatever reason refuses to take their “donation” back. Welcome to the 21st century lady and gents where worthless stock suddenly becomes both a hot commodity and potato:
While it is true that the Walshire stock is not tradable on any stock exchange and most likely has no value; in the event that it does ultimately prove to have value, we hope that you will be able to put it to good use to further the charitable purposes of your organization. If you have any questions, please call me, at (212) 233-7400.
Does anyone serious think the stock in Lincoln General will ever have value? Has anyone else heard of paying money to induce a charity to take a nonmonetary asset? The real Bagholders of course are the taxpayers in Pennsylvania as it is they who will ultimately honor Kingsway’s claims if this sham transaction is allowed to stand.
And that ladies and gents sums up the new fangled model of the insurance biz. Certainly the Kingsway folks watched insurers like State Farm, Allstate, Nationwide and USAA dump their losers on the taxpayers by paying their wind claims with taxpayer money from the National Flood Insurance Program after Katrina. This time it appears the moneychangers have gone too far.
I’ll have more on this in future post. In the meantime please don’t hold your breath that anything will be done about the criminal acts related to that conference call and the misrepresentations that were made to investors who were not in on the scam as our government would much rather go after folks who stole $2,000 from FEMA than a business exec who fleeces the taxpayers out of millions. It is after all, the new American way.