Florida insurers Southern Fidelity and Capitol Preferred merge

Two of Florida’s largest domestic property insurers have merged after reporting multi-million dollar losses for several years. One is under state supervision to get on a path toward financial stability.

Southern Fidelity Insurance Co., No. 11 by policies in the state, acquired No. 9 insurer Capitol Preferred Insurance Co. in late August, according to regulatory filings. The sister companies posted collective year-to-date losses of $40 million as of June 30.

“The key issue here is to maintain solvency,” said Mark Friedlander, Florida representative for the Insurance Information Institute. “It’s really important for them to position themselves and to make this transaction so they can continue to operate.”

The merger and regulatory arrangements are the latest development in a string of ailments for Florida’s property insurers. The state’s market has faced upheaval this year as insurers filed for double-digit rate increases brought on by increased litigation, lingering hurricane claims and hiked reinsurance rates. Regulators are currently undertaking an examination of how money flows between property insurers and their affiliates.

Under the restructure, Capitol Preferred will no longer exist. All of its 82,800 policies will shift to Southern Fidelity and be unaffected, according to the Florida Office of Insurance Regulation.

“There is no action needed by the consumer to maintain coverage,” said Alexis Bakofsky, spokeswoman for the regulator.

And if a recently-announced deal is approved, a Bermuda-based company will take over a majority stake in Southern Fidelity and guide its financial future.

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Regulatory filings show Capitol Preferred reported a loss of $5.1 million in 2017, $17.9 million in 2018 and $25.7 million in 2019. Its year-to-date losses in June were $20.7 million.

Southern Fidelity, meanwhile, saw losses spike from $108,700 in 2017 to $1.9 million in 2018 and $22.6 million in 2019. As of the end of June, its losses for the year totaled $19.3 million.

Each requested a sizable rate increase this year — 26 percent for Capitol Preferred and 31 percent for Southern Fidelity.

In the spring, the Office of Insurance Regulation took what it called an “extraordinary” measure by allowing Capitol Preferred to cancel 23,800 homeowners’ policies to maintain its financial stability.

It then required Capitol Preferred to file monthly financial statements with regulators and submit a revised business plan for how it will operate between July of this year through 2023. The merger cancels that requirement.

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As part of the deal, Southern Fidelity is required to cut the fees it pays to its managing affiliate, a subsidiary that handles day-to-day operations.

As of 2018, the most recent data available, Southern Fidelity’s managing affiliate collected 31 percent of the company’s premiums as a fee. It was paid $18.2 million for its services that year.

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Under the agreement with regulators, Southern Fidelity can only pay the company 26 percent of premiums over the next two years.

State regulators are currently examining insurers' financial arrangements with their managing affiliates, including Southern Fidelity’s, to look for areas of improvement.

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The merger is not the end of Southern Fidelity’s financial path.

As a condition, the Office of Insurance Regulation requires Southern Fidelity to raise additional capital by the end of the year. The specific amount was not disclosed and is considered a “trade secret” by the insurer.

The insurer missed its first deadline of Nov. 1 for the initial installment of funds, getting an extension until later this month for a deal it closed recently.

Under that arrangement, a Southern Fidelity press release said, Bermuda-based investment firm Hudson Structured Capital Management Co. would take a majority stake in the insurer, the financial details of which were not disclosed. This would require approval by regulators.

“This is a good-sized company with long standing in the market,” said Michael Millette, founder of Hudson Structured.

James Graganella, who founded Southern Fidelity and Capitol Preferred and is chief of both, will continue to lead the company.

Southern Fidelity is also paying off a $25 million loan it obtained in 2006. A legislative program meant to encourage investment in Florida’s insurance market awarded 13 insurers loans ranging from $7 million to $25 million. Southern Fidelity’s loan is set to mature in June of next year.

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If Southern Fidelity fails to bring in all of the capital it promised regulators it would, the Office of Insurance Regulation can “take any action it deems appropriate under the circumstances.”

One such path is a process called “receivership.” Under Florida law, the state can take control of an insurance company’s business if it becomes insolvent. The company can either be brought back into solvency and continue doing business or it can be liquidated. The insurance regulator can recommend a company for this process, but the Department of Financial Services will decide whether to go through with it.

This merger comes just two weeks before insurers' third-quarter financial results are due to the state.

These results are one portion of what private ratings agency Demotech Inc. uses to grade insurers' financial health. Southern Fidelity currently has an “A” rating. While Capitol Preferred previously had an “A” rating, Demotech withdrew the rating in mid-October.

In a call with the Tampa Bay Times last week, Joseph Petrelli, president of Demotech, said the ratings agency is currently “working with” the companies.

“I think they’re at a fairly sensitive point in time right now, but we have not revised our ratings,” he said.

Downgraded ratings can have serious consequences. Many mortgage companies require their policyholders to have insurance through an “A”-rated company, Insurance Information Institute’s Friedlander said. Should a company lose its top rating, customers might need to find another carrier.

Last year, Demotech warned 16 companies that they could face downgraded ratings for their financial performances.