Harleysville Group's bid rejection adds to merger's challenges

Harleysville Group Inc., the Montgomery County insurer that agreed to a $758 million buyout by Nationwide Mutual in September, rejected a rival bid by an unidentified firm that offered a lower share price but included $250 million for certain policyholders.

That disclosure in a Securities and Exchange Commission filing last week could add to the challenges already raised against the merger.

The root of the conflict is a murky notion of what it means to be a member of a mutual company and an extremely unusual corporate structure at Harleysville. Harleysville Mutual Insurance Co., which was formed in 1917, is the parent of Harleysville Group and owns 54 percent of that publicly traded subsidiary.

Harleysville Mutual policyholders have alleged in several lawsuits that Harleysville Mutual's directors enriched themselves by accepting the $60-per-share Nationwide Mutual Insurance Co. deal - which included no payouts to policyholders - at the expense of policyholders.

David Schiff, editor of Schiff's Insurance Observer in New York and a longtime advocate for the financial interests of mutual policyholders, estimated that there are currently only four insurance companies in the United States with structures the same as Harleysville.

"It's an unusual structure, but one that is rife with conflicts of interest," Schiff said.

Typically, insurance firms in which a mutual company owns a publicly traded subsidiary have overlapping boards of directors. In Harleysville's case, six of Harleysville Mutual's nine directors are also directors of Harleysville Group. Six of Harleysville Group's eight directors are also directors of Harleysville Mutual.

Lawsuits by policyholders have alleged that Harleysville Mutual directors would earn at least $39 million in proceeds from the sale of their Harleysville Group stock and from the exercise of their stock options in the Nationwide deal. Harleysville chief executive Michael L. Browne would be the biggest beneficiary if the deal closes, as expected, next year.

Harleysville Mutual directors "injured [Harleysville Mutual] and its policyholders" when they agreed to forgo any payment for the mutual company's stake in Harleysville Group, which is worth more than $800 million at the current stock price. The charge is made in a lawsuit filed this month in Montgomery County.

The rejected offer that included a $250 million special dividend to Harleysville Mutual policyholders would have paid $42 per share to Harleysville Group stockholders, substantially reducing the windfall for Harleysville Mutual directors.

The other bidder is identified only as "Company B." The reason for that bidder's special dividend was the planned elimination of the mutual-company structure in the proposed merger. In that process - known as a demutualization - the surplus built up by the mutual company is split among policyholders.

In the Nationwide deal, however, Harleysville Mutual is merging with another mutual, Nationwide Mutual. Such mutual-to-mutual mergers do not generally include a payout to policyholders.

Policyholders in a mutual company are not like investors in a publicly traded company. The mutual company is run for their benefit, but, for example, they can't sell their interest the way a stockholder can.

Robert A. Kauffman, Harleysville Group's general counsel, said the fiduciary duty of Harleysville Mutual's board was to the mutual company and required them to consider all constituents, including policyholders.

Other constituents include 800 to 900 employees in Harleysville. Those employees would have likely taken a hit in a merger with "Company B." Nationwide, by contrast, agreed to maintain the status quo at Harleysville for at least two years, according to the SEC filing.