NEW YORK-Folksamerica Holding Co. Inc.'s announcement last week that it plans to buy substantially all the reinsurance operations of Risk Capital Reinsurance Co. evinces the bigger-is-better mentality of the current reinsurance marketplace, analysts say.

The deal would make New York-based Folksamerica Reinsurance Co. the 11th-largest reinsurer in the United States-up considerably from its current No. 20 spot.

This ranking is based on the two companies' combined premium volume of $385.1 million for the nine-months ended Sept. 30, according to the Washington-based Reinsurance Assn. of America.

Risk Capital Re, a Greenwich, Conn.-based unit of Risk Capital Holdings Inc., ranked No. 14, with $232.7 million in premium volume for the nine-month period. Folksamerica, which is a subsidiary of Hamilton, Bermuda-based White Mountains Insurance Group Ltd., posted $152.4 million in net premiums for the period, according to the RAA.

Risk Capital Re's reinsurance business will be absorbed into Folksamerica's underwriting operation, said Michael E. Tyburski, executive vp and CFO for Folksamerica in New York. He noted that Risk Capital Re's business includes marine and accident and health risks, neither of which Folksamerica now writes, so the deal will increase the breadth as well as the size of its operations.

Analysts, who contend the deal will not have a major impact on the market, say it reflects the prevailing attitude that only larger reinsurers can ultimately survive in today's market environment.

They also say the deal represents the failure of a theoretically sound, but poorly timed, strategy by Risk Capital Re to simultaneously invest in and provide reinsurance to primary insurers. Risk Capital posted a $21.6 million loss for the nine-month period.

In addition to providing traditional and finite risk reinsurance, Risk Capital Re's Integrated Solutions program has offered insurers a blend of reinsurance and capital investment. It has also offered, on a stand-alone basis, either contingent capital or direct investments to insurers. Folksamerica will not acquire any of Risk Capital's publicly traded securities or private-placement investments in the deal.

Under terms of the complex deal, Folksamerica Re, a subsidiary of Folksamerica Holding, will assume $440 million of Risk Capital Re's liabilities and an equal amount of its assets, and it will pay $20.3 million in cash for the reinsurance operations.

In addition, $20 million will be held in escrow for five years to cover adverse loss-reserve development related to business produced by a managing underwriter. New York-based Capital Protection Insurance Services L.L.C. wrote long-tail and umbrella casualty business, now in runoff, on Risk Capital Re's behalf (BI, Nov. 1, 1999).

The transaction, which is expected to close in the first quarter, is subject to shareholder and regulatory approval.

In a separate transaction, which is not contingent on the Folksamerica deal, Risk Capital will repurchase all the common stock from one of its major investors, XL Capital Ltd., for an estimated $71.3 million.

Hamilton, Bermuda-based XL and Risk Capital's other major investors, Marsh & McLennan Risk Capital Holdings Ltd. and investment pool The Trident Partnership, currently own about 37.5% of Risk Capital's outstanding voting shares. They have already agreed to vote in favor of the transaction.

The Folksamerica deal leaves Risk Capital with a book value of about $300.8 million based on third-quarter numbers, said Peter Appel, executive vp and chief operating officer. This reflects about $260 million in private equity, public equity and fixed income investments plus the stock value of Risk Capital Re and of Cross River Insurance Co., an excess and surplus lines insurer formed by Risk Capital Re about a year and a half ago that has not yet written any business. Both units have about $20 million in statutory capital, noted Mr. Appel.

Mr. Appel said the company decided this deal would bring the best value to Risk Capital Re's shareholders in light of several quarters of poor earnings and a depressed stock price, which ruled out a transaction involving the holding company's stock. The stock closed at $14.88 per share on Monday, the day before the deal was announced. Its 52-week high was $22.25.

"We felt we had to remove the uncertainty that surrounded the company by selling the business the way we did," said Mr. Appel. This deal should "be able to get us to trade closer to book (value) than any other transaction before us" and leaves the company free to make new plans, he said, adding that those plans have not yet been determined.

Officials of both companies said the future of Risk Capital Re's highly regarded management, led by President and CEO Mark D. Mosca, has not yet been determined either.

Risk Capital, which raised $240 million in its 1995 initial public offering, fell victim to poor timing, analysts say. It began operations in a highly competitive market that was already awash in capital, and the insurer stocks in which it invested became depressed in value.

With M&M's backing and its experienced management, "Risk Capital Re was able to generate substantial premium volume from Day One," said Donald Watson, a director at rating agency Standard & Poor's Corp. in New York.

"The problem is, in a soft market environment, generating premium growth is difficult, and to get the business you typically underprice the competition," said Mr. Watson. "To some degree, that would appear to be the case at Risk Capital Re, given the underwriting performance that we've seen.

"The other aspect that was difficult with Risk Capital Re was with their making equity investments in insurance companies in order to garner a certain share of their reinsurance business," he added.

"There is a longstanding tradition of this by European reinsurers, but there was a larger difficulty for a startup company to engage in this strategy" because it did not have the large capital base needed to effectively diversify its investments, said Mr. Watson.

"The problem is that at the point in time that your primary insurance companies are producing losses that you have to pay out under the reinsurance policy, there's a reasonable likelihood that, because they are producing those losses, their equity values will be under pressure. And so at the point in time that you're paying out losses, your investment portfolio is also depreciating in value, which produces a credit squeeze on the reinsurer," Mr. Watson said.

Sarah Hibler, vp and senior analyst with rating agency Moody's Investors Service Inc. in New York, said that the relatively new Risk Capital Re was offering the same types of solutions as longer-established reinsurers.

In addition, given its limited operating experience, the company's rapid growth, which averaged nearly 80% over the last three years, created uncertainty about the profitability of its existing business, said Ms. Hibler.

The drive to grow in today's marketplace also encouraged the deal, analysts say.

"Reinsurers the size of Risk Capital Re aren't seeing the good business, apparently," said Michael Frinquelli, an analyst with Renaissance Fund Advisers in New York.

"Folksamerica is bulking up, so in a sense they're both doing the right thing," said Mr. Frinquelli. While Folksamerica is getting bigger, Risk Capital is selling a reinsurance operation it realized was just too small to compete, he said.

"Folksamerica will be able to bring a lower cost structure by spreading its administrative cost of handling the claims over a much larger base of business," said S&P's Mr. Watson.

"It's really an economies-of-scale play for Folksamerica. It also provides them access to a renewal book of reinsurance that could considerably increase their profile," he said.

White Mountains, which last year changed its name from Fund American Enterprise Holdings Inc., has a long history in the property/casualty business. It sold Fireman's Fund Group to Allianz A.G. Holding in 1991.

White Mountains, which redomesticated to Bermuda from New Hampshire last October, also owns about 25% of financial guarantee insurer Financial Security Assurance Inc., which is based in New York, among other insurer investments.

Karen Davies, a Moody's vp and senior analyst, noted that White Mountains sold a money-losing mortgage lending subsidiary, Source One Mortgage Corp. of Farmington Hills, Mich., to Citibank Mortgage last year.

The property/casualty business, though, is one the company knows well, said Ms. Davies. "They've gotten their best returns from that business," she said.

Donaldson, Lufkin & Jenrette Securities Corp. advised Risk Capital Re on the deal. Lehman Bros. advised Folksamerica.