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Why AmTrust Financial Services Inc. Stock Is Plunging Today

By Jordan Wathen - May 9, 2017 at 11:42AM

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Unfavorable prior-year loss developments are causing investors to worry that AmTrust isn't adequately reserved for losses at a time its accounting practices are in the spotlight.

What happened

Shares of AmTrust Financial Services Inc. (AFSI) are down about 19% as of 10:45 a.m. EDT after the company reported disappointing earnings results in its first fiscal quarter of 2017.

So what

AmTrust reported first-quarter operating earnings of $55.7 million, or $0.32 per diluted share. The consensus analyst estimate called for operating earnings of $0.60 per share.

Elevated insurance losses weighed on the company's results. The insurer reported a combined ratio of 95.6% in the first quarter, which included 2.1 percentage points that were related to catastrophe events, and 1.6 percentage points of unfavorable prior-year developments. Unfavorable developments occur when an insurer experiences higher losses on policies than it previously anticipated. Ideally, insurers would have favorable developments, which indicate conservative accounting practices. 

Coins in a jar

AmTrust earnings failed to live up to expectations. Image source: Getty Images.

In prepared remarks on the conference call, the company talked up the potential to sell a 51% stake in its fee business. President and CEO Barry Zyskind said, "After discussions with several interested parties, we believe that the best approach would be to sell 51% to a private equity-like partner. This would allow the company to potentially raise in excess of $1 billion in cash through a combination of sale and putting leverage on the business."

He went on to add that "based on our recent interactions with several interested parties, we believe that this is the best course and we are therefore pursuing this type of transaction."

Now what

AmTrust Financial Services finds itself in the crosshairs of a group that includes famed forensic accountant Harry Markopolos. In April, The Wall Street Journal reported that an auditor for BDO wore a wire while perusing AmTrust offices as part of a joint investigation of AmTrust Financial by the Securities and Exchange Commission and the Federal Bureau of Investigation. Markopolos is most famous for warning the SEC about Bernie Madoff's Ponzi scheme.

The WSJ report followed AmTrust's disclosure in March 2017 that revealed the company's financial statements in prior years contained "material errors." Earnings for 2015, 2014, and 2014 were later revised down by as much as 14% on a diluted earnings per share basis.

AmTrust's unfavorable developments this quarter did little to quell concerns that it was not adequately reserved for losses. On the company's conference call, Zyskind noted that the company recognizes:

...[there] has been speculation recently regarding the adequacy of our reserves. We believe we are properly reserved. We are confident in our actuarial reserving methodology.

Given all the question marks surrounding the quality of the company's accounting practices, Wall Street isn't so willing to take his message at face value.

Jordan Wathen has no position in any stocks mentioned. The Motley Fool owns shares of AmTrust Financial Services and has the following options: short June 2017 $17 calls on AmTrust Financial Services and long June 2017 $12 puts on AmTrust Financial Services. The Motley Fool has a disclosure policy.

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