The Bull Case for Fremont Michigan (FMMH)

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From Harry Long
http://contrarianindustries.com/

I've written about Fremont Michigan (OTCBB: FMMH) in the past (http://seekingalpha.com/symbol/fmmh.ob) and my activist efforts to push the company to lower its expense ratio, among other things.

Those efforts have started to bear fruit. However, I still highly disagree with certain of Fremont's actions, such as a new plan to allow agents to purchase shares at a discount to market value.

Below, I've enclosed the bull case for the company's acquisition by a private equity firm, larger insurer, or other acquirer. The numbers are quite striking.

Disclosures: Harry Long owns FMMH shares directly, through partnerships, and through trusts. To the best of his knowledge, certain of his family members own FMMH shares through partnerships and trusts. Such ownership may change at any time.
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[White Paper/Factsheet PDF]

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Letter to Fremont Michigan Insuracorp's Board of Directors

June 15, 2008

VIA FACSIMILE AND FEDERAL EXPRESS

Board of Directors

Fremont Michigan InsuraCorp, Inc.

933 East Main Street
Fremont, MI 49412

Dear Board Member,

In short, we respectfully propose that the company take two actions in the near future:

First, reduce the expense ratio to below 30.

Second, expand into other states while writing insurance over the Internet in these new states and through agents, similar to Progressive's model.

For the last 10 years, such a model has consistently achieved an average expense ratio of 20 or less, and it is the standard for industry profitability and competitiveness. Geico has also achieved remarkable results writing insurance directly over the phone and over the Internet. Doing so has allowed both companies to achieve strong profitability and growth through lean cost structures, for decades. Interestingly, such a strategy has allowed both firms, started in 1937 and 1936 respectively, to dominate the auto insurance industry (The Great Depression was a harsh teacher of the prime importance of low costs!).

We have attached an analysis of the company, which we are publicly disseminating, with the rationale for our proposals. As fair-minded fiduciaries, we trust you will read it in full. At your convenience, we request an in-person meeting with the Board of Directors to discuss our proposals. While reading a critical analysis of a firm that we all admire and respect can be difficult, we trust that you will heed Sir John Templeton's observation that "Minds are like parachutes—they only function when they are open." The objectives we share with the Board and with the management are to increase the intrinsic value of Fremont and to lower the company's business risk.

Competitive pressures in the insurance industry have mercilessly weeded out firms that have not achieved low cost structures and geographic diversification. There is no prudent business reason for
the company to risk the same fate through inaction or inertia.

I know that we all want Fremont to prosper and for more policyholders to enjoy the benefits of its great customer service. Expanding to other states is a natural evolution for Fremont, which would build upon the success that the company has had in Michigan. In addition, it will make the company more competitive in Michigan itself by benefiting the company's A.M. Best rating, which currently suffers from what A.M. Best termed "...risks inherent with the company's geographic concentration." Such an increase in the rating to A- or greater, by the company's own admission, would make agents more likely to write business with the company in Michigan itself. In addition, geographic diversification would also provide more protection for shareholders and for policy holders. I know that as Board members, both of these concerns weigh heavily in your thoughts and in your deliberations.

While I apologize if my remarks come off as heavy-handed, it is a great compliment to the company that we believe it has the potential to become a Progressive or a Geico. However, many companies could have become Progressives or Geicos. Achieving that level of success is a conscious decision, not some inevitable conclusion. Now is the time for action towards that goal.

Fremont's management and employees are perfectly capable of achieving a reduction in expenses and an expansion to other states. They are very talented. Please do not allow them, in their modesty, to convince you of otherwise.

Sincerely

/S/Harry Long

Attachments:

1. FMMH: A Financial Firm That Would "Put a Puritan to Sleep" by Harry Long and Sahil Gujral

2. "The Security I Like Best" by Warren E. Buffett

3. Excerpt from the 1995 Berkshire Hathaway Shareholder Letter

4. Tables A.18 and A.19, Pages 256-257, of The Warren Buffett Way by
Robert G. Hagstrom
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Some in depth articles/background on Fremont
http://seekingalpha.com/symbol/fmmh.ob

Article/Interview from SNL Financial
http://www.snl.com/InteractiveX/article.aspx?CDID=A-8307586-11358&KPLT=2

Older investor presentation
http://www.sec.gov/Archives/edgar/data/1271245/000119312508141164/0001193125-08-141164-index.htm
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[Excerpts from Fremont's 10-K on potential conflicts of interest
[pasted from various sections of the 10-K]:

14. Related Party Transactions

During 2005, the Company issued a $130,000 mortgage receivable to an agent of the Company. The note requires a monthly payment, including interest at 8%, of $1,097, which is based on a 15 year amortization. The note includes a 5 year balloon payment, which becomes due June 2010. During 2007 and 2006 the agent earned $62,946 and $55,117, respectively, in regular and profit sharing commissions. The terms and conditions of the agency agreement between this agent and the Company are similar in all material respects to agency agreements with other agents of the Company.

During 2003, the Company issued a $140,000 mortgage receivable to an agent of the Company. The note requires a monthly payment, including interest at 6%, of $1,003, which is based on a 20 year amortization. The note includes a 5 year balloon payment, which becomes due January 2009. During 2007, 2006 and 2005, the agent earned $90,422, $73,292 and $72,800, respectively, in regular and profit sharing commissions. The terms and conditions of the agency agreement between this agent and the Company are similar in all material respects to agency agreements with other agents of the Company.

Three nonemployee directors of the Company are also owners of independent insurance agencies. These individuals are currently appointed as agents with and write insurance for the Company. The terms and conditions of the agency agreements between these agencies and the Company are similar in all material respects to agency agreements with other agents of the Company. The Company pays all agencies commissions on business produced. All agencies are also able to earn profit sharing commissions based on the profit margins of the business produced. Total regular and profit sharing commissions earned by these agencies approximated $526,000, $484,000 and $487,000 in 2007, 2006 and 2005, respectively. The commission rates, including profit sharing commission opportunity, are the same as other agents of the Company. The agencies are independent agents and also write with regional and national insurers that may be competitors of the Company.

A nonemployee director of the Company is a partner in a law firm. The Company has retained this law firm for certain legal matters in the past and plans to continue to do so in the future. Legal fees paid by the Company to the law firm were approximately $74,000 in 2007, $35,000 in 2006 and $55,000 in 2005.

Various agents of the Company participated in the surplus note offerings and held surplus notes at December 31, 2006. The notes were paid in full in September 2007, as disclosed in Note 9--Surplus Notes. The terms and conditions of the agency agreements between the agencies and the Company are similar in all material respects to agency agreements with other agents of the Company. The Company pays the agencies commissions on business produced. The agencies are also able to earn profit sharing commissions based on the profit margins of the business produced. For the years ending December 31, 2007, 2006 and 2005 agents holding surplus notes earned regular and profit sharing commissions of approximately $224,000, $223,000 and $236,000, respectively.