Oil Ins. Ltd. on Watch Negative

Standard & Poor's lowered its counterparty credit and financial strength ratings on Oil Insurance Ltd. to "A+" and placed the company on CreditWatch with negative implications because of catastrophe losses and a decline in capital adequacy in 2001.

S&P expects to meet with management and review possible scenarios for recovery of the cash flow and expectations of future catastrophe losses, among other things, according to an S&P analyst. After the review, S&P expects to affirm Oil's ratings at "A+" or lower them a notch to "A."

Preliminary indications for first-quarter 2002 are positive, with close to breakeven underwriting results and significant improvement in the investment results. Oil Insurance Ltd. is expected to generate strong average RORs, with premium income rising significantly in 2002 and prospectively to recoup 2001 losses. Liquidity requirements and cash flow are more uncertain in the short term, but are expected to catch up to losses over the next 18-36 months with portfolio liquidations supporting cash flow as necessary in the interim.

Management expects to borrow less than $250 million in 2002. Even in the wake of high catastrophe activity, Bermuda-based Oil Insurance Ltd.'s unique retrospective rating will recapture all losses over the medium term.

State Farm Downgraded

S&P removed from CreditWatch and lowered the counterparty credit and financial strength ratings on State Farm's core operating units to "AA+" from "AAA." Also removed from CreditWatch was its "A" counterparty credit and financial strength ratings on State Farm Lloyds. The outlook on all these companies is negative.

A large collective operating loss from State Farm core p/c companies and State Farm Lloyds was a factor in the ratings action. The loss includes $ 9.3 billion and is the result of aggressive rate setting nationwide, among other things. S&P considers State Farm Lloyds strategically important to State Farm Mutual Automobile Insurance Co. (SFMA), the group's parent and the largest insurance company in the U.S.

State Farm retains great strengths, including extremely strong capital, unsurpassed spread of risk for an insurer, an extremely large market position in personal lines insurance, a very substantial and complementary position in life insurance, and an excellent reputation in all major lines of business.

S&P believes management has taken a variety of actions that could significantly
narrow the underwriting and operating losses in 2002 and produce an operating profit in 2003. Nevertheless, the underwriting and operating losses in 2002 will likely be significant. Their magnitude depends on variables such as customer acceptance of significant rate increases and the degree of reduction of loss ratios, particularly in coverages like mold and slab in Texas and automobile personal injury protection in the Northeast.

St. Paul Cos., Subs. on Watch Negative

S&P placed its ratings on The St. Paul Cos. Inc. and its insurance subsidiaries on CreditWatch with negative implications because of the uncertainty associated with St. Paul's determination to seek more aggressive early resolution of certain pending asbestos and environmental-related litigation and the resulting impact on this year's capital and earnings. The development was disclosed in St. Paul's Form 10-Q, which was filed on May 15. S&P plans to meet with St. Paul's management to review the development.

Western Specialty Rated 'R'

S&P assigned its "R" financial strength rating to Western Specialty Insurance Co. in recognition of an order of liquidation issued by the Cook County Circuit Court in Illinois on May 6. Western Specialty's active business was to be canceled within 31 days from the date of entry into the order of liquidation, on the policy's expiration date, or when the insured person cancels the policy, whichever takes place first.

Western Specialty is a subsidiary of Western Holdings Inc. The company
originally commenced operations in 1986 under the name Oak Brook Property and Casualty Insurance Co., a subsidiary of First Oak Brook Corporation Syndicate, which was placed in liquidation in 1996. The company took its current name when minority interest in it was sold to its current owners in 1996.

The company's major lines of business include commercial multiple peril, workers' compensation, other liability, and private passenger auto. It is licensed in California and Illinois.

Zenith Nat'l Ratings Fall

S&P lowered its counterparty credit rating on Zenith National Insurance Corp. (ZNT) to "BB+" from "BBB-" and its ratings on ZNT's affiliates, Zenith Insurance Co. and ZNAT Insurance Co. (Zenith), to "BBB+"from "A-"due to poor but improving operating results in workers' compensation and large losses in 2000 and 2001 in assumed reinsurance. The outlook is stable.

Although Zenith has a history of successful operations, bad conditions in its primary workers' comp market have adversely affected the company, according to an S&P analyst. Its assumed reinsurance, a secondary line, has suffered heavy losses from weather-related events and from the World Trade Center terrorist attacks.

By consistently adhering to its strategy, Zenith has positioned itself to take advantage of good conditions in the California market for the next year or two, despite the activities of the State Fund. Results in California should be good enough to outweigh lackluster results in Florida. If profitability in assumed reinsurance is at roughly the average of what Zenith has produced in this line over the years, ZNT and Zenith should record satisfactory earnings through at least 2002. Capitalization should remain satisfactory and perhaps continue to be a marginal strength for the rating.

Kemper FSR Lowered

A.M. Best Company lowered the financial strength rating to "A-" from "A" of the Kemper Insurance Companies, Long Grove, Ill. It also assigned a "bbb-" rating to the surplus notes issued by Lumbermens Mutual Casualty Company, the lead member of the group. The rating will remain under review with negative implications pending the close of the sale of its personal lines business and the consummation of its comprehensive strategic relationship with Berkshire Hathaway, which includes certain reinsurance and capital raising transactions.

Kemper's capitalization declined substantially in late 2001 due to a reduction in surplus caused by adverse loss reserve development principally in asbestos reserves, adjustments driven by the new NAIC accounting principles and modest losses from the September 11 attacks. At year-end 2001, the group entered into a retroactive reinsurance agreement on its asbestos reserves and in April 2002 signed two definitive agreements—one for the sale of its personal lines business to Unitrin and the other for the issuance of common stock for a newly-formed downstream holding company to Berkshire Hathaway.

Concurrent with the latter transaction, Kemper has entered into two reinsurance transactions, which incorporate an adverse development reinsurance cover on $3.5 billion core loss reserves that will be transferred to the downstream company and a third party quota share reinsurance agreement for 80 percent of some of its middle market businesses. Both of these will be provided by Berkshire Hathaway.

A.M. Best believes while these transactions provide near-term surplus relief, $125 million of additional equity capital and a certain degree of protection against adverse loss reserve development, the benefit to policyholders security provided by soft capital is short-term, and the financial flexibility of the organization is currently very limited. However, the new structure should provide Kemper with freer access to capital over the long-term. Kemper recorded strong operating income in the first quarter of 2002, with $54.5 million in after-tax earnings.