Fairfax Cos. Under Review
Fitch Ratings, Standard & Poor's and A.M. Best initiated rating actions on Fairfax Financial Holdings Inc. (Fairfax) and its subsidiaries, including TIG Insurance Group—Dallas, Ranger Insurance Group, and Commonwealth Insurance Company (Canada) following Fairfax's announcement that it would restructure TIG and place a portion of the subsidiary's business into runoff.
A.M. Best Co. placed the financial strength ratings of "B++" (Very Good) of TIG and Ranger under review with developing implications. Concurrently, the financial strength rating of "A-" (Excellent) of Commonwealth Insurance Company were placed under review with developing implications, and the financial strength rating of "B++" (Very Good) from International Insurance Company (IIC) (Illinois) was withdrawn. IIC was merged into TIG effective Dec. 16, 2002. All other A.M. Best financial strength ratings and debt ratings of Fairfax Financial Holdings are unaffected.
Standard & Poor's changed its outlook on Fairfax from "stable" to "negative," and its "BB+" counterparty credit rating and its "BBB" counterparty credit and financial strength ratings on Fairfax's affiliates.
Fitch downgraded the senior debt ratings of both Fairfax and TIG, as well as the insurer financial strength ratings (IFS) of the members of the TIG group, excluding Ranger, which is expected to be removed from the group during 2003. Additionally, Fitch affirmed the IFS ratings of the Fairfax Insurance Group and Odyssey Re Group.
Fairfax announced that as part of the restructuring process it will acquire the remaining 72 percent ownership interest in IIC over time. The structural realignment also includes the removal of Ranger, Commonwealth and a significant portion of OdysseyRe from under the direct ownership of TIG. Fairfax also placed the substantial program business of TIG into voluntary run-off. It is expected that certain books of business within TIG, considered to be ongoing, will be continued in other insurance subsidiaries, which will not be direct subsidiaries of TIG. Furthermore, the combined entity will be adding approximately $200 million to its reserves and taking approximately $35 million in restructuring charges, most of which will be offset by negative goodwill at the Fairfax level embedded in the IIC transaction.
S&P's analyst Matthew Coyle cited the broad restructuring plan as the reason for S&P's changes, calling the announcement "a setback for Fairfax and the progress it has made in other areas of the organization in the first nine months of 2002." It indicated that it considers the "reemergence of reserve issues at TIG (especially after 2001's gross charge of $210 million) to be disappointing and may be an indication that Fairfax management has not fully identified the extent of reserve issues elsewhere (e.g., Crum & Forster, Ranger Insurance Co., etc.) in the organization."
Fitch downgraded TIG's IFS rating two notches to "BB+." This reflects an expectation of a significant decline in the overall level of surplus of TIG, concerns regarding the loss reserve adequacy at TIG Insurance Co. and IIC, and the reduced financial incentive for Fairfax to support TIG following the completion of the restructuring.
ZFS Affirmed
A.M. Best Co. affirmed the "A" (Excellent) financial strength ratings of Zurich Financial Services Group (ZFS) and its core operating subsidiaries. Simultaneously, A.M. Best affirmed the "a" and "a-" ratings on the senior and subordinated debt instruments issued or guaranteed by Zurich Insurance Company. The ratings were removed from under review with developing implications where they were placed on Sept. 6, 2002. The outlook is positive.
The current ratings are based on the ZFS's excellent business position in its selected core markets (Switzerland, Germany, Italy, Spain, U.K. and North America), improving operating performance, restored risk-based capitalization and re-balancing of the investment portfolio. Offsetting factors are the challenges associated with the implementation of a strict cost reduction and divestment program, as well as uncertainty regarding potential adverse developments of its asbestos related reserves.
ERC Ratings Lowered
S&P's lowered its counterparty credit and financial strength ratings on Employers Reinsurance Corp. and its wholly owned subsidiaries (collectively, ERC) to "AA-" from "AA+" because of the serious deterioration in ERC's operating performance. Also lowered were S&P's counterparty credit and senior debt ratings on GE Global Insurance Holding Corp., the parent company of GE Capital Services's reinsurance businesses, to "A" from "AA-" because of ERC's dominant position in the group that services the company's debt.
General Electric Co. is expected to contribute $1.8 billion in capital, at which time the ratings will be removed from CreditWatch. They were placed on CreditWatch with negative implications on Sept. 30, 2002, following GE's announcement that ERC's third-quarter underwriting results deteriorated further and that the prospects for the full year were disappointing.
S&P's said the "downgrades reflect the serious deterioration in ERC's operating performance," noting the management team has taken steps to improve pricing adequacy and operating performance. However, S&P's believes that it is too early to judge their effectiveness fully.
ERC benefits from an established, diversified insurance/reinsurance platform, especially in light of recently improved market conditions, and a restored, very strong capital base. S&P's believes, however, that ERC is non-strategic to GE because of the nature of the insurance/reinsurance sector, which requires strong levels of dedicated capital and assumes a range of earnings volatility. As such, there is uncertainty about whether the management team, given its strong ties to GE, will remain in place and execute its long-term corporate strategy.
Willis NA's Outlook Raised
Moody's Investors Service revised its outlook on the debt ratings of Willis NorthAmerica Inc., a subsidiary of Willis Group Holdings. to positive from stable. The rating agency commented that improved earnings, future prospects and reduced financial leverage combine to generate a positive outlook.
The ratings reflect the company's franchise as the third largest insurance broker worldwide, its good international competitive position—particularly in the U.K.—its geographical diversification, and the strength of long-standing client relationships. The group has focused on developing a sales culture, generating revenue growth and gaining acceptance as a trading partner by clients and insurance carriers. In addition, over the medium term, the current hard market is benefiting the insurance brokerage industry, and in particular, Willis—since a large portion of its revenue is commission based.
Moody's noted that the company has limited earnings diversification outside of insurance brokerage. The group has initiated a merger and acquisition strategy, primarily to complement existing geographic areas. Moody's believes that integration risk represents a medium term challenge. Further, as an ordinary business matter, insurance brokers are subject to potential liabilities resulting from errors and omissions. While Willis has not been named as a party to any of the litigation involving disputes over insurance coverage terms related to the Sept. 11 attacks on the World Trade Center, Willis was the broker who placed the property and liability coverages. Moody's believes that, given the extensive litigation, uncertainty exists as to whether or not Willis will be brought into the dispute.
FM Global Affirmed
Fitch Ratings affirmed its "AA-" insurer financial strength ratings on Factory Mutual Insurance Company, Affiliated FM Insurance Company, and Appalachian Insurance Co. collectively (FM Global). The outlook is stable.
FM Global's strong competitive position in the highly protected risk (HPR) market, sound underwriting practices and risk control, and solid balance sheet were all considered in the ratings rationale. Partially offsetting these positives is the company's increase in operating leverage, lower risk-adjusted capitalization, and the underwriting volatility inherent in the HPR market.
Fitch believes that FM Global has built a strong competitive position in the HPR market by focusing on providing consistent high-loss limit capacity and extensive engineering and loss prevention capabilities. Fitch also believes that the size and expertise of FM Global's engineering staff provides the company with competitive advantages in risk selection and loss prevention, that over-time generate favorable underwriting results.
FM Global is a mutual company and its underwriting practices are designed in part to try to ensure that new insured's commitment to loss prevention practices are as strong as its existing policyholder's commitment. The company's underwriting process includes a detailed engineering review that prospective insureds must undergo before insurance is bound.
The company's strong balance sheet is characterized by solid loss reserves, good reinsurance protection and a strong surplus position.
FM Global utilizes a significant amount of excess of loss and facultative reinsurance to manage its loss exposure and uses sophisticated engineering and modeling techniques to simulate its maximum foreseeable loss from catastrophic events. It purchases reinsurance to limit its net per-risk losses to approximately $70 million. Fitch considers the overall credit-quality of FM Global's reinsurance recoverable to be good.
The company's premium base grew rapidly in the first nine months of 2002 continuing a trend that started in 2001 as premium rates in the property market hardened. This rapid premium growth coupled with the company's surplus declines has resulted in an increase in operating leverage.
FM Global's underwriting results through the first nine months of 2002 were very strong and its 65.7 percent combined ratio through Sept. 30, 2002 was significantly better than the industry average. Fitch believes that FM Global's strong results reflect the company's focus on the property market and its favorable pricing environment, coupled with the strong expense control and underwriting discipline.
