Fitch Downgrades CNA, Best Stands Still

A $308 million after-tax charge taken by Chicago-based carrier CNA Financial Corp.'s primary insurance subsidiaries have led to a downgrade by Fitch Ratings, while A.M. Best says its ratings had already taken into account the company's "sizable reserve deficiency."

Both CNA's and the Continental Corp.'s senior debt ratings were downgraded to "BBB-" from "BBB" by Fitch. Further, the insurer financial strength ratings for members of the Continental Casualty Pool (CCC), the Continental Insurance Company Pool (CIC) and the primary life insurance subsidiaries were each downgraded one level.

All ratings have been placed on rating watch negative, which reflects further uncertainty related to the reserve study that will be completed during the second half of 2003 and any potential capital actions that may occur as a result.

Given the multiple charges taken in the past five years to strengthen reserves, Fitch believes CNA's reserves have exhibited levels of volatility inconsistent with the prior rating category. As such, this continued reserve volatility was the main consideration in the downgrade. Between 1998 and 2001, CNA incurred $2.7 billion in after-tax adverse prior year reserve development. Favorably, the current charge is not expected to impact capital as both current accident year earnings and realized capital gains through the first half of 2003 will offset the expense.

Resolution of the rating watch will depend on the size of the reserve charge, if any, and the steps CNA takes to replenish capital in the event of a material loss.

A.M. Best said CNA management has indicated that a review of prior accident year reserves is continuing. Given the explicit support provided to CNA Financial Corp. by its majority owner, Loews Corp., A.M. Best does not foresee a possible charge arising from the reserve review as being likely to have a negative impact upon the financial strength ratings of the insurance underwriting subsidiaries or the ratings of the existing debt securities.

A.M. Best believes that the ongoing commitment of Loews Corp. will enable the group to strengthen its reserves for both asbestos and environmental (A&E) and non-A&E liabilities while maintaining appropriate balance sheet strength through capital support. The support provided by Loews Corp. was most recently evidenced in 2002 by the $750 million preferred stock offering from CNA to Loews. CNA used the proceeds of approximately $750 million primarily to repay debt coming due in 2003, with the balance being applied to increase the statutory surplus of its insurance subsidiaries.

Argonaut Affirmed, Off Watch

Standard & Poor's Ratings Services removed from CreditWatch and affirmed its "BB+" counterparty credit rating on Argonaut Group Inc. and its "BBB+" counterparty credit and financial strength ratings on Argonaut's property/casualty subsidiaries. Argonaut's substantially improved capital position since the beginning of the year and the expectation of further improvement in the second half of 2003 influenced the ratings action. S&P also said that the outlook on all these companies is negative.

S&P analyst John Iten said he expects Argonaut's underwriting results to improve in the second half of the year and into 2004, thanks to the hardened market. The outlook remains negative, however, because of the possibility of additional reserve strengthening.

Argonaut's acquisition of the Colony Insurance Group, which writes surplus lines business, in mid-2001 has greatly reduced Argonaut's historical dependence on workers' compensation. Surplus lines premiums constituted 41 percent of total gross written premium in 2002 and 49 percent in the first quarter of 2003. Argonaut expanded its surplus lines presence in April 2002 with the acquisition of the renewal rights of Fulcrum Insurance Co. from SCOR Group. Argonaut's expansion into surplus lines appears to have been well timed, and most of the company's future growth and earnings are expected to come from these operations.

Workers' compensation is a decreasing portion of Argonaut's book of business. The company is implementing a restructuring plan to focus on upper-middle-market, loss-sensitive accounts and, effective March 31, 2003, it exited the wrap-up and small commercial businesses.

Argonaut posted a $21 million pretax loss for 2002 versus a $3 million profit in 2001. Last year's results were hurt by reserve strengthening for asbestos of $59.8 million and a $70 million write-down of its deferred tax asset. Pretax income for the first half of 2003 was $67.0 million, up from $20.1 million in the prior-year period. Net income rose to $53.3 million from $13.6 million in the same period a year earlier, including net realized gains of $44.1 million and $9.1 million in the respective years. Earnings in the first half of 2003 included a reserve strengthening charge for lines of business the company is exiting, restructuring charges, and an increase in allowance for doubtful reinsurance recoverables.

National Indemnity Affirmed

Fitch Ratings affirmed the "AAA" insurer financial strength ratings of the National Indemnity Co. and the six associated members of the National Indemnity Group (National Indemnity). The rating outlook is stable.

The ratings reflect National Indemnity's enormous capital base, excellent reinsurance market position, solid liquidity profile, low operating leverage and underwriting discipline. Offsetting these positives is National Indemnity's high investment risk associated with their large equity allocation and the volatile nature of the group's high-level catastrophe excess-of-loss reinsurance product line.

National Indemnity reported a pre-tax (GAAP) underwriting gain of $534 million at year-end 2002 versus underwriting losses of $647 million in 2001. The vast majority of the gain in 2002 stemmed from National Indemnity's Catastrophe & Individual Risk Unit, which saw significant opportunities after the events of Sept. 11, 2001.

National Indemnity's non-catastrophe reinsurance business also continues to be an attractive product line due to the anticipated extended claim payment period that allows for large future investment income. Its high operating earnings in this line of business is a product of historically small underwriting losses offset by the large amounts of investment income on National Indemnity's substantial invested asset base.

HCC Insurance Group Assigned

Fitch Ratings assigned a "AA-" insurer financial strength (IFS) rating to HCC Insurance Group, which is led by Houston Casualty Company. Fitch also affirmed the "A-" long-term issuer and "A-" senior debt rating of HCC Insurance Holdings Inc. (HCC). The rating outlook is stable.

The ratings are based on HCC's market position in a number of specialty insurance segments, as well as the company's strong capital position at its insurance subsidiaries and at the parent holding company, conservative investment profile, adequate loss reserves, and favorable historical and recent operating profitability. The company's underwriting and intermediary businesses provide significant earnings and cash flow diversity, and a unique approach to managing underwriting risk that has proven successful over an extended period.

HCC has traditionally utilized significant amounts of reinsurance to manage underwriting risk. While this strategy allowed the company to effectively manage net loss exposures relative to capital and mitigate undue risk concentrations, it also created significant reinsurance recoverable balances and a requirement to carefully manage credit exposures to reinsurers. In response to more favorable market conditions, changes in business mix, and less attractive reinsurance pricing, the company increased its premium retention level (net written premium divided by gross written premium) to 47 percent in 2002 versus 37 percent in 2001. These changes led to a decline in HCC's consolidated GAAP reinsurance recoverables in 2002. The ratio of reinsurance recoverables to shareholders' equity was 109 percent at year-end 2002 compared with 127 percent in 2001.