A.M. Best, Fitch Explain Recent Downgrades of Tower Group

By Susanne Sclafane | October 16, 2013

Rating agencies have downgraded Tower Group following the insurer’s announcement of loss reserve and goodwill charges in excess of what was expected.

Tower has said that the company’s board of directors is reviewing a range of strategic options with its lead financial advisor, JP Morgan Securities LLC.

A.M. Best Co. recently downgraded the financial strength rating of members of Tower Group to B++ (Good) from A- (Excellent).

A.M. Best also cut issuer credit ratings (ICR) for the same members of the Tower US Pool (listed below)—to “bbb” from “a-”—taking similar actions on the FSR and ICR of CastlePoint Reinsurance Company, Ltd.

Additionally, A.M. Best has assigned an ICR of “bb” to the ultimate parent, Tower Group International, Ltd.

The A.M. Best action came right after the insurer announced a $365 million loss reserve charge on Oct. 7.

Fitch Ratings also took rating actions on Tower Group, including lowering the financial strength ratings of the operating units of Tower Group from “A-“ to “BB.”

Best’s Action

All Tower companies are under review with negative implications, A.M. Best said in its announcement, noting that the status, in part, reflects the potential negative impacts of the downgrade itself— competitive challenges and possible actions by reinsurers and lenders.

Explaining the downgrade action, Best said that the reserve charge indicated by Tower on Oct. 7 was well in excess of a $60-$110 million range initially indicated by the insurer in an Aug. 8 press release. In addition, Tower is taking a goodwill impairment charge of $215 million as a result of the reserve actions already taken.

In addition to considering the magnitude of the charges and their “material adverse impact on Tower’s risk-adjusted capitalization,” Best said the rating actions also consider “the reduced financial flexibility” given the delay in Tower’s earnings announcement which has fueled a “decline in shareholder confidence and the corresponding decline in share price.”

The Best actions came despite Tower’s efforts to enhance financial flexibility by entering into some reinsurance deals late last month, which the rating agency acknowledged in its announcement. “Considering the broad disparity between Tower’s reserve guidance in August and the actual reserve charge taken, A.M. Best believes Tower will be challenged to restore shareholder confidence, both in the near and long term,” the rating announcement said.

“Once well-regarded for its mergers and acquisitions strategy, equally important is the consequential impact this reserve charge has on Tower’s business model, business profile and earnings prospects going forward.”

On the plus side, Best said that Tower actually now has an adequate level of risk-adjusted capitalization and that the group has been re-underwriting its book of business since 2011.

“Management is confident in its earnings prospects and believes future underwriting results (excluding prior years) should be more reflective of Tower’s core business, which continues to outperform P/C industry norms,” the rating announcement said.

Still Best is assigning negative rating implications, pointing to the potential for more negative reserve news and fallout from the ratings downgrade itself. In the words of the Best statement, “Despite management’s sentiment, the negative rating implications assigned to Tower reflect the potential for further adverse reserve development, increased competitive challenges and due to the ratings downgrade, potential actions taken by third-party reinsurers and lenders.”

Best said there is a “reasonable likelihood” that the ratings or outlook could be downgraded or revised going forward.

A.M. Best Action Summary

The FSR has been downgraded to B++ (Good) from A- (Excellent) and the ICRs to “bbb+” from “a-” for the following pooled and reinsured members of Tower US Pool:

  • CastlePoint Insurance Company
  • CastlePoint National Insurance Company
  • Tower Insurance Company of New York
  • Tower National Insurance Company
  • Preserver Insurance Company
  • North East Insurance Company
  • Hermitage Insurance Company
  • CastlePoint Florida Insurance Company
  • Kodiak Insurance Company
  • York Insurance Company of Maine
  • Massachusetts Homeland Insurance Company
Fitch Ratings Action

Fitch Ratings has cut the financial strength ratings of the operating units from “A-“ to “BB”, noting that Tower Group’s announced reserve and goodwill charges represent more than 60 percent of year-end 2012 shareholder’s equity.

Based on financial information available on Tower’s website, the total amount of reserve strengthening is nearly 20 percent of reserves held at Dec. 31, 2012.

The magnitude of the overall reserve strengthening charge is higher than a range of figures—$60 million to $110 million pre-tax—that Tower said it anticipated when it announced the independent actuarial review and a delay of its second-quarter 10-Q filing with the Securities and Exchange Commission back in August. The August announcements caused Fitch to place Tower’s ratings on Rating Watch, and also caused rating agency A.M. Best to place its “A-” rating of the financial strength of Tower’s operating subsidiaries under review with negative implications.

On Oct. 7, Tower said the $365 million figure reflects adverse loss emergence, coupled with changes in judgment.

During 2012, Tower also took after-tax charges totaling $50.9 million to increase prior-year reserves, according to information on its website.

“Since 2010, Tower has been shifting its business mix, significantly de-emphasizing the lines that contributed to the reserve strengthening and modifying its book of commercial lines business,” Tower said.

Separately, in its ratings announcement, Fitch said Tower’s “inability to effectively place adequate controls on the loss reserving process,” and also the fact that Tower’s announcement of potential charges on Aug. 7 was followed by other events that “have led to a material weakening in the insurer’s financial profile.”

Fitch pointed to a drop in the company’s share price and the lack of new capital raising, adding that the rating agency is concerned that the company’s “competitive position has been materially damaged, negatively impacting the company’s financial flexibility and ability to write new business.”

In addition to cutting the financial strength ratings, Fitch also downgraded Tower Group International, Ltd.’s Issuer Default Rating (IDR) to “B” from “BBB.”

The ratings remain on Rating Watch Negative pending the company’s exploration of strategic alternatives, Fitch said.

Explaining the multi-notch downgrades, Fitch said the magnitude of the second-quarter charges was large enough to cause several key ratios to fall well outside of previously established ratings downgrade triggers, adding that the combined charges equate to approximately 63 percent of year-end 2012 shareholders’ equity.

Fitch said the majority of the reserve development relates to business acquired during the Specialty Underwriters Alliance, Inc. (SUA) acquisition, which Tower acquired in 2009.

Specialty Underwriters wrote niche specialty business including tow trucks, professional employer organizations, public entities, and contractors, the company said at the time of the acquisition.

Tower has been involved in a string of deals in recent years, including the latest—its merger with Canopius Holdings Bermuda Limited, which closed in March—as well as prior renewal rights deals (with Navigators in 2011 and AequiCap Program Administrators, for example in 2009 and 2010) and the acquisition of OneBeacon’s personal lines business in 2010.

Fitch said the Rating Watch Negative reflects the potential that ratings could be lowered further depending upon the company’s ability to seek strategic alternatives and future reserve development.

In its announcement, Tower said the goodwill impairment charge of approximately $215 million for the second quarter of 2013, represents all goodwill associated with its commercial and specialty and reinsurance segments, but added that Tower is completing its evaluation of other intangible assets associated with its commercial and specialty and reinsurance segments, as well as the goodwill associated with its personal lines segment.

Reinsurance Deals

Late last month, Tower announced it had entered into reinsurance deals with three reinsurers designed to enhance Tower’s financial flexibility.

Tower Group International, Ltd. said it is ceding more than 20 percent of its commercial liability business and 30 percent of its workers comp business to three reinsurers under pro-rata deals designed to enhance Tower’s financial flexibility.

The reinsurers extending lifelines to the troubled insurer are Arch Reinsurance Ltd., Hannover Re and Southport Re.

In addition to the quota-share deals, Southport is also providing two retrospective aggregate excess-of-loss covers.

The company provided the following descriptions of the reinsurance agreements:

In the deal with Arch Reinsurance, Tower Insurance Company of New York (Tower New York), on its behalf and on behalf of each of its pool participants, entered into a multi-line quota share agreement to cede a 17.5 percent quota share of certain brokerage commercial automobile liability, brokerage commercial multi-peril property, brokerage commercial multi-peril liability and brokerage other liability (monoline liability) business.

The agreement covers losses occurring on or after July 1, 2013 for policies in-force as at June 30, 2013 and policies written or renewed from July 1, 2013 to December 31, 2013.

• In the deal with Hannover Re (Ireland) Plc, Tower New York will similarly cede a 14 percent quota share of certain brokerage commercial automobile liability, brokerage commercial multi-peril property, brokerage commercial multi-peril liability, brokerage other liability (monoline liability), as well as brokerage workers compensation business.

This agreement likewise covers losses occurring on or after July 1, 2013 for policies in-force as at June 30, 2013 and policies written or renewed from July 1, 2013 to December 31, 2013.

• Three deals with Southport Re (Cayman), Ltd. involve only workers comp and employers liability business.

  • The first agreement with Southport, a quota-share agreement in which Tower New York cedes 30 percent of its workers’ compensation and employer’s liability business, will cover losses occurring on or after July 1, 2013 for policies in force as at June 30, 2013 and policies written or renewed during the term of the agreement.
  • The second agreement is an aggregate excess-of-loss agreement, with Southport Re assuming a portion of the losses incurred by Tower New York on its workers’ compensation and employer’s liability business between January 1, 2011 and May 31, 2013, but paid by Tower New York on or after June 1, 2013.
  • The third deal covers Tower Reinsurance, Ltd. (Tower Re), a wholly-owned Bermuda-domiciled reinsurance subsidiary of Tower, under the same terms—with Southport Re assuming a portion of the losses incurred by Tower Re on its assumed workers’ compensation and employer’s liability business between January 1, 2011 and May 31, 2013, but paid by Tower Re on or after June 1, 2013.

 

 

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