Fitch Affirms Merchants Mutual & Merchants N.H. ‘A-‘ IFS Rating

August 7, 2002

Fitch Ratings has affirmed its ‘A-‘ insurer financial strength rating (IFS) of Merchants Mutual Insurance Company (Merchants Mutual) and Merchants Insurance Company of New Hampshire, Inc. (Merchants New Hampshire). The Rating Outlook for each rating is Stable.

The ratings are based on each company’s expertise in its chosen insurance markets, adequate capital position, conservative investment portfolio and experienced management team. The ratings also consider the companies’ modest size, geographic concentration and scope of operations relative to peers.

Merchants Mutual is a mutual property/casualty insurer based in Buffalo, N.Y. At one time, Merchants Mutual owned 100 percent of Merchants New Hampshire, but as a result of an IPO of Merchants New Hampshire and subsequent stock sales, Merchants Mutual’s ownership percentage was 12.1 percent at March 31, 2002. Merchants Mutual and Merchants New Hampshire have a unique strategic relationship. The senior management of Merchants Mutual conducts the operations of Merchants New Hampshire through a management agreement that is set to expire in July 2003. Merchants New Hampshire is in discussion with various potential candidates, including Merchants Mutual, but has not finalized plans regarding operations after the expiration of the agreement.

The companies each focus on selling personal lines and small commercial lines (companies with less than 25 employees) insurance through the same network of independent agents in 14 states. Merchants New Hampshire is positioned in the market as a preferred carrier, while Merchants Mutual focuses on standard risks. The companies also purchase catastrophe reinsurance on a combined basis.

Merchants Mutual reported assets of $187.9 million and policyholders’ surplus of $44.1 million at March 31, 2002. Net written premium was $76.9 million in 2001. Underwriting performance slipped for the second consecutive year with the combined ratio increasing to 110.4 from 108.4 in 2000. Merchants Mutual recorded a net loss of $2.1 million in 2001 versus net income of $1.7 million in 2000.

Merchants New Hampshire is a somewhat larger company than Merchants Mutual, with assets of $235.9 million and policyholders surplus of $50.9 million at March 31, 2002. Net written premium was $94.0 million in 2001. The company’s combined ratio, including policyholder dividends, increased to 113.0 percent in 2001 from 108.3 percent in 2000. Net income dropped to $0.4 million in 2001 versus $4.0 million in 2000.

While both companies are adequately capitalized, operating leverage and risk-based capital levels are somewhat more conservative at Merchants Mutual relative to Merchants New Hampshire.

Merchants Mutual’s ratio of net written premium to surplus was 1.71 times (x) at year-end 2001 versus 1.34x in 2000. The risk-adjusted capital ratio was 331 percent of the company action level versus 292 percent in 2000.

Merchants New Hampshire had net premiums to surplus of 1.79x at year-end 2001 versus 1.86x in 2000. The risk-based capital ratio was 260 percent of the company action level versus 221 percent in 2000.

Investment policy is similar for Merchants Mutual and Merchants New Hampshire, emphasizing high quality and liquidity. Fixed-income securities represent more than 86 percent of each company’s invested assets. Exposure to non-investment-grade securities and equities is modest.

Going forward, Fitch expects modest premium growth given management’s intentions to focus on bottom line profitability. Fitch expects to see gradual improvement in each company’s combined ratio on a long-term basis.

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