S&P Announces Lower Ratings on PMA Capital

February 2, 2004

Standard & Poor’s Ratings Services made several announcements concerning PMA Capital Corp.’s (PMACA) credit ratings. It has lowered its counterparty credit rating on PMACA to “CC” from “B” and removed it from CreditWatch, where it had been placed on Nov. 4, 2003. It called the outlook “developing.”

S&P also said it had revised its counterparty credit and financial strength ratings on PMACA’s reinsurance subsidiary, PMA Capital Insurance Co. (PMACIC), to “R” from “BB” and removed them from CreditWatch, and has lowered its counterparty credit and financial strength ratings on PMACA’s primary insurance subsidiaries–Pennsylvania Manufacturers Assoc. Insurance Co., Pennsylvania Manufacturers Indemnity Co., and Manufacturers Alliance Insurance Co. (collectively referred to as PMAIG)–to “BB-” from “BBB-,” removed them from CreditWatch, and assigned a negative outlook.

Subsequently, S&P said it had withdrawn all these ratings–except for the ratings on PMACA–as it had previously announced.

“These rating actions follow PMACA’s recent 8-K filing, in which it disclosed that its subsidiary, PMACIC, entered into a letter agreement (dated Dec. 22, 2003) with the Pennsylvania Insurance Department in which PMACIC agreed to request prior regulatory approval for a number of actions,” explained S&P credit analyst Laline Carvalho.

The bulletin noted that these actions included:
— Entering into any new reinsurance contracts, treaties, or agreements.
— Making any payments, dividends, or other distributions to–or engaging in any transactions with–any of PMACIC’s affiliates.
— Making any withdrawal of monies from PMACIC’s bank accounts or making any disbursements, payments, or transfers of assets exceeding certain thresholds.
In addition, at the request of the Pennsylvania Insurance Department, PMACIC has agreed to engage an independent actuary to review the group’s reserves as well as to provide the regulator with monthly statutory financial reports.

S&P said its interpretation of the language of this agreement is that “PMACIC has experienced a regulatory action with regards to its solvency, which is why Standard & Poor’s revised the ratings on PMACIC to ‘R’. Given the increased regulatory control over PMACIC, which is PMACA’s sole source of dividends, Standard & Poor’s believes that there is significant risk that PMACA might not be able to obtain regulatory approval for dividends from PMACIC to service PMACA’s interest and principal debt payments.”

The rating agency added that “This is a significant concern, particularly given PMACIC’s very weak stand-alone capital adequacy. Over the medium term, Standard & Poor’s believes PMACA’s ability to obtain any dividend payment approvals will be dependent on how the group’s loss reserves develop over time and whether PMACIC will be able to successfully run-off its liabilities over the medium term. Standard & Poor’s believes PMACA currently has enough resources to service interest payments for about a year.”

“Although on a stand-alone basis, Standard & Poor’s believes PMAIG [the group as a whole] has very strong capital adequacy, the ratings on these entities were lowered to reflect increased risk that the Pennsylvania insurance regulator could decide to dividend some of PMAIG’s excess capital to help service PMACIC’s policyholder obligations because of the PMAIG companies’ position as direct subsidiaries of PMACIC,” Carvalho added. “In addition, Standard & Poor’s believes PMAIG’s franchise has deteriorated further as a result of the 8-K disclosure and increasing problems experienced by the group.”

S&P said the “developing outlook on PMACA reflects uncertainty related to the holding company’s ability to obtain regulatory approval for dividend payments out of PMACIC over the medium term in order to service PMACA’s interest and principal debt payments. In addition, Standard & Poor’s believes PMACA remains exposed to potential further reserve development at its operating companies.

“The negative outlook on PMAIG, the ratings on which have now been withdrawn, reflected uncertainty related to its future capital position, significant franchise risk, and potential exposure to reserve development,” it concluded.

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