Best Affirms Most Ratings on Canada’s Fairfax

March 17, 2003

A.M. Best Co. announced that it has affirmed the various financial strength ratings of the operating subsidiaries of Toronto-based Fairfax Financial Holdings Limited, with the exception of TIG Insurance Group, which was lowered to B+ (Very Good) from B++ (Very Good).

“Concurrently, the senior debt rating of Fairfax was lowered to ‘bb+’ from ‘bbb-‘, the senior notes of TIG Holdings were lowered to ‘bb-‘ from ‘bb+’ and the capital securities of TIG Capital Trust I were lowered to “‘+’ from ‘bb’,” said Best. It also noted that “the outlook on all ratings is negative.”

The announcement indicated that the rating actions followed a “comprehensive review of Fairfax and each of its insurance and reinsurance subsidiaries including ORC Re, its Dublin reinsurance subsidiary.” Best said the debt ratings downgrades were “based on the decreased flexibility in the company’s cash flows, diminished refinancing options and reliance upon the non-public markets for refinancing to maintain holding company liquidity.”

“Management has historically utilized the non-public markets to create options to provide several avenues to liquidity. As such, Fairfax has been in a position over the past few years to provide capital to its subsidiaries and to meet corporate obligations without heavily relying on subsidiary dividends. However, reliance upon non-public markets, sale of assets, realized investment gains, uncertain future liquidity and the potential for unforeseen financial shocks warrant debt ratings below the investment grade level,” said the report.

Best concluded, however, that “the capital levels of each of Fairfax’s operating companies meet or exceed the level commensurate with their financial strength ratings. No additional operating capital requirement is anticipated in 2003 if premium growth projections are maintained.”

It said “The lowering of TIG’s financial strength rating reflects the ultimate run-off nature of the restructured operation. There are currently ongoing books of profitable business within TIG, which A.M. Best anticipates will be moved to other Fairfax subsidiaries within the next twelve months. Further, A.M. Best believes that Fairfax will continue to meet its obligations without compromising the capital levels of the subsidiaries.”

Best noted that, although Fairfax is faced with a heavy debt load this year, it has cash reserves of around Can$ 500 million (U.S.$339 million) and sufficient sources of revenue to meet its obligations. It also has the option of selling some assets to raise cash if needed. The rating agency sees a lessening of these obligations in 2004.

Concerning ORC Re, Best said it had “performed a comprehensive review of the assets, capital, cash flows and reinsurance provisions and protections.” It concluded that although the structure and purpose of the Dublin-based subsidiary has changed since it was established, “cash flows, discount rates of the run-off operations and reinsurance contracts appear reasonable, and capital levels are sufficient to provide Fairfax with dividend capacity in 2003.”

Best said it “believes that the respective management teams at each of Fairfax’s ongoing operating subsidiaries have made considerable progress in improving operating fundamentals. The consolidated combined ratio for 2002 was favorable at 100.1%, including 95.8% for the Canadian companies, 106.0% for TIG ongoing operations and 99.1% for Odyssey Re. In particular, Crum & Forster’s reported results for 2002 at a 103% combined ratio are a noticeable improvement over the 131% reported in 2001.” It stressed that “Crum & Forster’s well regarded management team has made significant progress in stabilizing the balance sheet and re-focusing operations on underwriting profitability,” and added that its “ratings on these companies are prospective, and it anticipates further improved 2003 combined ratios at or below 100% for ongoing operations.”

Best explained that “the negative outlook on all of Fairfax’s ratings is due to constrained financial flexibility of the holding company to meet any unforeseen capital needs. Fairfax currently maintains a number of private market financing options; however, those options are not unlimited. Should Fairfax utilize its existing private market options to replenish the CAD 500 million of holding company liquidity in 2003, its future financing options to maintain balance sheet quality and financial strength ratings, if required, would be diminished. Conversely, should Fairfax’s operating subsidiaries meet or exceed 2003 projections and holding company liquidity and financial leverage improves, A. M. Best will reevaluate its current rating outlook.”

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