Best Affirms Munich Re, American Re FSR; Removes from Review; Assigns Negative Outlook

November 4, 2005

A.M. Best Co. announced rating actions on Germany’s Muenchener Rueckversicherungs (Munich Re) and its U.S. subsidiary American Re Corporation Group. Best affirmed its financial strength ratings on the companies, lowered Munich Re’s debt ratings one notch, removed all the ratings from under review status and assigned a negative outlook.

Best said it has downgraded Munich Re’s issuer credit rating (ICR) to “aa-” from “aa,” but affirmed the financial strength rating (FSR) of “A+” (Superior). It also downgraded the reinsurer’s subordinated debt ratings to “a” from “a+.” These consist of debt issued by Munich Re Finance B.V. that is guaranteed by Munich Re.

Best affirmed American Re’s financial strength ratings of “A” (Excellent). The rating is also applicable to its member companies, which include American Re-Insurance Company, American Alternative Insurance Corporation and The Princeton Excess & Surplus Lines Insurance Company (all domiciled in Wilmington, Del.). Best also removed from under review the issuer credit ratings of “a” for American Re and its member companies, as well as the ICR of “bbb” and the senior debt rating of American Re Corporation (Princeton, NJ).

Best said Munich Re’s ratings reflect its “reduced risk-adjusted capitalisation as a result of the significant reserve strengthening at American Re, as well from the impact of the recent hurricanes in the United States. The rating also factors more volatile prospective earnings due to Munich Re’s high exposure to natural catastrophes. A further factor is Munich Re’s excellent business position in the worldwide reinsurance market.”

The rating agency explained that the “negative outlook reflects the potential pressure on Munich Re’s consolidated capitalisation from uncertainties regarding future claims patterns for U.S. liability and the increased frequency of natural catastrophes for which Munich Re provides significant reinsurance capacity.”

Best noted that the recent hurricanes and floods would likely reduce Munich Re’s risk-adjusted capitalisation of its reinsurance operations, as well as the reserve strengthening of $1.6 billion in combination with other measures at American Re. “However,” the bulletin continued, “this is partially compensated by improved capitalisation, mainly due to higher revaluation reserves. A.M. Best recognises Munich Re’s strong financial flexibility and low financial leverage.”

Commenting on Munich Re’s earnings prospect, Best said they are “likely to remain excellent and within Munich Re’s earnings target of 12 percent return on equity, as higher non-recurring capital gains are partially offsetting the impact of the U.S. hurricanes and other natural catastrophes as well as the reserve strengthening at American Re. Prospectively, A.M. Best believes earnings are likely to be more volatile due to Munich Re’s significant exposure to worldwide natural catastrophes.” Best warned that Munich Re’s ratings “could become under pressure if the company is unable to achieve its own earnings targets in 2006.”

Best also noted: “Munich Re’s excellent business position in the worldwide reinsurance market, where it remains one of the market leaders despite further premium reduction as a result of strict adherence to underwriting standards and the cancellation of a larger quota share contract. In primary insurance, Ergo Versicherungsgruppe benefits from higher demand for supplementary health insurance in Germany and stronger growth of life products abroad.”

Best’s ratings on American Re and its subsidiaries closely follow the ratings on the parent company. They are based, Best indicated, “on an extensive recapitalization plan executed by American Re’s ultimate parent,” Munich Re, “following a $1.4 billion net reserve charge by American Re in the second quarter of 2005. The recapitalization plan incorporated a capital contribution of $1.1 billion from Munich Re, which was included in American Re’s statutory surplus as of June 30, 2005, and the conversion of intra-group loans totaling $1.6 billion into equity at American Re Corporation’s immediate parent, Munich-American Holding Corporation.

“The plan also included a loss portfolio transfer to Munich Re of reserves covering the 2001 and prior accident years and protection for any additional adverse development from those accident years. Further, liabilities for subsequent accident years are protected by comprehensive internal reinsurance arrangements with Munich Re.”

The reserve strengthening has been sunstantial. Best explained that the “$1.4 billion reserve charge taken by American Re represented continued emergence of adverse development out of 2002 and prior accident years. Cumulatively, American Re has added $5.3 billion to its reserve base since 2001 relating to prior year reserve development, including asbestos and environmental exposure.”

Best also said that, although it “believes that operational controls at American Re have been strengthened since 2002 when a new senior management team was established, such controls and the dexterity to maintain underwriting discipline have yet to be fully tested through the inevitable softening in the reinsurance cycle. Furthermore, the extent of this most recent reserve charge calls into question whether those controls previously implemented are sufficient to provide an early indication of pricing adequacy.”

In conclusion Best indicated that its negative outlook on American Re “mirrors that of its parent, Munich Re, which in turn, partially reflects the historical poor performance of American Re and the contingent risk associated with the most recent formal loss protection agreements provided by Munich Re.”

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