Fitch Ratings has downgraded the Insurer Financial Strength ratings of the Kemper Insurance Companies (KIC) from ‘A-‘ to ‘BBB’. Additionally, Fitch has downgraded the surplus notes rating of Lumbermens (Lumbermens) Mutual Casualty Company, the lead property-casualty insurance underwriter of the group, from ‘BBB-‘ to ‘BB-‘. All ratings have been placed on Rating Watch Negative.
The rating action reflects Fitch’s opinion that there has been a material deterioration in the financial profile of the organization. The primary change relates to the decline in KIC’s capital as reflected by a 30 percent decline in policyholders’ surplus at Lumbermens to $1.27 billion at year-end 2001 from $1.81 billion at year-end 2000. The main cause of this decline relates to reserve increases recorded in the fourth quarter 2001. The deterioration of the capital profile is further evidenced by the decline in Lumbermens’s NAIC Risk-Based Capital (RBC) Ratio to 110 percent of the company action level at year-end 2001, down from 227 percent of the company action level at year-end 2000.
Lumbermens participates in two retroactive reinsurance transactions which alleviated some of the capital deterioration in 2001. These transactions created a $158 million surplus benefit at year-end 2001. Additionally, KIC has signed a significant reinsurance treaty for ongoing commercial lines business with a financially secure reinsurance organization to further relieve near-term capital pressure.
As a result of the reduction in capital, key financial ratios at Lumbermens have increased to levels inconsistent with the previous rating level. Gross leverage in 2001 increased to 10.97X from 6.28X in 2000. Surplus notes (Debt) as a percentage of policyholders’ surplus increased to 55 percent from 38 percent. Net reinsurance recoverables as a percent of policyholders’ surplus increased to 294 percent from 131 percent. Fitch believes the ratings’ current level properly reflects the more uncertain nature of the organization’s financial profile.
The announced sale of KIC’s personal lines business on April 12 in Fitch’s opinion, is an effort by management to improve its long-term operating and financial profile by exiting non-core businesses. However, the operating improvements from the sale will not be realized until the intermediate term at the earliest. In the near term, Fitch is concerned that the sale of KIC’s personal lines business, at least in part, reflects efforts by management to improve risk based capital through premium relief given the otherwise limited financial flexibility available to the company as a mutual insurer. Fitch is also concerned that potential restructuring and execution risk may cause additional operating challenges.
The Negative Rating Watch reflects Fitch’s view that significant uncertainty remains regarding reserve adequacy and future profitability. The magnitude of reserve increases from prior underwriting periods and from asbestos and environmental (A&E) exposures were the primary factors contributing to the decline in capital in 2001. While the reserving actions taken at year-end 2001 have improved these positions, Fitch will look for signs that prior accident year and A&E incurred losses have stabilized prior to the removal of the Rating Watch. Prior to the rating actions, KIC was on Rating Watch Negative due to concerns over exposure to the tragic events of Sept. 11. At this time, Fitch believes that ultimate losses will remain consistent with KIC’s current estimates of $60-$80 million pre-tax (net of reinsurance).
KIC’s commercial lines business segment is ratings sensitive and Fitch believes it would be significantly more difficult for KIC to compete with financial strength ratings below the ‘A’ category. Peer rating agencies have placed their respective ‘A’-level ratings on Rating Watch or Under Review for possible downgrade.
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