Best Announces Ratings Actions on Aon Subsidiaries

May 12, 2004

A.M. Best Co. has taken a number of rating actions concerning several subsidiaries of Aon Corp.

It affirmed the financial strength ratings of “A” (Excellent) of Aon’s life/health operations–Combined Insurance Company of America (CICA) and Combined Life Insurance Company of New York (CLNY) (New York), a wholly-owned subsidiary of CICA, but revised the outlook on them to negative from stable.

Best also said it has downgraded the financial strength ratings to “A-” (Excellent) from “A” (Excellent) of Aon’s property/casualty operations–Virginia Surety Company, Inc. (VSC) and FFG Insurance Company (FFG). The outlook, however, remains stable.

In addition, Best said it has downgraded the financial strength rating to “B++” (Very Good) from “A-” (Excellent) of Resource Life Insurance Company (Resource) with a stable. Outlook, and has revised to negative from stable the rating outlook on the financial strength rating of “A-” (Excellent) of Sterling Life Insurance Company (Sterling). Both Sterling and Resource are wholly-owned subsidiaries of CICA. All companies are located in Glenview, IL, except where noted.

“The negative outlook on CICA is based on concerns surrounding the level of concentration associated with CICA’s less-liquid high-risk assets, uncertainty with regards to parental support for the organization and ongoing operational and business profile issues,” said Best.

The rating agency said it “remains concerned about the level of risk CICA has within its investment portfolio, particularly below investment grade holdings and future commitments, related to the group’s securitization of its sizeable limited partnership position. While Aon and CICA have a plan for reducing this risk, as it stands now, the investment quality and concentration in these particular investments are not appropriate for a highly-rated health insurance company.”

Best also noted that following “Aon’s aborted divestiture of its insurance operations in 2002,” it “does not view these operations as core to the organization. While capitalization has not been an issue for CICA, Aon dividended much of CICA’s earnings prior to 2002. This has inhibited surplus growth in earlier periods. Plans call for more modest dividends to be paid from CICA beginning again in 2004.”

Best said it “has discussed a number of operational issues with CICA’s management regarding foreign currency risk, market competition, and potential risks related to several of its core individual accident and health products. While management is presently addressing a number of A.M. Best’s issues, some are more related to A.M. Best maintaining a cautious view of certain industry segments.”

The revised rating outlook for Sterling is “primarily based on both Medicare supplement and Medicare Advantage markets being highly-regulated commodity-type products and that these markets are becoming increasingly competitive,” said the bulletin. “Moreover, while Sterling turned profitable in 2003, A.M. Best will look for it to continue a profitable growth trend going forward, with capital support from CICA as needed to maintain an appropriate risk-adjusted capital position. CICA contributed $15 million to Sterling in the first quarter of 2004, to support its below average risk-adjusted capital ratio.

“The rating of Resource was downgraded based on its substantial use of financial reinsurance and the downgrade of Aon’s extended warranty insurance company, VSC, which works in conjunction with Resource.”

As far as Aon’s P/C companies were concerned, Best said the changes were mainly “a result of the poor operating results of the lead property/casualty company, VSC, in 2002 and 2003. VSC’s operating performance has not been commensurate with its ‘A’ (Excellent) rating and it has resulted in weakened capital strength over that time.

“As a result of VSC’s downgrade, FFG was downgraded too. The largest driver of VSC’s financial under performance was a poorly performing apartment liability book written in 2001 and 2002. Between 2002 and 2003, VSC recorded approximately $100 million in pre-tax reserve charges on this book–the equivalent of one-third of total year-end 2003 reserves.”

Best said it “remains concerned about the reserve adequacy of the apartment liability book. In addition, VSC has recorded approximately $30 million of restructuring charges on its core extended warranty business over the same time, which significantly reduced the profitability of what historically has been a very profitable business for VSC.

“Finally, VSC’s capitalization, as measured by A.M. Best, would have deteriorated materially in 2003 if not for the stock price performance of a single large investment–equivalent to approximately 70 percent of surplus–which resulted in an unrealized gain of approximately $150 million.”

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