Best Places Two Kingsway Subs ‘Under Review/Negative’- Company Analysis

June 8, 2007

A.M. Best Co. has placed the financial strength rating (FSR) of “A-” (Excellent) and the issuer credit ratings (ICR) of “a-” of Penn.-based Lincoln General Insurance Company and Barbados-based Kingsway Reinsurance Corporation (KRC) under review with negative implications.

At the same time Best affirmed the ICRs of “bbb-” of Kingsway Financial Services Inc. (KFSI), the main Canadian-based company, and Kingsway America Inc. (KAI) of Elk Grove Village, Ill. But the rating agency has revised its outlook on their ratings from stable to negative. Best also affirmed the FSRs and ICRs of the remaining property/casualty subsidiaries of KFSI with various rating outlooks.

In addition Best affirmed its revised its “bbb-” ratings on a number of KFSI’s debt instruments, but likewise revised its outlook on them from stable to negative. Best also noted that the “debt ratings of KAI are based upon the unconditional guarantee of KFSI.”

“The under review status of Lincoln’s ratings is due to its continued poor operating performance, due primarily to adverse loss reserve development,” Best explained. “As a result, risk-adjusted capitalization has deteriorated and no longer adequately supports the underwriting and investment risks at the current rating level, given the poor operating performance.”

Best also pointed out that it “remains concerned with this continued poor reserving trend of KFSI overall.”

The rating agency believes that “market conditions in Lincoln’s core commercial trucking, commercial auto and non-standard personal auto markets will have put greater pressure on pricing,” largely as a result of “significant reserve deficiencies.” Best also noted that “Lincoln is highly dependent upon KRC for reinsurance protection and as a primary source of capital support. Because of the concentration of risk in the affiliated reinsurer, Lincoln’s capitalization is highly susceptible to changes in the financial position of KRC and the overall capitalization of KFSI.”

Best did recognize that KFSI’s “commitment to achieve capitalization levels commensurate with Lincoln’s risk appetite and current rating level,” at least partially mitigate it concerns. However, Best said it would downgrade the ratings if the risk-adjusted capitalization “does not appropriately support the current ratings.” The outcome depends on the ongoing review; however Best added that “any significant deterioration in the financial strength of KRC would result in inadequate support of Lincoln General’s current ratings.”

KRC is in turn under review as it supports Lincoln General. Therefore, Best indicated, that if there’s further weakening in its risk-adjusted capitalization, it “may not support the current ratings without additional capital support from KFSI.” In addition, “as a dedicated reinsurer of KFSI’s U.S. business, KRC is also dependent upon the profitability of its U.S. affiliates.” Citing “current soft market conditions,” Best indicated that it doesn’t “expect KRC’s 2007 earnings to be as strong as they have been in recent years,” and it would therefore downgrade the ratings if they KRC’s financial projections “do not exceed” its expectations, ‘or if capital is not replenished by KFSI.”

As far as KFSI’s ICR’s are concerned, Best said they are “reflective of its history of profitable operating performance, market leadership position among commercial trucking and professional non-standard auto writers in the United States and Canada, good geographic spread of risk and financial flexibility as a publicly traded company.”

However, Best warned that KFSI’s “diminished risk-adjusted capitalization due to a continuing pattern of adverse reserve development and the growing use of debt to finance,” which Best sees as “an aggressive growth appetite through organic growth as well as acquisitions,” should be considered as offsetting factors. “While the recent adverse development of loss reserves is not material relative to KFSI’s overall reserve position, it is a continuation of a loss development pattern that in aggregate is material,” Best continued. It added that even though reserves have been increased, in its opinion “the pattern of adverse loss development will continue and be difficult to absorb in a soft market.”

The analysis concluded: “When considering this potential reserve deficiency within current capitalization levels, there is insufficient capitalization to support the current rating levels. Without improvement in capitalization to address KFSI’s growth orientation, offset A.M. Best’s concerns with potential reserve deficiencies and reduce adjusted financial leverage, the ratings of KFSI and its Excellent rated subsidiaries will be downgraded.”

Best gave the following summary of the ratings:
The FSR of A- (Excellent) and the ICRs “a-” have been affirmed with a negative outlook for the following subsidiaries of Kingsway Financial Services Inc.:
— American Service Insurance Company Inc.
— Southern United Fire Insurance Company
— Universal Casualty Company

The FSR of A- (Excellent) and the ICRs “a-“have been affirmed with a negative outlook for the following subsidiaries of Kingsway Financial Services Inc.:
— JEVCO Insurance Company
— Kingsway Reinsurance (Bermuda) Limited

The FSR of B++ (Good) and the ICRs of “bbb” have been affirmed with a stable outlook for the following subsidiaries of Kingsway Financial Services Inc.:
— Kingsway General Insurance Company
— York Fire & Casualty Insurance Company

The FSR of B+ (Good) and the ICRs of “bbb-” have been affirmed with a stable outlook for U.S. Security Insurance Company Inc., a subsidiary of Kingsway Financial Services Inc.

The FSR of B+ (Good) and the ICR of “bbb-” have been affirmed with a negative outlook for American Country Insurance Company, a subsidiary of Kingsway Financial Services Inc.

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