Ratings Recap: Auto Club (Michigan), Atlas Financial, Merced Mutual, ING US (Notes), PEMCO

February 8, 2013

A.M. Best Co. has downgraded the financial strength rating (FSR) to ‘A-‘ (Excellent) from ‘A’ (Excellent) and the issuer credit ratings (ICR) to “a-” from “a” of Auto Club Insurance Association (ACIA), headquartered in Dearborn, Michigan, and its insurance subsidiaries. The outlook for all of the ratings has been revised to stable from negative. Best explained that it has downgraded the ratings “based on the deterioration in ACIA’s underwriting results and operating earnings, which has led to a decline in policyholders’ surplus in recent years. The deterioration in underwriting results was driven by unfavorable loss experience for private passenger auto liability and non-Michigan business, as well as an increased frequency and severity of homeowner weather losses. In addition, the group maintains above-average non-affiliated investment leverage, driven by its investment holdings in unaffiliated common stock and bank loans, which equate to approximately 30 percent of surplus, and its non-investment grade bond holdings, which equate to approximately 10 percent of surplus.” On a more positive note Best said that “ACIA’s ratings and outlook reflect its strong risk-adjusted capitalization and well-established position as a personal lines market leader in Michigan, as well as the benefits derived from offering insurance products to American Automobile Association (AAA) members. The group’s strong risk-adjusted capitalization is driven by its moderate underwriting leverage, partially offset by its above average non-affiliated investment leverage and moderate gross and net catastrophe exposure. These positive attributes are derived from ACIA’s AAA affiliation, through which it writes a controlled book of business with a select class of policyholders. Management remains focused on improving its competitive position in Michigan, and by acquiring Meemic Insurance Company in 2009 and Fremont Insurance Company in 2011, it has further diversified its distribution channels and targeted audience in Michigan.” In addition Best noted: “ACIA has recently implemented numerous strategic initiatives to improve underwriting performance, which included private passenger auto and homeowner rate adjustments in states where they were indicated; increased pricing sophistication and product enhancements to improve profitability and competitive position; refinements to underwriting guidelines and modifications to its reinsurance program. Additional negative rating actions could occur from continued deterioration in ACIA’s operating performance and policyholders’ surplus, resulting in a material decline in risk-adjusted capitalization.” Best summarized the ratings as follows:
The FSR has been downgraded to ‘A-‘ (Excellent) from ‘A’ (Excellent) and ICRs to “a-” from “a” for Auto Club Insurance Association and its following insurance subsidiaries:
•MemberSelect Insurance Company
•Auto Club Group Insurance Company
•Meemic Insurance Company
•Fremont Insurance Company
•Auto Club Property/Casualty Insurance Company

A.M. Best Co. has removed from under review with negative implications and affirmed the financial strength rating (FSR) of ‘B’ (Fair) and issuer credit ratings (ICR) of “bb” of Illinois-based American Service Insurance Company Inc. and American Country Insurance Company. Best also removed from under review with developing implications and affirmed the FSR of ‘B’ (Fair) and ICR of “bb” of the newly acquired, St. Louis-based, Gateway Insurance Company. All three companies are subsidiaries of Atlas Financial Holdings, Inc. (AFH), which is domiciled in the Cayman Islands.” Best explained that these companies operate under an intercompany reinsurance pooling agreement and are collectively referred to as American Service Pool (ASI Pool). Concurrently, Best has removed from under review with negative implications and affirmed the ICR of “b-” and the debt rating of “ccc” of $18 million 4.5 percent preferred shares of Atlas. At the same time, Best withdrew the debt rating. The outlook assigned to all the remaining ratings is stable. “The rating actions follow the regulatory approval of a definitive agreement under which Atlas acquired all of the issued and outstanding shares of Camelot Services, Inc. and its wholly owned subsidiary, Gateway,” said Best. “In addition, effective January 1, 2013, ASI Pool’s intercompany reinsurance pooling agreement was revised to add Gateway as a participating company. The rating affirmations reflect a level of execution risk associated with ASI Pool management’s refocusing on its core lines of business while attempting to meet business plans and grow its premiums during a time of competitive market conditions, as well as during the run off of unprofitable business written while the pool was under the control of prior ownership. In addition, there is inherent risk associated with integrating Gateway’s taxi business into the existing pool’s infrastructure as well as handling Gateway’s commercial truck run off.” Best added, however, that the “negative rating factors are partially offset by ASI Pool’s improving risk-adjusted capitalization, which is supportive of its current ratings, its management team with extensive experience in its targeted commercial auto lines of business and the potential for improved earnings, as was the case in 2012, as management focuses on historically profitable lines of business and runs off non-core lines and books produced by general and managing general agents.” Best said that while it “believes the ASI Pool is well positioned at its current rating level, factors that may lead to negative rating actions include further deterioration in its underwriting and operating performance, increased magnitude of adverse loss reserve development and the erosion of surplus that could cause a decline in the pool’s risk-adjusted capital position. Factors that may lead to positive rating actions include stabilization of the pool’s loss reserve position, improved operating profitability and enhanced risk-adjusted capitalization.”

A.M. Best Co. has commented that the financial strength rating of ‘A’- (Excellent) and issuer credit rating of “a-” of California-based Merced Mutual Insurance Company are unchanged, and the outlook for both of the ratings is stable. Best analyzed the proposed transaction between Merced Mutual and United Heritage Financial Group, Inc. (UHFG), indicating that it “does not anticipate that the sale of Merced Mutual will result in a material change in its risk-adjusted capitalization or operating performance. The management of Merced Mutual is expected to remain intact with the buyer appointing one additional director. The transaction is expected to close by the second quarter of 2013, pending policyholder and regulatory approvals. Currently, UHFG consists of United Heritage Life Insurance Company, United Heritage Property & Casualty Company (both domiciled in Meridian, Idaho) and Sublimity Insurance Company, which is based in Oregon.

A.M. Best Co. has assigned a debt rating of “bbb” to the recent issuance of $1.0 billion 2.90 percent five-year senior unsecured notes of ING U.S., Inc. headquartered in New York, NY, the holding company for the U.S. operations of the Netherlands ING Groep N.V., and has assigned the notes a stable outlook. Best said the “rating recognizes ING U.S.’ strong market position in the life insurance and retirement markets, profitable operating results and sound level of risk-adjusted capital.” Although historically supported by its European parent, Best pointed out that “ING Group has filed with the SEC for an initial public offering (IPO) of its U.S.-based retirement, insurance and investment operations during 2013.” Best also indicated that the assigned rating reflects the “expected completion of this process, which will demonstrate ING U.S.’ ability to successfully execute its capital plans. The new senior notes, together with the $850 million 5.5 percent 10-year notes issued in July 2012 and proceeds from the anticipated IPO, should facilitate ING U.S. achieving its targeted independent capital structure. As such, ING U.S.’ financial leverage and interest coverage are expected to fall within Best’s guidelines for its current ratings. The proceeds from the new senior notes will be used for general corporate purposes, including the repayment of outstanding borrowings.” As partial offsetting factors Best cited ING U.S.’ “ongoing exposure to both equity markets and interest rates through product guarantees, spread compression as well as its material holdings of below investment grade structured securities and commercial mortgage loans. Additionally, the inherent uncertainty surrounding the timing and execution of the IPO process could negatively affect the group’s business profile with respect to products, customers, distribution and market positions, in addition to having an unfavorable effect on leverage and interest coverage metrics.”

A.M. Best Co. has affirmed the financial strength rating of ‘A-‘ (Excellent) and issuer credit rating of “a-” of Seattle-based PEMCO Mutual Insurance Company, but has revised its outlook on both ratings to negative from stable. Best explained that the revised outlook “reflects PEMCO’s recent weakened operating performance accompanied by its continued weak underwriting performance that together has begun to minimally erode capital at the company.” Best also said it has considered “PEMCO’s elevated, however markedly improved, expense ratio; elevated loss severities and frequencies in the most recent underwriting years; slightly above average underwriting leverage ratio; and a business concentration in the state of Washington, which subjects the company to judicial, regulatory and competitive risks.” Best also cited positive rating attributes, which “are derived from PEMCO’s historical operating gains and surplus growth, which have historically generated improved total returns on equity, as well as the operational improvements management has made in the past five years to refocus PEMCO’s efforts wholly on its property/casualty insurance base. These include the sale of PEMCO Technology Services Inc. and PEMCO Life Insurance Company, as well as the merger of PEMCO’s subsidiary, PEMCO Insurance Company, back into PEMCO. PEMCO also has made a commitment to diversify its geographical footprint by augmenting its strong market presence in Washington with its entrance into the Oregon market, effective July 2011. PEMCO maintains a somewhat conservative investment philosophy, which is reflected in its moderate common stock leverage.”

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