Rating Agencies React to Harleysville Profit Warning

October 20, 2003

A.M. Best Co., Standard & Poor’s and Moody’s all reacted to the announcement by Pennsylvania-based Harleysville Insurance that it, “expects to report a diluted net loss per share in the range of $1.15 to $1.17 in the third quarter of 2003, reflecting loss reserve increases in several business lines and the cost of claims resulting from Hurricane Isabel.” (See IJ Web site Oct.17)

Best said it had nonetheless affirmed the financial strength rating of A (Excellent) for the P/C pooling members of the group, but has changed its outlook on all of the group’s ratings to “stable” from “positive.”

S&P said it had placed its ‘BBB’ counterparty credit and senior debt ratings on Harleysville Group Inc. on CreditWatch with negative implications. Moody’s affirmed its current A2 insurance financial strength ratings, but changed its outlook on all ratings to negative from stable.

“These rating actions follow the recent announcement that the company would report a net loss for the third quarter 2003 and year-to-date due to loss reserve increases in several lines of business and the cost of claims resulting from Hurricane Isabel,” said Best’s bulletin. It indicated that “despite the losses, the rating affirmation reflects the company’s strong capitalization, historical profitability and strong regional market franchise.”

Best said, however, that it was concerned that the potential for continued adverse loss reserve development in 2003 could negatively affect the company’s operating results and would offset the positive rating factors. “According to management,” said the bulletin, “the loss reserve development stems from increased loss severity and different loss patterns since the recent reorganization of the group’s claims operations.”

S&P indicated, “third quarter loss reserve strengthening totaled $55 million pretax on its workers’ compensation, commercial auto liability, commercial multiperil, personal auto liability lines of business, and there were losses of $9 million associated with Hurricane Isabel in September. Although management expects double-digit rate increases in the company’s commercial lines segment and the re-underwriting or shedding of different portions of its personal lines segment, at this time Standard & Poor’ does not expect the company to meet underwriting expectations, measured by a combined ratio of about 100%.”

Moody’s cited the same figures, noting that the charges follow “a $20 million pre-tax reserve charge taken during 1Q2003 for workers’ compensation business written from 1998-2001. Taken together, these charges are significant relative to HGIC’s core earnings power and fall outside of Moody’s range of expectations for the company’s performance.” It also indicated that “HGIC remains conservatively capitalized, with relatively modest financial and operational leverage and adequate liquidity. However, with pricing increases moderating and with the company facing intense competition within its core small commercial lines business, Harleysville will be challenged to fix the problems that have contributed to its poor recent operating performance.”

Both A.M Best and S&P expressed concerns of another sort – the imminent retirement of Chairman and CEO Walter R. Bateman, who will step down at the end of the year. Best noted that “there is some additional uncertainty as respects to Harleysville’s leadership and future direction due to” his retirement, and added that as a consequence, the company “will be without a permanent successor until a replacement is appointed.” It added that the “change in outlook reflects these uncertainties and is contingent upon stabilization in prior year reserves and restored profitability.”

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