S&P Downgrades Atlantic Mutual; Cites Need for Continued Support from Agents

April 19, 2004

Standard & Poor’s Ratings Services has lowered its counterparty credit and financial strength ratings on Atlantic Mutual Insurance Co., Centennial Insurance Co., and Atlantic Lloyds Insurance Co. of Texas (collectively referred to as Atlantic Mutual) to ‘BB+’ from ‘BBB’.
Standard & Poor’s also lowered its surplus note rating on Atlantic Mutual Insurance Co. to ‘B+’ from ‘BB+’.

At the same time, all the ratings were removed from CreditWatch where they were placed on Dec. 5, 2003, following Atlantic Mutual’s announcement that it had reached an agreement to sell most of its remaining commercial lines business to OneBeacon Insurance Co. (OneBeacon). The outlook is stable.

“The downgrades are based on the less diversified business position of the company following its exit from commercial lines, a substantial
decline in surplus driven primarily by reserve strengthening, uncertainty regarding the adequacy of reserves for the discontinued commercial lines business, low interest coverage prospectively, and minimal financial flexibility,” said Standard & Poor’s credit analyst John Iten. “Another factor is the high proportion of surplus derived from surplus notes and surplus generated by reinsurance transactions.”

These concerns are offset to some extent by the continued support of Atlantic Mutual’s agents in placing business with the company, good
capitalization relative to its ongoing book of personal lines business,
and a high-quality investment portfolio.The expansion of the difference between the financial strength and surplus note ratings from two to three notches reflects Standard & Poor’s normal gapping once a company’s financial strength rating falls below ‘BBB-‘.

Atlantic Mutual has completed its exit from commercial lines and is now focused on bringing its cost structure in line with its much-reduced revenues. Meeting its revenue and profitability targets in 2004 and beyond will depend largely on the willingness of Atlantic Mutual’s personal lines agents to continue placing business with the company. The agents appear to be supportive of the company’s new strategy, and premium volume through first-quarter 2004 is running above plan.

Because proposed expense reductions are largely within management control, the company should be able to meet the earnings target for its personal lines business and cover interest expense. Atlantic Mutual also has excess capital from a regulatory perspective, so it is likely that approval for interest payments will continue to be forthcoming.

Should further reserve strengthening or other factors lead to a significant decline in surplus, regulators might be reluctant to approve further interest payments to surplus note holders, preferring instead to conserve surplus for policyholder obligations.

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