Best, S&P Announce Rating Actions on ACE Ltd. and Subs after Reserve Increase

January 7, 2005

Standard & Poor’s Ratings Services came down a bit harder on ACE Limited’s ratings than A.M. Best following the announcement that the company would increase its reserves for asbestos and environmental claims by $298 million (See IJ Website Jan. 6).

S&P said it has placed its counterparty credit and financial strength ratings on ACE Ltd.’s active operating insurance companies on CreditWatch with negative implications. S&P also said that its ratings on ACE, “including the ‘BBB+’ counterparty credit rating,” have also been placed on CreditWatch negative.

Best, however announced that it has affirmed the financial strength ratings of “A+” (Superior) and “A” (Excellent) of ACE Ltd. and the ACE American Pool, respectively. Best did not place those ratings “under review,” but it did lower them on several of the subsidiary companies as well as placing them under further review. It also noted that it had considered the management changes at ACE USA (See IJ Website “National” Jan. 6) in making the decision, and affirmed the overall ratings stable outlook.

S&P said it has “lowered its counterparty credit and financial strength ratings on Century Indemnity Co. to ‘B+’ from ‘BB+’ and placed these ratings on CreditWatch negative.” S&P credit analyst Damien Magarelli explained that the action was taken “following ACE’s announcement of a $298 million after-tax reserve charge and the uncertainty surrounding this event.” He added that S&P “has questioned whether the ultimate reserve requirement to fulfill policyholder obligations for Century Indemnity Co. and affiliates–as well as the other related entities within Brandywine–is sufficient even with the $298 million after-tax reserve charge.”

In a further explanation concerning the “uncertainty about the degree to which this obligation is limited by contract,” S&P said: “If the obligation is not limited to this legal contract, the ratings on ACE could be lowered one notch. (A two-notch downgrade is possible but less likely.) This view encompasses the uncertainties surrounding the sale of ACE American Re and the approval by the Pennsylvania Insurance Department and the U.K. Financial Services Authority.”

S&P also noted, however that its ratings on ACE “reflect its strong competitive position as a global and diversified property/casualty company as well as its strong financial flexibility and operating performance. Offsetting these considerations to some extent are the company’s amount of reinsurance recoverables, runoff reserves, and intangibles. The company’s execution of an aggressive growth strategy through more competitive rates is also viewed as a negative factor.

“Furthermore, ACE’s good combined ratio must be considered in light of a relatively modest level of accident-year reserve bookings. Lastly, the ongoing investigation of the insurance and brokerage industry by the State of New York with regard to various pricing practices, given the scope of the investigations, still remains a negative factor for the company.”

Best confirmed that it has “downgraded the financial strength rating to ‘B- ‘(Fair) from ‘B+’ (Very Good) of Brandywine Group (Brandywine) and has placed the rating under review with negative implications pending regulatory approvals.” It noted that the “Brandywine Group consists of Century Indemnity Company (Century Indemnity) and its two wholly-owned subsidiaries, Century Reinsurance Company and ACE American Reinsurance Company. These companies are in runoff and constitute the majority of the asbestos and environmental (A&E) liabilities of ACE Group (ACE) (Bermuda).”

Best said it had downgraded Brandywine based on its estimates of the increase in its “ultimate asbestos liabilities as well as the significantly reduced protection available under the $800 million reinsurance protection from the ACE American Pool. The downgrade follows ACE’s announcement that it intends to take a $298 million after-tax GAAP charge for prior year reserve deficiency including an addition of approximately $95 million to its bad debt reserve within the Brandywine companies. The charge causes a negative capital position at Century Indemnity, which ACE intends to address with an immediate $100 million surplus note. The capital will be provided by ACE INA Holdings, Inc. (Pennsylvania), allowing the surplus position to remain positive.”

Best also noted ACE’s intention to “sell its assumed reinsurance runoff businesses within Brandywine, which would reduce reserves by approximately $1 billion or 17 percent of Brandywine’s liabilities. The sale will cause a minimal statutory loss (mainly due to discounting) and a nominal GAAP gain. The primary benefit of this sale would be to reduce Brandywine’s assumed reinsurance exposure while a secondary benefit would be to reduce liabilities ceded to National Indemnity Company (NICO) (Nebraska) with liabilities currently ceded to the ACE American Pool of approximately $200 million.

“The Brandywine reserve charge is based on its internal best estimate of reserves, which is materially less than the outside actuarial best estimate. The charge will be ceded to the ACE American Pool companies under the existing $800 million reinsurance protection, after which no amount of protection remains at year end 2004.

“While the charge is well within the expectations of A.M. Best regarding A&E deficiencies, A.M. Best believes the charge is less than conservative when compared to the outside actuaries’ midpoint. Considering the results of the outside actuarial opinion and additional information from ACE, A.M. Best has increased its estimate of Brandywine’s ultimate asbestos liabilities while significantly reducing its estimate of its environmental liabilities, which led to the rating downgrade. It should, however, be noted that the NICO cover has begun to pay claims and more than $2 billion of remaining coverage will continue for years before the cash is exhausted.”

Best concluded that after a review of the capital models of all of the ACE companies affected by the Brandywine charge, “Brandywine remains minimally capitalized after a $100 million surplus note from ACE INA Holdings, Inc. Subsequent to the charge, the capital levels of the affected subsidiaries remain within the appropriate range for their rating.

“Moreover, the capital of ACE is sufficient to withstand a charge roughly equivalent to the actuarial best estimate. A.M. Best expects that additional charges will need to be taken in the next several years. However, given ACE’s current capital levels and its substantial earnings projections, potential charges taken in subsequent years should be readily absorbed.”

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