Best Takes Rating Actions on Kingsway

March 29, 2006

A.M. Best Co. announced that it has affirmed the issuer credit rating (ICR) “bbb-” of Canada’s Kingsway Financial Services Inc. (KFSI). Best also affirmed the debt rating of “bbb-” on KFSI’s C$78 million (US $66.4 million) 8.25 percent senior unsecured debentures, due 2007. Both ratings have been removed from under review and assigned a stable outlook.

In addition Best said it has assigned an ICR of “bbb-” to KFSI’s subsidiary holding company, Kingsway America Inc. (KAI) headquartered in Elk Grove Village, Ill. and debt ratings of “bbb-” to the senior notes of KAI, also with a stable outlook. Concurrently, Best assigned ICRs to all the remaining KFSI operating companies, with either a stable or negative outlook.

“The ratings of KFSI reflect its stronger balance sheet and ongoing profitability in its core property/casualty insurance operations,” said Best. “Furthermore, the ratings reflect KFSI’s financial flexibility, geographic diversification of risk, experienced management and its niche market leadership position.

“These rating strengths are partially offset by the current downturn in the pricing cycle, particularly in commercial lines, historical reserve inadequacies, the use of managing general agents with binding and claim settling authority and continued sluggishness in the investment sector.”

Best noted: “KFSI is one of the leading providers of non-standard and commercial automobile insurance in North America. Its experienced management team has attained this position through rapid expansion both organically and through acquisitions. The strength of the consolidated balance sheet is excellent and continues to improve primarily as a result of improvement in its core property/casualty operating companies.

“Overall, these companies have produced solid profits due to improved underwriting results. Combined ratios have dropped as a result of higher rates, lower claims frequency, more disciplined underwriting, tighter claims controls and higher case and incurred but not reported (IBNR) reserves. Growth has slowed substantially, lowering critical leverage ratios to more normal levels. Additionally, profitability has been enhanced by the use of internal reinsurance where it has taken advantage of favorable business environments in Bermuda and Barbados to maximize returns.

“Moreover, as a publicly-traded company on the Toronto and New York stock exchanges, KFSI has been able to bolster its balance sheet by using various capital-raising initiatives to support growth and acquisitions. These include common shares and various forms of debt offerings over the last five years and access to immediate cash through a credit facility with several banks.”

However, Best also indicated that “these rating strengths are partially offset by the current downturn in the underwriting cycle, primarily in commercial lines. Although KFSI has a concentration of risk in only a few lines of business, its risks are well diversified by geographic region, minimizing the effects of local market competitive pricing pressures, weather-related losses and changes in the regulatory environment. In addition, KFSI’s insurance subsidiaries have had a history of adverse reserve development, which was eroding the overall financial strength of the organization.

“KFSI has taken serious steps to mitigate any future development by aggressively closing older claims, shortening the claims settlement process, reorganizing its back office claims operations, setting higher initial case reserves and strengthening IBNR levels.

“Furthermore, KFSI uses managing general agents extensively to produce business, especially in the United States. The binding and claims settling authority of these agents puts KFSI at risk to honor policies, which may be written outside the boundaries of its underwriting guidelines.

“However, these risks are somewhat mitigated by KFSI’s current actions to bring most of the claims settlement process in-house and by making frequent operational audits to ensure compliance standards.”

In conclusion Best said it “anticipates that KFSI’s insurance operations will continue to be profitable in the near term despite sluggish investment returns due to below average interest rates.”

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