S&P Lowers Kingsway’s Ratings to ‘BB’

May 12, 2008

Standard & Poor’s Ratings Services has lowered its long-term counterparty credit and senior unsecured debt ratings on Toronto-based specialty insurance provider Kingsway Financial Services Inc. to ‘BB’ from ‘BB+’. S&P also lowered the debt ratings on Kingsway’s subsidiaries to ‘BB’ from ‘BB+’, and maintained its negative outlook on the ratings.

“The downgrade follows Kingsway’s first-quarter 2008 earnings announcement, which included disclosure that its lead U.S. operating company, Lincoln General Insurance Co. (unrated), had incurred further unfavorable reserve adjustments beyond our expectations,” explained S&P credit analyst Foster Cheng. (See also IJ web site – https://www.insurancejournal.com/news/international/2008/05/08/89818.htm).

S&P noted that “Kingsway posted an additional US$52.8 million (all reserve adjustments quoted on a pretax basis) in adjustments for Lincoln General, making this the sixth consecutive quarter in which it needed to increase reserves for this subsidiary. The cumulative amount of reserve increases for Lincoln General has been US$337.1 million during the past nine quarters (US$76.1 million in 2006, US$208.2 million in 2007, and US$52.8 million in first-quarter 2008).

“All of these adjustments can be attributed to under-reserving and deterioration in Lincoln General’s trucking and general liability lines of business. The total cost of these net reserve adjustments equals about two years’ of earnings for Kingsway.”

S&P also pointed out that “Lincoln General is the largest U.S. operating insurance company within Kingsway and represents just under half of the group’s gross written premiums and about a quarter of the total assets.”

S&P said that reserve releases that were recognized elsewhere within the Kingsway group during 2006 and 2007- US$14.3 million and US$37.6 million – partially offset the negative developments.

The rating agency added: “On a positive note, Kingsway has demonstrated the capacity to absorb these reserve adjustments for the most part without dipping into its consolidated capital (until this quarter) and has continued to maintain solid capital ratios.

“However, the ongoing reserve adjustments at Lincoln General and the lack of definitive proof that these issues have been resolved cause us to question the quality of governance, senior management oversight, and enterprise risk management (ERM) within its operations. In our July 23, 2007, annual review of Kingsway, we concluded ERM practices were weak relative to those of its insurance peers; this opinion has not changed.”

S&P said its negative outlook “reflects the uncertainty surrounding the ongoing strength of the company’s insurance franchise and management infrastructure, given all of the negative news that has surfaced in the group. Moreover, it also reflects the reduction in financial flexibility, considering the reserve overhang that continues to persist around Lincoln General and the resulting unfavorable operating earnings.

“If Kingsway were to experience material deterioration within its insurance franchise, or if future reserve adjustments exceeded our expectations, we could lower the ratings by another notch.

“However, if Kingsway is able to demonstrate stability around its underlying franchise position, reserves, and underwriting performance, we could revise the outlook to stable within the next six to 18 months.

“To improve the ratings, Kingsway will need to improve its management oversight, ERM, and financial performance metrics, specifically its fixed-charge coverage ratio (currently negative 3.9x) and consolidated combined ratio (currently 115.6 percent),” S&P added. It’s expecting Kingsway to “maintain a leverage ratio of less than 40 percent, a fixed charge coverage ratio of 3x or better, and a hybrid-to-total capital ratio of less than 15 percent by the end of this year. Double leverage should be maintained at less than 125 percent.”

Source: Standard & Poor’s – www.standardandpoors.com

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