Best Downgrades Kingsway and Some Operating Company Ratings

January 23, 2009

A.M. Best Co. has downgraded the issuer credit ratings (ICR) to “b” from “bb-” of Canada’s Kingsway Financial Services Inc. (KFSI) and Kingsway America Inc. (KAI), which is headquartered in Elk Grove Village, Ill.

Best also affirmed its ratings on a number of Kingsway’s other subsidiary companies (See below).

In addition Best downgraded the financial strength rating (FSR) to ‘C++’ (Marginal) from B- (Fair) and the ICR to “b” from “bb-” of Barbados-based Kingsway Reinsurance Corporation (KRC); as well as the FSR to.’ B’- (Fair) from ‘B+’ (Good) and ICR to “bb-” from “bbb-” of Pennsylvania-based Lincoln General Insurance Company and the FSR to ‘B-‘ (Fair) from B (Fair) and the ICR to “bb-” from “bb+” of American Country Insurance Company.

Best also downgraded the FSR to ‘B’ (Fair) from ‘B+’ (Good) and the ICR to “bb” from “bbb-” of Kingsway General Insurance Company. All the companies are subsidiaries of KFSI. The outlook for all ratings is negative, except for American Country’s FSR, which has been revised to negative from stable.

“The downgrading of KFSI’s rating is a direct reflection of the reduced financial strength of the underlying insurance companies, poor operating performance and diminished financial flexibility,” Best explained. “The overall financial strength of the insurance companies has been weakened primarily by a sizeable loss of surplus since March 2008, which is attributable to reduced earnings and dividends to fund KFSI’s payback of its bank debt, shareholders’ dividends and normal course issuer bid.”

Best added than its opinion “KFSI’s financial flexibility has been reduced. KFSI’s share price is trading well under book value, and the current credit crisis significantly hinders the company from raising capital through equity offerings or through debt at favorable terms. Although debt leverage has been reduced by the repayment of bank debt, the funds to pay the debt came from the operating units whose underlying strength is the basis for KFSI’s rating.

“Capital-raising initiatives have included the sale of non-core assets; however, the gains from these sales have not materially benefited the overall financial strength of the organization.”

Best also explained that it “remains concerned about earnings potential given ongoing adverse reserve development, soft market conditions, strong competition, lower production, turmoil in the investment markets and execution risk for various initiatives to raise profitability by improving controls, eliminating or repricing unprofitable business and reducing expenses.”

As far as KRC is concerned, Best said it had downgraded the ratings due primarily “to a significant drop in surplus over the last six months from dividends and lower earnings, which was partially offset by lower investment, premium and reserve risk.

“The rating actions on KRC have a negative effect upon the ratings of Lincoln General and American Country due to their material dependency and concentration of credit risk, which is only partially mitigated by collateral. Additionally, these companies continue to lose capital through negative earnings.”

Finally Best pointed out that “Kingsway General’s ratings were downgraded due to its weakened capitalization from negative earnings as a result of adverse reserve development on prior accident year claims and ongoing challenges in the volatile Ontario automobile market.”

The Company responded to the ratings change in a press bulletin (See related article).

The following is a summation of Best’s rating actions:
The FSRs of B+ (Good) and ICRs of “bbb-” have been affirmed for the
following subsidiaries of Kingsway Financial Services Inc.:
— American Service Insurance Company, Inc.
— JEVCO Insurance Company
— Kingsway Reinsurance (Bermuda) Ltd.
— Mendota Insurance Company
— Mendakota Insurance Company
— Southern United Fire Insurance Company
— U.S. Security Insurance Company, Inc.
— Universal Casualty Company

The following debt ratings have been downgraded:
— Kingsway America Inc. } to “b” from “bb-” on USD 125 million 7.5 percent senior unsecured notes, due 2014; to “b” from “bb-” on USD 74.1 million 7.12 percent senior unsecured notes, due 2015
— Kingsway Financial Services Inc. (issued under Kingsway General Partnership) } to “b” from “bb-” on C$100 million 6 percent senior unsecured debentures, due 2012.
All senior debt is unconditionally guaranteed by KFSI and KAI.

Source: A.M. Best –

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