Ratings Roundup: Zenith, State Farm, Restoration RRG

March 17, 2009

Fitch Ratings has affirmed Zenith National Insurance Corp.’s ratings as follows: Zenith –Issuer Default Rating (IDR) ‘BBB+’. Zenith National Insurance Capital Trust I
–$58.5 million 8.55 percent trust preferred securities due Aug. 1, 2028 at ‘BBB-‘. Zenith’s insurance subsidiaries: Zenith Insurance Company, ZNAT Insurance Company –Insurer Financial Strength (IFS) rating ‘A’. The Rating Outlook is Stable. “Zenith’s ratings reflect solid capitalization, strong underwriting results, conservative reserving practices and a strong balance sheet,” said Fitch. “Offsetting factors include Zenith’s geographic and product concentration, an intensely competitive market and legislative/regulatory uncertainty.” Fitch added that “despite recent turmoil in the financial markets, Zenith’s capital position has remained solid for its rating category with a risk-based capital ratio of 683 percent and low operating leverage (net premiums written to surplus) of 0.6 times (x) in 2008. Zenith endured a modest 5 percent decline in equity, due primarily to unrealized investment losses, while statutory surplus remained relatively flat when adjusted for the reversal of the minimum reserve requirement in California (CA). Zenith continues to report outstanding workers’ compensation underwriting results with an 86 percent combined ratio in 2008 compared to 67 percent in 2007. This compares favorably to workers’ compensation industry combined ratios estimated at approximately 106 percent and 98.5 percent in 2008 and 2007, respectively. Zenith’s results include favorable reserve development on prior accident years amounting to $79 million and $113 million in 2008 and 2007, respectively, which was driven by lower long-term claims frequency trends and favorable short-term deflationary trends in paid losses for 2003-2005 accident years. Slightly offsetting this favorable development, Zenith recognized adverse reserve development in the 2006 and 2007 accident years caused by medical inflation in recent years.” Fitch also said it “views favorably Zenith’s competitive strategy, which focuses solely on profitability as opposed to growth. Zenith does not set growth targets and is not a low-cost provider, allowing premium volume to fluctuate based on market conditions. As a result, Zenith has endured premium declines of 18 percent and 21 percent in 2008 and 2007, respectively. Continued premium declines will further pressure Zenith’s expense ratio, which will be partially offset by the company’s recently announced workforce reduction.

Fitch Ratings has affirmed its Insurer Financial Strength (IFS) ratings for State Farm Mutual Automobile Insurance Company, State Farm Life Insurance Company and State Farm Life and Accident Assurance Company at ‘AA+’. The outlook on the ratings, however, is negative. Fitch said the outlook “reflects both State Farm’s exposure to equity markets and below average underwriting performance in its core markets. State Farm’s ratings could face downward pressure due to further deterioration in statutory surplus from investment losses or if underwriting losses continue at 2008 levels. State Farm statutory surplus declined by greater than $10 billion or 16 percent to $53 billion at Dec. 31, 2008 due primarily to unrealized losses on common equity securities. State Farm’s allocation to equity securities has historically been in excess of one-third of total invested assets and has exposed the company to significant volatility in its surplus account. In spite of the significant decline in surplus, State Farm’s capitalization remains strong whether measured by Fitch’s Prism capital model or by more traditional economic operating leverage ratios.” Fitch noted that “contributing to the fall in surplus was a $6.3 billion underwriting loss in 2008 that was heavily influenced by catastrophe losses. State Farm reported a 113 percent combined ratio for 2008 with catastrophe losses accounting for approximately 10 percentage points. Hurricanes Ike and Gustav accounted for only one-third of catastrophe losses in 2008, while Midwest storms during the first half of 2008 accounted for the majority of catastrophe losses. State Farm’s personal auto line of business reported a combined ratio of 109 percent, which is the third consecutive year of underwriting losses. The personal auto line represents nearly two-thirds of State Farm’s total premium. At the end of 2008, State Farm announced its exit from the Florida homeowners market after it failed to receive rate increases from the Florida Department of Insurance. The exit will take over one year to complete and strains an already difficult situation regarding homeowners insurance coverage in a catastrophe-prone state. This is not expected to affect State Farm’s ratings going forward.”

A.M. Best Co. has assigned a financial strength rating of ‘A-‘ (Excellent) and an issuer credit rating of “a-” to Restoration Risk Retention Group, Incorporated (RRRG) of Phoenix, Ariz., both with stable outlooks. “These rating actions reflect RRRG’s solid capitalization, risk management guidelines and favorable operating performance driven by very good underwriting results,” said Best. “Mitigating these positive rating factors are RRRG’s short history and limited business profile. Additional offsetting factors are RRRG’s financial leverage position, with a significant portion of the company’s surplus in the form of a clean letter of credit, and the execution risk associated with the implementation of the company’s business plan. Additional rating factors taken into consideration are the company’s fundamental business strategies, which include providing stable insurance coverage and quality service for its members. RRRG has a limited business profile as an insurer exclusively oriented toward one class of insureds. The company maintains a conservative operating strategy by limiting participation in its insurance program to member-insureds, thereby mitigating adverse selection risk. However, geographic diversification is adequate since RRRG is registered in 50 states and franchisees are spread throughout the United States. The insurance program provides general liability, pollution liability and excess coverage to segments of Servpro industry franchises. The company has consistently posted positive underwriting profits in its three years of operations. Its three-year projected financial operating results indicate favorable returns.”

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