Ratings: Western, Hanover (debt), Public Service/Magna Carta, First Hawaii

March 2, 2010

A.M. Best Co. has downgraded the financial strength ratings to ‘B++’ (Good) from ‘A-‘ (Excellent) and issuer credit ratings to “bbb” from “a-” of Western Insurance Company (WIC) and Western Bonding Company (WBC), both of Reno, Nevada, and has revised the outlook on the ratings to negative from stable. Best said the rating actions follow the “analysis of WIC’s underwriting exposure to a sister company, Western Thrift and Loan, Inc. (WTL), which was placed under a cease and desist order by the State of Nevada Department of Business and Industry Financial Institutions Division in October 2009.” Best added that the rating actions also “reflect the impact from the economic downturn in the construction industry and the significant underwriting losses and cash outflows associated with the group’s California subdivision bonds. An additional factor is management’s recent diversification of WIC’s bond offerings to include bail bonds in California, a program undertaken with due diligence but requiring monitoring for execution risk. While management has responded to all of the points in the cease and desist order, there is still significant uncertainties regarding the ultimate impact on WTL and WIC, which insures WTL’s certificates of deposit. Per management, this exposure is being aggressively managed downward during 2010.” As “mitigating factors” Best cited the “contractual requirement for WTL to reimburse any loss payments by WIC, with certain real estate assets and auto loans currently held by WTL, as well as access to additional funding primarily through existing bank lines of credit and funds available from a non-insurance affiliate. WIC’s risk-adjusted capitalization, as measured by Best’s Capital Adequacy Ratio, would still be adequate should the bond be triggered. In addition, should WTL fail, its principal shareholders and those of WIC, may encounter some liquidity issues, which could put pressure on WIC and WBC.”

Standard & Poor’s Ratings Services has assigned its ‘BBB-‘ senior debt rating to The Hanover Insurance Group Inc.’s (THG) proposed issue of approximately $200 million at 7.50 percent coupon senior unsecured notes, which are due on March 1, 2020. S&P also noted that the ‘BBB-‘ counterparty credit rating on THG and the ‘A-‘ counterparty credit and financial strength ratings on THG’s operating companies (collectively referred to as Hanover) are unaffected. The outlook on all of these companies remains stable. “THG will use the net proceeds of the issue for general corporate purposes, including improving financial flexibility, strategic growth by way of organic or acquisitions, and share repurchases,” S&P acknowledged. The rating agency also explained that the “ratings reflect Hanover’s strong competitive position, the successful execution of management’s strategy to refocus the company on its property/casualty business, improved operating performance, and a very strong capital position.” S&P said it expects that this issue “will result in estimated leverage of about 23 percent and fixed-charge coverage of approximately 6x on a pro forma basis for year-end 2009. During the past few years, Hanover’s underwriting results have improved, and they remain stable relative to peers’ and the industry average. Nevertheless, its geographic concentration and relatively high expense structure remain weaknesses and limiting rating factors.” S&P also indicated that it expects Hanover’s underwriting performance to “remain good in 2010 and begin benefiting more from the company’s technological, staffing, and catastrophe-management improvements. We expect that the GAAP combined ratio–excluding catastrophe losses and prior-year reserve development–will remain at less than 97 percent.” Nevertheless, S&P added, it believes the company will “underwrite cautiously and preserve its capital cushion, which remains very strong. In light of that, we expect premiums written to increase at a mid-single-digit rate. In addition, we expect the holding company’s financial leverage to remain appropriate for the rating at less than 30 percent in 2010 and GAAP fixed-charge coverage to remain at more than 5.5x. Including this new issuance, we expect that the company’s capitalization, liquidity, and competitive position will remain consistent and strong. Deviation from this could cause us to consider a downgrade, though we do not expect this to occur. We also do not expect to raise the rating in the intermediate term because of the factors that limit the group’s competitive position, such as its geographic concentration and relatively high expense structure.”

Standard & Poor’s Ratings Services today has revised its outlook on New York-based Public Service Mutual Insurance Co. and its wholly owned affiliates–Paramount Insurance Co. (NY) and Western Select Insurance Co. (collectively, Magna Carta)–to negative from stable. S&P also affirmed its ‘BBB’ counterparty credit and financial strength ratings on the companies. “Our outlook revision reflects concern about Magna Carta’s operating performance in 2009, which was weaker than our expectations,” explained credit analyst Michael Gross. “An above-average level of claims activity, partially a result of poor weather conditions, and unfavorable prior-year reserve development primarily in the company’s workers’ compensation line of business hurt the company’s underwriting performance during the year. The company’s 2009 combined loss and expense ratio was 126.8 percent, compared with our expectation of approximately 100 percent.” In addition, S&P noted the “ongoing court actions surrounding Magna Carta’s 2008 acquisition of California-based Business Alliance Insurance Co.,” adding that it constitutes “somewhat of a distraction and creates some uncertainty for management at a time when economic and industry conditions are challenging. S&P explained that “Magna Carta is a mutual insurance organization providing competitive workers’ compensation and commercial multiperil insurance products to small to midsize businesses in a number of states.” S&P said it expects” premium growth to be flat to slightly negative in 2010 given the competitive pricing of commercial insurance. We expect Magna Carta to demonstrate improved underwriting performance in 2010, with a combined loss and expense ratio of approximately 105 percent, excluding any catastrophe losses. During 2010 and into 2011, we expect the company’s performance to become more closely aligned with the industry’s average performance. We expect the organization to generate an expense ratio of 34 percent-36 percent and positive operating cash flow. Capital will remain very strong, as measured by our capital adequacy model.”

A.M. Best Co. has affirmed the financial strength rating (FSR) of ‘A’ (Excellent) and issuer credit ratings (ICR) of “a” of First of Hawaii Group and its members. The outlook for all ratings is stable. The ratings reflect the group’s “strong risk-adjusted capitalization, strong overall earnings profile and sound localized market presence as a leading insurance provider in Hawaii,” said Best. “Somewhat offsetting these positive rating factors are the group’s concentration risk as a single state insurer, its potential exposure to catastrophe losses, slightly elevated common stock leverage and the current weak economic conditions and highly competitive environment in its marketplace.” Best pointed out that the group’s strengths are “derived from its local brand name recognition, well-established agency relationships, local market expertise and diverse product portfolio. These strengths are partially offset by a geographically concentrated book of business, which exposes the group to regulatory and catastrophe risk. Management has taken an active role in monitoring its catastrophe exposure and mitigating this risk through disciplined underwriting and extensive reinsurance protection. As a result, the group’s net catastrophe exposure is at a manageable level. In addition, through its recent partnership with Argo Group US, Inc. to provide hurricane coverage to the majority of its existing personal lines insureds, the group’s gross hurricane exposure was significantly lowered in 2008 and 2009. The group also benefits from the operational and financial support of its ultimate owners, CNA Financial Corporation and Tokio Marine & Nichido Fire Insurance Co., Ltd.”

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