S&P Affirms USAA Ratings; Outlook Stable

January 7, 2004

Standard & Poor’s Ratings Services affirmed its ‘AAA’ counterparty credit and financial strength ratings on United Services Automobiles Assoc., USAA Casualty Insurance Co., and USAA General Indemnity Co. (collectively referred to as USAA).

At the same time, Standard & Poor’s affirmed its ‘AAA’ long-term counterparty credit rating on USAA Capital Corp. In addition, Standard & Poor’s affirmed its ‘AAA’ counterparty credit and financial strength ratings on USAA Life Insurance Co. and USAA Life Insurance Co. of New York, as these entities are considered core to the parent company. The outlook on all these companies is stable.

The ratings are based on USAA’s extremely strong (though lower than historical levels) capital adequacy, extremely strong business position, better-than-industry-average liquidity, and improved operating performance. USAA’s investment portfolio allocation is also a positive rating factor, as the company has sold all its common equity holdings as of August 2002, so it has less investment risk than its peers.

Offsetting these positive factors are USAA’s nationwide insurer geographic spread and financial flexibility, which are narrower than would normally be expected. This is because of the higher concentration of USAA policyholders in areas exposed to catastrophic losses from natural events and because USAA’s structure as a reciprocal insurance exchange limits its access to the capital markets compared with stock companies.

The USAA family of companies is headed by the ultimate parent, United Services Auto Assoc., a reciprocal interinsurance exchange that provides auto and homeowners insurance, primarily to U.S. military officers and noncommissioned officers. Its rated insurance affiliates include USAA Casualty Insurance Co., which writes similar insurance, mainly for children of members, and USAA General Indemnity Co., which writes nonstandard auto coverages for the membership. The companies provide a wide range of insurance and financial products, including property/casualty, health, and life insurance; annuities; no-load mutual funds; discount brokerage services; credit cards; banking; and alliance services.


USAA has a leadership position within personal lines. Increased rates will have a favorable effect on earnings, as industry pricing adequacy continues to improve, although at a slower pace than in 2003. As a result, USAA’s operating results are expected to increase further in 2003 and 2004. USAA’s combined ratio in 2003 is projected to be 87%-90% (excluding policyholder dividends), which is significantly better than the personal lines peer group at 99%-100%. USAA’s more conservative investment allocation, with an increased bond weighting, will lead to liquidity that is better than industry averages. Standard & Poor’s expects USAA’s capital adequacy to remain extremely strong.

Major rating factors

— Extremely strong business position. USAA enjoys a unique and extremely strong position among members of the U.S. military and certain other groups that are units of the U.S. government and their families. This group, to which USAA’s products and services are restricted, has demonstrated very strong risk characteristics. This enables USAA to provide financial services to these people on very attractive terms while reaping the resulting benefit of perhaps the best persistency of any insurer of any material size and still realizing excellent underwriting results. USAA’s extremely strong business position supports its leadership status. It ranks seventh and fifth within personal auto and homeowners, respectively, with a market share of about 3.3% of the personal auto market and 3.6% of the homeowners market based on direct premiums written in 2002.

— Strategy. For years, management has pursued a strategy of providing for almost all the financial needs of its policyholders. This strategy, which was being pursued with the full resources of USAA before stock insurers had started to follow similar paths, has enhanced persistency and promoted better loss development. It has also facilitated the group’s fundamental goal of providing good value to its members.

— Extremely strong capitalization. USAA’s consolidated capital adequacy is viewed as extremely strong, with a capital adequacy ratio of 266.6% at year-end 2002. The capital adequacy ratio for year-end 2003 is expected to be about the same. The decline from prior year highs stems from increased premium rates, which translate into higher required capital, along with policyholder dividends paid that mitigate earnings growth. Unrealized losses and premium growth have led USAA’s historically higher excess capital to decrease each year since 330.7% in 1998. However, USAA does possess capital adequacy above the personal lines peer group average, which was estimated at 158% through September 2003.

— Conservative investments with above-average liquidity. USAA’s investments and liquidity are viewed as extremely strong. Before 2002, USAA had a moderately more aggressive investment allocation than its peers. However, in the third quarter of 2002, the company sold the equity portion of its property/casualty portfolio and realized a significant loss. This change eliminated USAA’s exposure to equity market volatility and any effect on its capital base. USAA maintains liquidity well above that of its peer group, as demonstrated by underwriting cash flow of 114.1% in 2002 compared with 104.8% for the peer group. USAA’s better-than-industry-average liquidity is a result of better underwriting and expense control.

— Policyholder dividends. USAA has historically paid policyholder dividends, and this financial strategy is expected to continue. However, management will only pay policyholder dividends consistent with its business position, while maintaining excess capital adequacy. The decrease in operating performance and investment losses led USAA to lower its policyholder dividend in 2000 and 2001. USAA will not pay large dividends that bring capital adequacy to levels inconsistent with the rating. The ratio of policyholder dividends to surplus averaged 5% from 2000-2003.

— Downstream holding company. USAA Capital Corp. is the downstream holding company of USAA, providing product breadth by offering mutual funds, banking, and credit cards through its various entities. USAA Capital Corp. is very conservative financially, as demonstrated by a debt-to-capital ratio projected at 18% (including bank and real estate debt) and 0% (insurance operations only) in 2003. Furthermore, interest coverage is consistent with the ratings.

— Improving operating performance. The group’s operating returns over the last five years have been somewhat volatile because of increasing loss costs, a competitive environment, catastrophe losses, and the payment of policyholder dividends. Management has implemented various corrective actions to bolster the group’s operating results, which included rate increases where appropriate, further refining its underwriting capabilities with additional risk segmentation, and further increasing efficiency through staffing reductions and reallocations. Underwriting performance improved to 98.8% in 2002 from 103.5% in 2001 as a result of overall price increases, broader market segmentation, and more disciplined catastrophe-management strategies. Operating performance continued to improve through the third quarter of 2003, with the combined ratio decreasing to 87% (excluding dividends). Standard & Poor’s believes operating performance will further improve as USAA continues benefits from rate increases and other underwriting actions, including expense reduction to sustain the level of profitability.

— Financial flexibility. USAA’s financial flexibility is viewed as a slight weakness to the rating. USAA is established as a reciprocal organization, so it is more limited than stock companies in its ability to obtain external financing. As a result, USAA has implemented a surplus and liquidity recovery plan to ensure that it can recover its financial positions after a major loss. United Services Automobile Assoc., USAA’s parent and flagship company, can contribute earnings in excess of what it needs to support its individual operations and chooses to pay out in policyholder dividends or subscriber savings accounts for its policyholders. Reinsurance utilization, temporary suspension or delay of subscriber savings account distributions and policyholder dividends, capital market borrowings, and borrowings from affiliated entities offer increased financial flexibility.

— Some geographical concentration. USAA’s spread of risk is narrower than one would normally expect from a nationwide insurer of USAA’s very large size because the parent’s policyholders are mostly either active duty or retired military personnel who often live in areas exposed to catastrophic losses from natural events. However, management comprehensively mitigates potential losses with methods including reinsurance, bonds issued to investors in the capital markets that assume high-level catastrophic risk, and membership in risk-dispersion and -moderation schemes sponsored by the governments of Florida and California, two of the states most prone to these heavy losses.Ratings List United Services Automobiles Assoc.USAA Casualty Insurance Co.USAA General Indemnity Co. Counterparty credit rating AAA/Stable/– Financial strength rating AAA/StableUSAA Capital Corp. Counterparty credit rating AAA/Stable/A-1+ Senior debt rating AAA Commercial paper rating A-1+USAA Life Insurance Co.USAA Life Insurance Co. of New York Counterparty credit rating AAA/Stable/– Financial strength rating AAA/Stable

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