A.M. Best Co. has placed the financial strength rating of A- (Excellent) of National Service Contract Insurance Company RRG (NSC) (Hawaii) under review with negative implications. The status will remain pending the results of an independent actuarial analysis of the Loss Reserve Fund (LRF) at Interstate National Dealers Service (INDS), the parent company.
The independent actuarial analysis, at the behest of A.M. Best,
follows the reduction of shareholders’ equity after INDS’ privatization in January 2003. To fund the buy-out of INDS’ existing shareholders, it liquidated 70 percent of its retained earnings and invoked bank debt. INDS’ financial leverage at fiscal year-end 2003 is elevated at 2.3 to 1, due to debt incurred. Management believes leverage will decline to around 1.1 to 1 by the fiscal year-end 2006, which is a level more in line with an Excellent rating.
NSC provides aggregate stop-loss contractual liability coverage on
vehicle service contracts issued by INDS. In the event of an overall
inadequacy of the LRF at INDS for all years combined, NSC could then incur a claim. Management believed that at fiscal year-end October 2002 the LRF was more than sufficient. NSC remains well capitalized for its Excellent rating based on its current level of reserves. However, capitalization of NSC will not be apparent until the completion of INDS’ actuarial analysis.
A.M. Best will reevaluate NSC’s rating at the completion of the
actuarial analysis. Regardless of the results, there remains negative
pressure on the rating given INDS’ decreased stockholders’ equity and debt burden, which increases the chance that NSC’s capital may be used for either claim or debt payments. INDS is projected to generate earnings over the next five years, which will comfortably allow for the repayment of debt.
Additionally, despite pledging assets of NSC as collateral for the
debt, management has stated it will not utilize the funds at NSC to pay either interest or principal.
In A.M. Best’s opinion, management will be challenged to demonstrate consistent, quality earnings and cash flow due to recent lower operating results, current economic and investment conditions and a competitive auto warranty environment.
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