Standard & Poor’s assigned its ‘BBB+’ counterparty credit rating to 21st Century Insurance Group and assigned its ‘BBB+’ senior debt rating to TW’s proposed $100 million 10-year note issuance, of which $85 million is expected to be contributed to the operating subsidiaries.
At the same time, Standard & Poor’s affirmed its ‘A+’ counterparty credit and financial strength ratings on operating units 21st Century Insurance Co. and 21st Century Casualty Co. (collectively referred to as 21st Century).
The outlook is negative.
The financial strength and counterparty credit rating on 21st Century is based on the company’s strong business position in its core California personal auto market, extremely strong capital, strong operating performance of the core personal auto line and its status as a nonstrategic, majority-owned subsidiary of American International Group Inc. (AIG). The rating also reflects the business risk of pursuing rapid growth of the personal auto book in California, completion of IT system development work, settlement of the remaining SB1899 Northridge earthquake claims, and the geographically concentrated monoline business profile.
The ‘BBB+’ rating on the parent company, 21st Century Insurance Group and its $100 million debt issuance is supported by consolidated financial leverage and interest coverage of 20 percent and more than 8x, respectively.
21st Century is expected to post excellent accident-year auto results in 2003 and 2004 with a combined ratio of about 97 percent. The potential for less profitable growth, higher than expected settlement costs for SB 1899 earthquake claims, and unanticipated additional IT expenses, however, could diminish profitability. Revenue is expected to grow by 26 percent and 20 percent in 2003 and 2004 respectively with growth declining to a more modest level in 2005. California will provide most of the 2004 growth but with an increasing amount coming from outside of California in subsequent years. Capitalization, bolstered by the prospective $85 million capital contribution from the holding company is expected to improve to more than 235 percent in 2003 and remain more than 215% in 2004 as strong operating earnings are offset by rapid growth.
Consolidated financial leverage is expected to be less than 20 percent with interest coverage exceeding 8x. If the company is successful in profitably growing its business, and the Northridge and systems implementation issues are resolved without further material adverse development, Standard & Poor’s will revisit the outlook. Conversely, if the rapid business growth or Northridge claim development or IT system implementation materially strain earnings and/or capitalization, Standard and Poor’s will consider lowering the rating.
Major rating factors
— Strong business position. 21st Century is the seventh-largest writer of private passenger auto insurance in California with $894 million of California premiums through September 2003 constituting an estimated 6 percent of the California market. This business position is supported by 21st Century’s high-feature policies that are competitively priced and serviced through its relatively low-cost infrastructure.
— Extremely strong capital. The group’s capital adequacy ratio, based on Standard & Poor’s risk-based capital adequacy model for property/casualty insurers, was 210 percent as of year-end 2002, which is considered to be extremely strong.
— Strong personal auto operating performance. 21st Century operates entirely as a direct writer of personal automobile insurance. Despite heavy strengthening of 2000 and prior accident-year reserves in 2001, it has a consistent record of posting better auto results than the average of its competitors. Measured on a GAAP basis, the combined ratio of 96.8 percent through September 2003, is an improvement compared with 98.5 percent in calendar year 2002 and 103.0 percent in 2001.
— AIG ownership. Standard & Poor’s does not consider 21st Century to be strategically important to AIG. Therefore, Standard & Poor’s limits the benefit of AIG’s majority ownership to one ratings notch; however AIG’s 21st Century board members include the head of AIG’s personal lines business, AIG’s chief financial/administrative officer, and AIG’s general manager of direct personal lines marketing for Japan and Korea. 21st Century recently cut its dividend (AIG being the main recipient) from 8 cents per quarter to 2 cents in the fourth quarter of 2002.
— Rapid growth strategy. The company has pursued a rapid growth strategy resulting in direct written premiums increasing by 26 percent to $918.7 million for the nine months ended Sept. 30, 2003. A significantly enhanced direct sales force, combined with enhanced advertising has recently initiated targeted Latino marketing, Internet sales and a newly activated nonstandard auto line previously sold as an accommodation to current customers. Although recent data suggests that the profitability of the new business is consistent with the current customer base, the potential exists, even with the company’s significant pricing and underwriting controls in place, that the new business will not develop as expected. Vehicles in force has grown to nearly 1.4 million vehicles as of September 2003 compared with less than 1.1 million vehicles insured in June 2002 and slightly more than 1.2 million vehicles insured in January 2000. The relatively high retention rate of the nonstandard auto business raises Standard & Poor’s concern of adverse selection, particularly given the company’s limited experience in writing this business. Although Standard & Poor’s draws some comfort from management’s assertion that its 96 percent combined ratio target is more important than the 20% business growth projection for 2004 and that they would respond to adverse loss development by curtailing new business, Standard & Poor’s is concerned that the company’s growth might be from less profitable business.
— IT system implementation. In 2002, the company recorded a $37.2 million charge to write-off previously capitalized software costs for abandoned portions of its software initiative. Although the company has successfully developed replacement modules to replace the abandoned modules, the potential exists, despite the company’s proactive testing initiatives, that additional implementation expenses and/or future write-offs could exist. As of Sept. 30, 2003, management has estimated that $73 million in currently capitalized costs and $35.6 million in future costs are recoverable in cost savings from future operations. The successful implementation of this software initiative would further enhance the company’s competitive cost structure.
— SB 1899 earthquake claim development. Earnings were adversely affected in 2001 through 2003 by California legislation allowing the reopening of claims from the 1994 Northridge earthquake. In 1994, the Northridge earthquake virtually bankrupted 21st Century, which was then a writer of homeowners’ (the company withdrew completely from homeowners insurance in January of 2002) as well as auto insurance. Standard & Poor’s believes that the $157 million in reserves established subsequent to 2000 (of which $28.6 million remains outstanding as of September 2003) to cover the new claims could be adequate, but additional development ($37 million of adverse development was reported in 2003) is possible.
— Business concentration in California. Although management has plans to expand outside of California, about 97.7 percent of premiums written for the nine months ended Sept. 30, 2003, were personal auto premiums in California (70 percent in Southern California). This exposes nearly all of the company’s business to changes in the California competitive, regulatory, economic, legislative, and legal environment that compared with more diverse competitors, would have a disproportionate effect on the company. Ratings List To From 21st Century Insurance Co. 21st Century Casualty Co. Counterparty credit rating A+/Negative/– A+/Negative/– Financial strength rating A+/Negative/– A+/Negative/– 21st Century Insurance Group Counterparty credit rating BBB+/Negative/– Senior debt rating BBB+.
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