CHICAGO--()--Fitch Ratings has affirmed the 'BBB' Issuer Default Rating (IDR) of Tower Group, Inc. (Tower) and the 'A' Insurer Financial Strength (IFS) ratings Tower's operating subsidiaries. A full list of ratings follows at the end of this release. The Rating Outlook is Stable.
The rating rationale considers Tower's historical profitability and expectations of a reversion towards previous profit levels in the near future; the company's multi-tiered approach to underwriting; history of modest reserve development; and a well-diversified investment portfolio that has an average credit rating of 'A+'.
Also factored in to Fitch's rating rationale is the company's appetite for growth, complex organizational structure, and an elevated catastrophe profile given the company's concentration in New York, New Jersey, and Massachusetts markets where approximately 70% of total direct written premiums are derived.
Fitch recognizes that historical catastrophe losses have been modest at Tower, but Hurricane Sandy and Hurricane Irene produced significant pretax net catastrophe related losses of approximately $110 million and $52 million respectively. Tower's geographical concentration of Northeast property related premiums leaves the company more susceptible to tail event risk than most peers. In particular, in a large catastrophe event Tower is heavily dependent on reinsurers in its catastrophe program providing timely payments.
Adverse reserve development has historically been modestly favorable at Tower. However, Tower took $70.9 million in pretax reserve strengthening for first nine months of 2012. The majority of the reserve development comes from commercial insurance in accident years 2009 - 2011 and pertain to various programs, most of which have been terminated.
Fitch notes that the reserve development is outside of ratings expectations and coupled with Hurricane Sandy losses is of sufficient magnitude to cause financial leverage and interest coverage downgrade triggers to be met. Fitch anticipates that Tower will reverse this trend over the next 12 - 18 months through profitable operations and possibly from capital raise related to merger in Canopious Holdings Bermuda Limited.
Tower, including the reciprocal exchanges it manages, reported a GAAP calendar year combined ratio of 102.2% and an accident year combined ratio of 96.8% for the nine months ended Sept. 30, 2012.
Despite completing nine acquisitions over the last nine years, Fitch notes that half of Tower's transactions generated no or negative goodwill. Tower's debt to capital and debt to tangible capital ratio was 31% and 41% respectively at Sept. 30, 2012. Fitch notes that with the change in the agency's rating criteria, Tower's hybrid debt securities no longer receive any equity credit. Earnings based interest coverage was 2.5x at Sept. 30, 2012, compared with 3.6x for full year 2011.
Fitch will carefully monitor Tower's progress to see if historical trends of profitability and leverage will be maintained. To the extent that each year has significant one-off items, Fitch would have concerns that this is a long term performance issue rather than temporary blips and ratings would likely be downgraded at least one notch.
In late April 2012, Tower invested approximately $75 million to acquire a 10.7% stake in Canopius Group, Ltd (Canopius) the ultimate parent of Canopius Holdings Bermuda, Ltd (Canopius Bermuda), subject to an acquisition of Omega Insurance Holdings Limited (Omega) by Canopius which closed on Aug. 20, 2012. In late August Tower filed an S-4 with the SEC regarding Tower's merger with Canopious Holdings Bermuda Limited (CHBL).
Fitch views this transaction as potentially favorable if executed properly as it creates a larger, more geographically diverse business platform with access to three major insurance markets: U.S., Bermuda, and the Lloyds markets, in addition to an international holding company. This broader diversification is expected to enhance profitability and provide a sufficient source of capital to support Tower's US growth.
This structure will allow Tower to take advantage of the lower tax rate afforded by the holding company's Bermuda domicile. Similar to many Bermuda (re)insurers, this approach exposes Tower to any changes in U.S. tax laws that would reduce or eliminate tax advantages on business generated in the U.S. but reinsured to affiliated offshore companies.
Fitch recognizes that this transaction is subject to several approval stages and can still be terminated by Tower at will. However, Fitch anticipates that this transaction will likely close in the next few months. Fitch will review all current ratings if any transaction is announced.
The following is a list of key rating triggers that could lead to a downgrade:
--Sustained financial leverage above 30% or a sustained decline in operating earnings-based coverage below 6 - 7x range;
--Adverse reserve development in excess of 5% of prior year surplus;
--Material deterioration in capital adequacy levels as measured by traditional operating leverage ratios, risk-based capital, and Fitch's Prism capital model;
--Any large acquisition, defined as approximately 25% - 30% of Tower's net written premium, in the near term or an acquisition that does not complement Tower's current underwriting platform.
The following is a list of key rating triggers that could lead to an upgrade:
--Material improvement in the company's catastrophe profile;
--Sustained strong profitability and internal capital formation, especially relative to peers at the current rating level and the industry aggregate, over the business cycle.
Fitch has affirmed the following ratings with a Stable Outlook:
Tower Group, Inc.
--Issuer Default Rating (IDR) at 'BBB';
--5% senior convertible debt rating at 'BBB-'.
Tower Insurance Company of New York
Tower National Insurance Company
Preserver Insurance Company
CastlePoint National Insurance Company
York Insurance Company of Maine
Hermitage Insurance Company
CastlePoint Florida Insurance Company
North East Insurance Company
Massachusetts Homeland Insurance Company
CastlePoint Insurance Company
Kodiak Insurance Company
--Insurer Financial Strength (IFS) ratings at 'A-'.
Additional information is available at 'www.fitchratings.com'. The ratings above were solicited by, or on behalf of, the issuer, and therefore, Fitch has been compensated for the provision of the ratings.
Applicable Criteria and Related Research:
--'Insurance Rating Methodology' (Jan. 11, 2013).
Applicable Criteria and Related Research:
Insurance Rating Methodology -- Amended