CHICAGO--(BUSINESS WIRE)--Fitch Ratings has affirmed the 'A+' Insurer Financial Strength (IFS) ratings of Attorneys' Liability Assurance Society Ltd. (ALAS Ltd.) and Attorneys' Liability Assurance Society, Inc., A Risk Retention Group (referred to collectively as ALAS). The Rating Outlook is Negative.
KEY RATING DRIVERS
ALAS Ltd. re-domiciled to Vermont, from Bermuda effective Nov. 30, 2013. The principal accounting impact of the move related to income taxes including: the immediate recognition of a deferred tax expense of $109 million (the difference in a blended U.S. federal and state tax of 36% compared to 0% for Bermuda) and the establishment of a net deferred tax liability (DTL) of $103 million that will decline over the 11 years following the change in domicile. ALAS's members' net worth declined $116 million to $574 million at fiscal year-end 2013, principally due to the deferred tax expense.
Fitch believes ALAS's capitalization provides ample cushion against high-severity, low-frequency losses and the potential for adverse reserve development. Traditional metrics measured under GAAP, including operating leverage of 0.4x and net leverage of 2.4x at year-end 2013, were more conservative than statutory sector credit factors (SCF) medians for 'AA' IFS ratings of 1.1x and 3.5x, respectively.
ALAS's score on Fitch's Prism capital model was 'strong' at year-end 2013, the same result as 2012. Prism available capital (AC) is an accounting figure representing cash equivalent funds that are readily available under stressful conditions. As such, the establishment of a $103 million DTL in 2013 as a non-cash item did not impact the derivation of AC because Prism AC ignores both deferred tax assets and DTL.
Fitch expects ALAS to continue to protect and manage its capital position by addressing pricing considerations and loss experience.
Fitch views ALAS's exposure to reserve risk as high due to the nature of lawyers' professional liability (LPL) claims, but recognizes this risk has been conservatively and consistently managed. Adverse development of prior-period reserves improved to 2 points on the combined ratio in 2013, from 52 points in 2012 and 39 points in 2011 and was primarily due to higher claims severity in two policy years. In contrast, reserve development was strongly favorable for 2002 - 2010 averaging 20 points annually.
ALAS's accident year combined ratios (AY-CR) improved to 113.7% in 2013 from 126.2 in 2012. While varying from year to year, ALAS' AY-CRs, including member premium credits, have been very consistent over long periods, averaging 117.8%, 113.1%, and 117.0% over the five-year, 10-year, and 20-year time periods ending 2013. The standard deviation of the AY-CR declined to 5.8%, 9.5% and 16.4% for the five-year, 10-year, and 20-year periods, respectively, as the premium credit mechanism is used to reflect loss experience and to protect and manage capital. ALAS has not paid premium credits to its members since 2010.
Fitch believes that ALAS's reserve development trends in 2011 and 2012 do not reflect a fundamental or systematic change and other LPL providers have experienced similar results. Thus continued improvement in reserve development trends and the AY-CR over the next several quarters could result in a return to a Stable Rating Outlook.
Rating strengths also include ALAS's sustainable competitive positioning with superior business retention that is derived through its service orientation to member law firms in loss prevention and claims management. A high-quality, fixed-income portfolio provides sufficient liquidity to meet policyholder obligations.
Ratings concerns are focused on business concentration risks. As a monoline LPL insurer, ALAS is reliant on a single market characterized by low-frequency/high-severity claims and higher-than-average reserve risk and capital volatility. An above-average exposure to equity and alternative investments at 60% of members' net worth is an additional source of capital volatility.
Key rating triggers that could lead to a downgrade include continued adverse reserve development similar in level to 2011 and 2012, a deterioration of net leverage to greater than 2.5x based on U.S. statutory statements, and a material and sustained deterioration in the Prism score and/or membership base.
Key rating triggers that could lead to a return to a Stable Rating Outlook include growth in members' net worth and strong evidence that adverse reserve development experience has subsided and that recent rate increases are promoting improved accident year results.
Additional information is available at 'www.fitchratings.com'.
Applicable Criteria and Related Research:
--'Insurance Rating Methodology' (Nov. 13, 2013).
Applicable Criteria and Related Research:
Insurance Rating Methodology