Best Removes Berkshire Companies from ‘Under Review;’ Affirms Ratings

A.M. Best Co. has issued three separate bulletins announcing that it has removed a number of Berkshire Hathaway’s insurance companies from the “under review with negative implications” status it announced in November.

The companies directly affected are:
Seaworthy Insurance Company
United States Liability Insurance Group, which includes Mount Vernon Fire Insurance Company, U.S. Underwriters Insurance Company and United States Liability Insurance Company
North American Casualty Group, which includes California Insurance Company and Continental Indemnity Company

Companies indirectly affected are:
Berkshire Hathaway
National Indemnity
Applied Underwriters

In each case Best explained that it had “placed the ratings on all rated members of Berkshire Hathaway Inc. under review with negative implications as a result of the Berkshire acquisition of the remaining 77 percent of Burlington Northern Santa Fe (BNSF) railroad, which was not already owned.”

The under review status reflected Best’s concerns “regarding the potential utilization of Berkshire’s insurance and reinsurance operations as a funding source for the transaction given the size of the acquisition.” Best also expressed concern “with the potential liquidity impact on some of the insurance and reinsurance operations given their exposure to high severity events.”

However, Best has now indicated that, following a review of Berkshire’s financial position and the completion of the acquisition, its “concerns have been largely mitigated or resolved.”

Best affirmed Maryland-based Seaworthy’s financial strength rating of ‘A+’ (Superior) and issuer credit rating of “aa,” both with stable outlooks. Best said the “ratings reflect Seaworthy’s strong capitalization, historic underwriting profitability indicative of management’s niche ocean marine expertise and the implicit and explicit financial support provided by the ultimate parent, Berkshire, and a Berkshire subsidiary in the form of two significant reinsurance transactions.”

The bulletin also noted the reinsurance transactions “include a loss portfolio transfer and quota share agreement between Seaworthy and National Indemnity Company, which acquired Seaworthy’s immediate parent, Boat America Corporation, in August 2007. In addition to Berkshire’s track record of supporting its member companies, these transactions demonstrate in effect the explicit commitment provided by Berkshire, for which Seaworthy receives rating enhancement.”

However, Best expressed some concern with Seaworthy’s “product and revenue concentration, as well as the recent deterioration in operating performance. But the bulletin also indicated that “despite these factors, the outlook is based upon Seaworthy’s enhanced financial flexibility, strong balance sheet, as well as Best’s “expectation of improvement in underwriting results to more historic levels.”

Best affirmed US Liability’s ‘A++’ (Superior) financial strength rating and issuer credit rating of “aa+” also with stable outlooks. The ratings also apply to the Group’s members, as listed above.

Best said the ratings reflect the Group’s “strong capitalization, outstanding long-term operating profitability and the advantages derived from management’s proven underwriting discipline, as well as “the implicit and explicit financial support provided by its ultimate parent, Berkshire, and the added financial flexibility afforded by a Berkshire subsidiary as demonstrated in 2007.”

Best explained that on that date each member of the group entered into a 50 percent loss portfolio transfer agreement and a 50 percent quota share reinsurance agreement with Berkshire’s affiliate National Indemnity. “The effect of these transactions led to a substantial reduction in the group’s underwriting leverage, which then helped to facilitate the extraordinary stockholder dividend taken that year,” Best noted.

As “offsetting factors,” Best cited US Liability’s “high investment leverage exhibited by the level of unrealized gains and losses reported in 2008 and 2009 due to the global financial crisis, the asset concentration risk associated with a limited number of common stock holdings and multiple notes held by one issuer, and the group’s dependence on a single method of distribution source, the professional wholesaler.”

Best affirmed the financial strength rating of’ ‘A’ (Excellent) and issuer credit ratings of “a” of North American Casualty Group (NAC), whose members, as listed above, operate under a pooling arrangement, all with stable outlooks.

As with the other Berkshire companies, Best said the ratings reflect the group’s “strong capitalization and the favorable historical underwriting performance of business produced by its parent, Applied Underwriters, Inc. (Applied), a leading provider of bundled workers’ compensation insurance and payroll processing services to small and medium-sized businesses. The ratings also acknowledge management’s conservative operating philosophy, along with its strategic business plans and projections that call for near-term earnings and capital accumulation.”

Best also indicated that it “anticipates that Applied will continue to support NAC with additional capital contributions as necessary, allowing the group to maintain a level of risk-adjusted capitalization that remains supportive of its rating. Lastly, the ratings also recognize the additional financial flexibility and support provided by its publicly traded ultimate parent, Berkshire Hathaway Inc.”

However, Best also noted the positive factors are somewhat offset by NAC’s limited operating experience and the significant deterioration in the group’s underwriting results in 2009 driven by several large losses. Additionally, NAC has significant business concentration risk, operating predominately as a workers’ compensation insurer with limited geographic spread that exposes operations to potential regulatory, judicial, legislative and competitive risks.”

Source: A.M. Best