Fitch Ratings has affirmed the 'BBB' Issuer Default Rating (IDR) of
Tower Group, Inc. (Tower). Fitch has also affirmed the Insurer Financial
Strength (IFS) ratings of Tower's operating subsidiaries at 'A-'. A full
list of rating actions follows at the end of this release. The Rating
Outlook is Stable.
Tower pre-announced earnings for the second quarter today, which
included expectations of unfavorable reserve development of $42.3
million after tax that will lead to an operating loss for the quarter.
In addition Tower announced that the company has exercised its option to
combine with the Bermuda reinsurance business currently operated by
Canopius Holdings Bermuda, Ltd (Canopius Bermuda).
The unfavorable reserve development was outside of previous expectations
and of significant magnitude to cause financial leverage and interest
coverage downgrade triggers to be met. Pro forma estimates for Tower's
half year 2012 results are that financial leverage will be approximately
30-32% from a previous 29% and that earning based interest coverage will
range from 1-2 x versus a previous 4.7x. Fitch believes that full year
earnings should promote a decline in the financial leverage ratio to
below 30%, but notes that interest coverage will be below expectations
on a stated basis and in line on a run-rate basis.
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 significant one-time items continue to mar profitability,
Fitch would have concerns that this is a long-term performance issue
rather than unusual instances.
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. At
this time, Tower entered into an agreement with Canopius to assist Tower
with establishing a presence at Lloyd's of London and granting Tower an
option to combine with the Bermuda reinsurance business currently
operated by Canopious.
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, and an international holding company. This
broader diversification is expected to enhance profitability and provide
a sufficient source of capital to support Tower's U.S. growth.
This structure will allow Tower to take advantage of the lower tax rate
afforded by the holding company's Bermuda domicile and it is similar to
the structures employed by many of its Bermuda-based competitors.
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
Fitch recognizes that this transaction is subject to several regulatory
steps and can still be terminated by Tower at will. Fitch will evaluate
any changes to the transaction as they are announced. Tower estimates
that this transaction could close by the end of this year.
The rating rationale for the affirmation continues to include Tower's
solid historical profitability, multi-tiered approach to underwriting,
history of modest reserve development, and a well diversified investment
portfolio that has an average credit rating of 'AA-'.
Also factored in to Fitch's rating rationale are the company's appetite
for growth via acquisitions and an elevated catastrophe profile given
the company's concentration in New England and New York markets where
approximately 70% of total net written premiums are derived.
While historical catastrophe losses have been modest, Tower's
geographical concentration of Northeast property related premiums leaves
the company more susceptible to tail event risk than most peers.
Additionally, in a large catastrophe event Tower is heavily dependent on
reinsurers in its catastrophe program providing timely payments.
The following key rating triggers could lead to a downgrade:
--Inability to quickly improve financial leverage below 30% or a
sustained decline in operating earnings-based coverage below 6-7x range;
--Continued adverse reserve development relative to peers and industry
--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 key rating triggers 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.
--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
--IFS ratings at 'A-'.
Fitch has withdrawn its 'A-' rating on the Mountain Valley Indemnity
Company since the entity is no longer part of Tower Group.
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' (Sept. 22, 2011).
Insurance Rating Methodology
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Fitch RatingsPrimary AnalystGerald B. Glombicki, CPA, +1
312-606-2354DirectorFitch, Inc.70 West Madison St.Chicago,
IL 60602orSecondary AnalystJames B. Auden, CFA, +1
312-368-3146Managing DirectororCommittee ChairpersonAndy
Davidson, CFA, +1 312-368-3144Senior DirectororMedia
Relations:Brian Bertsch, +1 212-908-0549Email: email@example.com
Source: Fitch Ratings