Fitch Affirms Tower Group, Inc.’s Ratings on Announcement

CHICAGO--(BUSINESS WIRE)-- 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 companies.

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 averages;

--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).

Applicable Criteria and Related Research:

Insurance Rating Methodology

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=651018

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Fitch Ratings
Primary AnalystGerald B. Glombicki, CPA, +1 312-606-2354
Director
Fitch, Inc.
70 West Madison St.
Chicago, IL 60602
or
Secondary Analyst
James B. Auden, CFA, +1 312-368-3146
Managing Director
or
Committee ChairpersonAndy Davidson, CFA, +1 312-368-3144
Senior Director
or
Media Relations:Brian Bertsch, +1 212-908-0549
Email: [email protected]

Source: Fitch Ratings