S&P Affirms Zenith National Ratings

Standard & Poor’s Ratings Services has affirmed its ratings on Zenith National Insurance Corp. (Zenith; see ratings list) and its operating subsidiaries.

At the same time, Standard & Poor’s revised the outlook to stable from negative.

The rating action is based on significantly improving operating results, a good competitive position in the workers’ compensation segment, a sound and disciplined operational strategy, and strong capital adequacy. Offsetting these strengths are historically poor operating results, a concentrated competitive position in the historically volatile workers’ comp industry segment, and the increased risk presented by the similarly volatile catastrophe reinsurance business.

Outlook
Operating performance, benefiting from currently adequate rates and loss cost reform in California and Florida, is expected to remain at very strong levels through 2005 with a combined ratio in the workers’ comp segment of less than 93%. Performance beyond 2005 will be dependent on the full effect of these reforms and the pricing response of competitors that are not readily measurable at this time. Capital adequacy, supported by organic capital growth from the retention of earnings, is expected to remain at more than 135%, a strong level. Financial leverage and fixed-charge coverage, reflecting the very strong earnings stream through 2005, are expected to improve to about 30% and more than 10x respectively.

Major rating factors

— Zenith’s operating results have markedly improved as measured by a 89.8% combined ratio for the six months ended 2004, and a 95% combined ratio in 2003 that mark a significant and consistent improvement from 2002 and 2001 combined ratio’s of 106.5% and 118.9%, respectively.

— Standard & Poor’s views Zenith’s competitive position as good, as demonstrated by superior operating results as measured by the loss ratio being below industry averages for the past 25 years. In 2002 through June 2004, Zenith has successfully leveraged its competitive position by realizing profitable business growth.

— Standard & Poor’s believes that Zenith’s operational strategy in addressing the historically cyclical workers’ comp segment is sound and continues to be successfully implemented. Zenith’s successful operational strategy includes disciplined underwriting with willingness to give up inappropriately priced business, the writing of guaranteed-cost insurance with accompanying aggressive loss control, maintenance of infrastructure in good times and bad, and vertical integration through the use of in-house lawyers and nurses as well as underwriters and claims handlers. Although this strategy has resulted in high general and administrative and loss adjustment expenses when business conditions were poor, this strategy has spared the company the extremely severe losses experienced by its competitors.

— Zenith’s capital adequacy, incorporating Standard & Poor’s view that reserves are deficient by 10% to 14%, of 148% as of year-end 2003 is considered strong and is improved from 125% in the prior year. Although historically poor results in combination with premium growth necessitated net capital contributions from the holding company in 2002 and 2003, Standard & Poor’s believes that prospective capital growth will be derived from markedly improved operating performance.

— Though superior to the industry, risk adjusted operating performance of 8%, as measured by Standard & Poor’s five year weighted earnings adequacy model, is poor for the five years ended Dec. 31, 2003. Underwriting losses, reflecting industry conditions, were particularly onerous in 1999 through 2001 as measured by the GAAP combined ratio of 135% in 1999, 130% in 2000, and 119% in 2001.

— Standard & Poor’s views Zenith’s competitive position as good but geographically concentrated with California and Florida constituting 64% and 18% of 2003 earned premium respectively. With about a 3.7% share of California workers’ comp premium ($458 million of earned premium in 2003), Zenith has limited pricing power relative to its peers. This concentration exposes Zenith, relative to more diversified peer’s, to geographic and segment specific developments in its business mix.

— Standard & Poor’s views Zenith’s diversification into assumed catastrophe reinsurance as an additional risk to the rating. Standard & Poor’s believes that this volatile segment, in combination with the historically volatile workers’ comp segment, exposes the company to coincidental large losses in both areas.

Ratings list

To/From
Zenith National Insurance Corp.
Counterparty credit rating BB+/Stable/– BB+/Negative/–
Zenith Insurance Co.
ZNAT Insurance Co.
Counterparty credit rating BBB+/Stable/– BBB+/Negative/–
Financial strength rating BBB+/Stable BBB+/Negative
Zenith National Insurance Capital
Trust I Preferred stock rating B+