Rating Agencies React to Fairfax Zenith Deal; See No Ratings Change

Neither Standard & Poor’s Ratings Services nor A.M. Best are currently expecting to change their ratings on Zenith National Insurance Corp or on Toronto-based Fairfax Financial Holdings, following the announcement on Thursday, Feb. 15, that it will buy all the shares of Zenith that it does not already own in a deal worth about $1.4 billion [See IJ web site – https://www.insurancejournal.com/news/national/2010/02/18/107455.htm ].

S&P affirmed its ‘BBB-‘ counterparty credit rating on Zenith and its ‘A-‘ counterparty credit and financial strength ratings on Zenith Insurance Co. and ZNAT Insurance Co., which are the members of the Zenith Insurance Group Intercompany Pool.

Best commented that the financial strength rating of ‘A’ (Superior) and issuer credit ratings (ICR) of “a” of the operating companies of Zenith National Insurance Corp. and the ICR of “bbb” of Zenith “remain unchanged” following the announcement of the Fairfax deal.

Both rating agencies also stated that the outlook on all of Zenith’s ratings also remains stable.

S&P commented that “Zenith has shown very strong underwriting discipline over the past 30 years, and its strong earnings and strong competitive position in the California workers’ compensation market support this belief. In addition to the company’s conservative and disciplined pricing and underwriting, strong capital adequacy, low financial leverage at the holding company, and strong liquidity play a significant role in the stability of the company’s financial strength. Offsetting these strengths are Zenith’s concentration in the volatile workers’ compensation segment and high geographic concentration in California, which have limited the company’s earnings and revenue growth over the past two years.”

In a separate announcement S&P affirmed its ‘BBB-‘ counterparty credit rating on Fairfax Financial (FFH), as well as its counterparty credit and financial strength ratings on FFH’s ongoing operating insurance subsidiaries. The outlook for the ratings also remains stable.

Best commented that its ratings on Fairfax its subsidiaries would remain “unchanged,” as will the stable outlook on the ratings. Best noted that “Fairfax will pay $38 per share, representing a 31.4 percent premium over the Zenith closing price on February 17, 2010. Total consideration to be paid is approximately $1.3 billion, which will be derived from Fairfax holding company cash, subsidiary dividends and a forthcoming $200 million equity offering to be completed prior to the closing of the transaction. Fairfax anticipates that approximately $1.0 billion in cash and marketable securities will be maintained at the holding company following the transaction.”

Best added that it “expects risk-adjusted capital of the operating insurance subsidiaries of Fairfax to remain supportive of their current ratings following the acquisition. No change is expected to the strategic or day-to-day control of Zenith’s operations, with the exception of investment management, which will be centralized at Fairfax.” The rating agency also pointed out that “Fairfax has integrated previous acquisitions into its structure in a similar manner.”

S&P noted that “FFH, with $7.6 billion in shareholders’ equity at year-end 2009, is the parent organization of a number of global insurance operations, including Odyssey Re, Northbridge Financial, Crum & Forster, Falcon Insurance, and Polish Re. FFH’s historically above-average investment performance, attributable to the leadership of affiliate investment manager Hamblin Watsa, complements the company’s strong and diversified insurance business profile.”

Best also listed FFH’s major operating subsidiaries, adding that, “following the completion of all transaction related items, Fairfax’s unadjusted debt-to-total capital ratio will be 29 percent, well within A.M. Best’s guidelines for its current ratings,” as are the individual ratings of the of the subsidiaries.”

In addition S&P said that the $463 million in net premiums earned by Zenith in 2009 along with its total assets of approximately $2.4 billion as of Dec. 31, 2009, are seen as “adding further product diversification, greater underwriting and claims expertise, and increased asset management opportunities to FFH.

“In line with Fairfax’s operating philosophy toward its insurance subsidiaries, we expect Zenith to be managed on a decentralized basis through the existing Zenith management team. We also expect that Hamblin Watsa will manage Zenith’s investments.”

Fairfax Chairman and CEO Prem Watsa confirmed S&P’s conclusion. He said there will be no changes in Zenith’s strategic or operating philosophy. “Zenith will continue to operate its business as it always has been run under (Zenith Chairman) Stanley (Zax)’s excellent leadership, with investment management centralized at Fairfax. All other Fairfax group companies will continue to operate independently on a decentralized basis.”

Sources: A.M. Best – www.ambest.com and Standard & Poor’s – www.standardandpoors.com