On Friday, A.M. Best Co. announced that it changed the “under review” status Tower Group ratings to “under review with developing” implications rather than “negative” implications—a reaction to Tower Group International, Ltd.’s Jan. 6 announcement of a $172 million merger agreement with ACP Re. Ltd.

The change relates to:

• The financial strength rating (FSR) of B (Fair) and issuer credit ratings (ICR) of “bb” of the pooled and reinsured members of the Tower US Pool
• The ICR of “b-” and the debt rating of “b-” on $145.4 million 5.00% senior convertible notes due 2014 of the intermediate holding company, Tower Group, Inc.
• The FSR of B (Fair) and ICR of “bb” of CastlePoint Reinsurance Company, Ltd. (Bermuda)
• The ICR of “b-” of the ultimate parent, Tower Group International, Ltd. (Tower) (Bermuda)

Under terms of the plan of merger with ACP Re Ltd. and its wholly-owned subsidiary, entered into on Jan. 3, Tower is the surviving corporation.

Best said that the “under review status with developing implications” reflects potential benefits of the deal and also the potential downside from any additional adverse reserve development or unforeseen events that could occur before the deal closes in the summer of 2014.

In October 2013, Best downgraded the financial strength rating of members of Tower Group to B++ (Good) from A- (Excellent), one day after the company announced a $365 million loss reserve charge for the second quarter. In December, Best cut the ratings again, this time to B (Fair), when Tower’s announced that it would need to further strengthen prior-year loss reserves in the third quarter in a range between $75-$105 million,

According to the latest A.M. Best announcement regarding the continuation of an “under review” status, ratings will probably be upgraded if the ACP Re merger closes, but could be downgraded if the merger falls through or the unforeseen circumstances—like more reserve charges—occur.

A.M. Best believes the deal “gives Tower access to additional capital and liquidity that it otherwise would not have. This allows Tower some additional financial flexibility, which could lessen the strain on its risk-adjusted capital,” the announcement said.

In related announcements on Friday, A.M. Best announced that:

• It has placed the financial strength rating of A- (Excellent) and issuer credit rating of “a-” of ACP Re Ltd. (ACP Re) (Bermuda) under review with negative implications.
• It is not changing the financial strength rating of A (Excellent) and issuer credit ratings (ICR) of “a” of the subsidiaries of AmTrust Financial Services, Inc. (AmTrust), and is maintaining a stable outlook on all AmTrust’s ratings.
• It is not changing the financial strength rating of A- (Excellent) and the issuer credit ratings (ICR) of “a-” of the subsidiaries of National General Holdings Corporation (National General) (Delaware), and is maintaining a stable outlook on all National General’s ratings.

The controlling shareholder of ACP Re, a Bermuda- based reinsurer, is a trust established by the founder of AmTrust, Maiden Holdings, Ltd. and National General.

These rating announcements come in reaction to the merger deal and related Jan. 6 statements from Tower, AmTrust and National General, revealing that:

• AmTrust will enter into a 100 percent quota share reinsurance agreement and provide a cut-through endorsement on a portion of Tower’s commercial lines business, effective Jan. 1, 2014.
• AmTrust intends to reinsure not less than 60 percent on a prospective basis of the approximately $290 million of unearned premium relating to Tower’s commercial business.
• AmTrust intends to acquire the commercial lines renewal rights and assets, including several of Tower’s domestic insurance subsidiaries, to support the commercial lines business, upon completion of the merger with ACP Re.
• National General intends to acquire the renewal rights and assets, including several insurance subsidiaries, of Tower’s personal lines insurance operations.

According the A.M. Best announcements, the purchase price of the subsidiaries acquired by AmTrust and National General will be equal to the statutory tangible book value of the acquired companies and ACP Re will retain all liabilities at the time of sale of the acquired companies through a reinsurance agreement that will be fully collateralized.

Best said the “under review with negative implications status” for ACP Re’s reflects the execution risk of a significant change in the business plan and the uncertainty regarding the adequacy of loss reserves from the acquired Tower business, adding, however that management has a “successful track record of acquisitions” as well as the “financial wherewithal to maintain risk-adjusted capitalization at strong levels.”

Separately, Best explained why the AmTrust and National General ratings remain unchanged.

“AmTrust has historically maintained excellent risk-adjusted capitalization and has reported strong operating results driven by an experienced management team, emphasis on technology and focus on low hazard and predictable books of business,” A.M. Best said.

The rating agency also noted that at significant portion of AmTrust’s growth has been driven by successfully executing on renewal rights transactions similar to Tower.

Best also commented on National General’s excellent historical risk-adjusted capitalization and favorable earnings. Best noted that National General was formed in 2009 to acquire GMAC’s personal lines business. According to Best, the Tower transaction will provide product diversification to National General, which currently writes largely personal auto business. Roughly two-thirds of Tower’s personal lines book is homeowners’ business, Best said.

Noting the potential downside risk of increased variability from weather events, Best said the exposure will be manageable assuming that all existing Tower reinsurance treaties will remain intact, which Best believes will be the case.

Source: A.M. Best