Best Downgrades CNA Surety, Fitch Affirms CNA Financial Corp.

A.M. Best Co. has downgraded the financial strength ratings to “A” (excellent) from “A+” (superior) of the members of the Chicago-based CNA Surety Corp. Group. The rating outlook is negative.

The rating action follows the group’s announcement of an $88 million third quarter 2003 reserve charge arising from its recently completed reserve reviews. The reserve charge resulted in a precipitous drop in surplus that more than negated all of the organic surplus growth that had occurred in the prior five-year period. In addition, the group has experienced a five-year downward trend of underwriting and operating profitability.

The negative rating outlook is pending CNA Surety’s demonstration of reserve adequacy, and resulting operating profitability, in addition to organic surplus generation that would be considered commensurate with an “A” rating.

The third-quarter charge primarily consisted of reserve strengthening relating to accident year 2003, which included an unusual amount of large claim activity. In particular, seven principals accounted for approximately $50.6 million of net reserve development. The reserve charge does reflect a more conservative reserving philosophy to incorporate continued exposure to a number of severity losses.

Management is confident that its bulk reserve position is more than adequate to cover any severity issues that may arise on a going forward basis.

Fitch Ratings, meanwhile, has affirmed the current ratings on CNA Financial Corporation and its primary property/casualty insurance subsidiaries. At the same time, the ratings have been removed from rating watch negative. The rating outlook is negative.

To offset the balance sheet impact from the operating loss, CNA has established a capital plan that will result in funds being replaced through support from the company’s majority owner, Loews Corp. and potential other asset sales. Loews will purchase $750 million of convertible preferred stock, which converts to common stock once certain approvals are obtained.

In addition, Loews is providing contingent capital of up to $500 million, in the form of surplus notes issued by the property/casualty operation, if needed by late February 2004. A combination of the capital plan and nine month earnings, which includes the reserve charges, will lower shareholders’ equity by approximately $350 million (considering $1.6 billion net loss offset by a $1.25 billion capital plan addition), which represents roughly 5% of shareholders’ equity. In addition to capital commitments from Loews, the capital plan includes possible sales or other dispositions of businesses and assets.

Fitch said it believes that the recent accident year reserve additions were prudent and the process and methodology to determine the amount appear reasonable. Meanwhile, the increase in asbestos reserves moves the company’s survival ratio to 18x, and it is higher excluding structured settlements. Given CNA’s above average claims payments trend in recent years compared with historical market share, the current asbestos reserves place CNA in an adequate position relative to peers, Fitch said in a statement.

Fitch also said it believes that the combination of the first two points above will result in stable operating performance for the ongoing operating performance beginning with the fourth quarter of 2003.