These rating actions follow today's pre-announcement by St. Paul Travelers that it would increase reserves by $1.625 billion in second quarter 2004 to be reported on July 28, 2004. These rating actions consider this substantial reserve increase and its negative effects on statutory earnings, capital accumulation and holding company cash, which were not previously anticipated. From a GAAP accounting standpoint, depending on guidance from the Securities and Exchange Commission (SEC), the reserve increase could be recorded through St. Paul Travelers' income statement and could result in a substantial net loss for the second quarter, or potentially, under purchase accounting, be charged directly to St. Paul Travelers' opening balance sheet and not impact earnings. Alternatively, some of the charges could be recorded through the income statement and some directly to the opening balance sheet. However, under statutory accounting principles, the charge will be recorded through the income statement.
The debt rating downgrades reflect A.M. Best's view of St. Paul Travelers, which considers the elimination of dividends from the St. Paul Companies (St. Paul, MN) in the second half of 2004 and the planned $650 million dividend from Travelers Property Casualty Pool (Travelers PC Pool) (Hartford, CT) for the benefit of the St. Paul Companies. Short-term borrowings--expected to be repaid--will remain outstanding through 2004, and holding company cash will fall short of A.M. Best's expectations. It is important to note, however, that barring any unusual charges, prospective earnings for the group should be more than adequate to service existing debt obligations, stockholder dividends and the repayment of its commercial paper program.
Additionally, A.M. Best has affirmed the financial strength ratings of A+ (Superior), A (Excellent) and A- (Excellent) of Travelers PC Pool, St. Paul Companies and Discover Reinsurance Company (Indiana), respectively. The rating outlook for Travelers PC Pool remains stable. The rating outlook for the St. Paul Companies has been revised to stable from positive given that virtually all of the charges to be taken in second quarter 2004 are related to the St. Paul Companies. In addition, the rating outlook for Discover Reinsurance Company has been revised to negative from stable, reflecting the potential for further reserve strengthening at the company in 2004.
The $1.625 billion reserve increase by the St. Paul Companies in the second quarter 2004 exceeded A.M. Best's expectations by a sizable margin. The degree and need for Travelers to financially support the St. Paul Companies was unanticipated. While St. Paul Travelers has referred to the $1.625 billion reserve increase as conforming reserve valuation adjustments, A.M. Best considers nearly all of the reserve increase to be akin to loss reserve strengthening. Moreover, statutory earnings, surplus and holding company cash projections have all been revised downward.
With regard to asbestos and environmental (A&E) reserves, A.M. Best is cautiously awaiting the completion of an internal annual reserve study to be concluded in fourth quarter 2004, which may result in the possibility of further A&E reserve strengthening at the St. Pa