Fitch's rating actions reflect HGIC's recent underwriting performance which is outside of Fitch's expectations and which remains below that of peer companies. The rating actions also reflect Fitch's concerns about HGIC's ability to improve its underwriting profitability and to maintain its competitive position as premium rates moderate and price competition increases.
Fitch's last rating action on HGIC was in December 2003 when it downgraded the company's senior notes' rating and IFS ratings to 'BBB' and 'A' respectively due primarily to concerns about the company's run-rate profitability. Subsequent to that rating action, HGIC reported $42 million of prior-accident year reserve development in the fourth quarter 2003. This followed $75 million of adverse reserve development in the first three quarters of 2003, including a $55 million charge in the third quarter 2003.
While Fitch believed that the potential for some additional reserve development existed at the time of our last rating action, Fitch also believed that HGIC would close the gap between its underwriting profitability and that of its peers, at a faster rate than it has to date.
HGIC's combined ratios for the first quarter 2004 and the fourth quarter 2003 were 107.2% and 134.6% respectively. Fitch considers these combined ratios to be high and notes that the industry-wide average combined ratio for commercial lines writers (approximately 80% of HGIC's net premiums written are derived from commercial lines) was 101.5% in the fourth quarter 2003.
The gap between HGIC's personal lines' underwriting performance and the industry average personal lines underwriting performance is even wider. In the first quarter 2004 and fourth quarter 2003, HGIC's personal lines' combined ratios were 116.2% and 125.9% respectively. In contrast, the personal lines industry average combined ratio in the fourth quarter 2003 was 97.2%.
HGIC has consciously reduced the amount of personal line premiums that it writes in an effort to improve profitability. Fitch views this action favorably because it believes that the company lacks scale in the more commodity-oriented personal lines. However, Fitch also believes that this complicates HGIC's efforts to maintain and to grow relationships with its independent distribution force and its small commercial account target market.
Fitch believes that HGIC's effort to improve its underwriting profitability is hampered by its comparatively high expense structure. Although the company's expense ratio is comparable to other regional insurers at approximately 34%, it is consistently higher than the industry average and in Fitch's view, has become more of a rating issue as the company's loss ratio has increased in recent years.
HGIC's capitalization remains solid characterized by moderate financial leverage, and despite its disappointing underwriting profitability, good earnings-based interest coverage. At March 31, 2004, the company's ratio of debt?to-capital was 17% and its operating earnings-based interest coverage for the first quarter was 6.5 times.
Entity/Issue/Type Action Rating/Outlook
Harleysville Group Inc.
--Senior debt Downgrade 'BBB-'/Stable;
--Long-term Downgrade 'BBB-'/Stable.
Insurer Financial Strength
--Harleysville Atlantic Downgrade 'A-'/Stable;
--Harleysville Insurance Downgrade 'A-'/Stable;
--Harleysville of New Jersey Downgrade 'A-'/Stable;
--Harleysville of New York Downgrade 'A-'/Stable;
--Harleysville of Ohio Downgrade 'A-'/Stable;
--Harleysville Lake