DBRS Downgrades Kingsway to BBB (low), Negative Trend

DBRS has today downgraded the long-term debt ratings of Kingsway Financial Services Inc. (Kingsway or the Company), Kingsway America Inc. (its U.S. holding company) and Kingsway 2007 General Partnership to BBB (low) from BBB, with a Negative trend. The ratings have been removed from Under Review with Negative Implications, where they were placed on December 20, 2007.

This rating action reflects the impact of a relatively high debt ratio, compounded by continued weak earnings related to adverse reserve development at the Company’s Lincoln General Insurance Company subsidiary (Lincoln). On December 20, 2007, DBRS placed Kingsway’s ratings Under Review with Negative Implications as a result of the continued reserve development on account of the 2004 and 2005 accident years at Lincoln. At that time, management suggested that as of the end of 2007, reserves at Lincoln would have been set at a sufficiently high level to limit the need for further adverse reserve development in 2008. DBRS indicated that further adverse reserve development, given the relatively high senior debt ratio of 32.7% at year-end 2007, would put downward pressure on the ratings. Correspondingly, the Company’s Q1 2008 report of additional adverse reserve development of $52.8 million at Lincoln related to the 2007 accident year, combined with no material reduction in the Company’s debt ratio, has precipitated this rating action.

Reserve development associated with more recent accident years and the continued high debt ratios justify putting the Company’s rating on Negative trend despite the Company’s announced intention to focus on underwriting profitability at the expense of growth in written premiums. DBRS would expect to see several sequential quarters of positive underwriting results or a material reduction in the Company’s debt ratio before taking any positive rating actions. However, recent changes to senior management at both the Company and at Lincoln are expected to help address deficiencies in risk management and operating controls, providing support for a return to longer-term profitability.

Continuing reserve development highlights the difficulty of setting accurate reserves in the property and casualty insurance business. DBRS does not believe that there is any systemic actuarial weakness at the Company with regard to setting reserves, given the relatively strong earnings performance and favourable reserve development at most of the Company’s operating subsidiaries, notwithstanding weakening underwriting results in 2008. However, Lincoln’s rapid growth over the period that it has been owned by Kingsway has increased the proportion of outsourced claims functions, which resulted in the Company consistently underestimating its risk exposures, suggesting a lack of effective risk management. With 85% of Lincoln’s claims management now managed in house, better-quality claims information should provide for more-appropriate pricing, which should ultimately stabilize Lincoln’s underwriting profitability.

Note:
All figures are in US dollars unless otherwise noted.