PMA $150M Charge Brings Downgrades

PMA noted in its announcement that, as a result of this charge, it will suspend its stock dividends at this point and that the company is exploring "strategic alternatives" for its reinsurance business with assistance from Charlotte, N.C.-based Banc of America Securities LLC.

Possible alternatives might include selling all or parts of PMA reinsurance assets or even placing the unit in runoff.

"Certainly, the $150 million reserve charge they have taken is nothing like anything we have expected, and the magnitude of the charge is also way beyond what we might have expected," said Laline Carvalho, a director at Standard & Poor's Ratings Services, which took a number of rating actions on PMA's group of companies.

She noted that the ratings agency had downgraded PMA ratings last year, with a negative outlook.

"PMA had some liquidity issues at the time, and it had had reserve strengthening. Those downgraded ratings were based on expectation that most reserving issues with PMA would be over with," Ms. Carvalho told National Underwriter. "So this reserve charge was certainly unexpected."

S&P's ratings action, announced on the same day PMA disclosed its reserve charge, involves lowering its counterparty credit and financial strength ratings on PMA's reinsurance unit?called PMA Capital Insurance?to "triple-B-minus" from "A-minus" and cutting counterparty credit and financial strength ratings for PMA insurance operations?known as PMA Insurance Group companies?to "triple-B" from "A-minus," both with the CreditWatch "negative" status.

"And we downgraded the holding company from "triple-B-Minus" CreditWatch ?negative' to "double-B-Minus" CreditWatch ?negative,'" Ms. Carvalho said. "So there were different rating actions in the whole group of companies."

She noted the actions reflect much-higher-than-expected reserve charges, significantly weaker capitalization on a standalone basis at the reinsurance company, and four consecutive years of operating results below S&P's expectations.

Ms. Carvalho also pointed out that as a result of this charge, PMA will record a net loss for the year.

"We still have CreditWatch ?negative' on the company," she said, "and one way that will help us resolve the CreditWatch status is to understand what the structure of the group will look like going forward, and that depends somewhat on what management may decide to do."

Robert Farnam, senior financial analyst at A.M. Best Co., which also cut PMA ratings within hours of the company's announcement, agreed that the $150 million reserve charge was higher than what the industry watchers may have been expecting.

"They have been taking charges more along the lines of $40-to-$50 million in the last couple of years. So a big lump like $150 million caught ratings agencies off guard," Mr. Farnam said.

The reasoning behind their reserve charge, he added, may be that the company "finally had another outside actuary take a look at the reserves, and I think that's what prompted them to take a larger charge."

He said that "the company had three separate reviews that went into this decision, and I think the board just said, "Alright, let's just put all this behind us in one shot.'"

Still, PMA is far from being alone in boosting reinsurance loss reserves?Mr. Farnam noted that most reinsurance companies "got hammered" by the accident years of 1998 to 2000. This was a period when business was underpriced "and it was a soft market for reinsurance. PMA wasn't alone in getting hammered in that," he said.

Mr. Farnam said A.M. Best ratings action involved downgrading the financial strength ratings of PMA Insurance Group companies and PMA Capital Insurance to "B-double-plus" (Very Good) from "A-minus" (Excellent). The Oldwick, N.J.-based ratings agency also lowered the senior debt rating of the holding company, PMA Capital Corp., to "double-B" from "triple-B-minus."

Mr. Farnam said all the ratings will be under review with negative implications. "Both the rating for the reinsurance company and the rating for the insurance group are under review," he noted. "We will basically wait to see what happens when the dust settles?what they will do with their reinsurance and what their corporate structure will look like."

Regarding PMA insurance units, company management announced it had looked at reserves for insurance operations?their workers' compensation piece?but it was determined that the company didn't need to take a charge for those, Mr. Farnam said.

But A.M. Best also downgraded PMA insurance operations, Mr. Farnam explained, because of the fact that "insurance operations are stacked underneath the reinsurance company." He also said their insurance operations, while relatively unaffected by the reserve charge, may have to endure more strain from having to fund holding company issues.

"So, depending on what they do with the reinsurance company, it has a direct impact on insurance operations," he said.

Commenting on the news that PMA is in talks with the Pennsylvania Insurance Department regarding its operations, Mr. Farnam said that since PMA is domiciled in Pennsylvania, "they have to talk to the commissioner to see what the plan would be going forward."

"Obviously," he said, "when you have a large hit like this, it may have implications if they are trying to decide what to do with the reinsurance piece."

Right now PMA management is trying to determine what to do with the reinsurance operation, Mr. Farnam said. "They are exploring so-called strategic alternatives. So it's still a question mark as to what they will do with the reinsurance piece."

Moody's Investors Service, another major ratings agency, also took a ratings action following PMA's announcement.

The New York-based ratings firm lowered the insurance financial strength rating of reinsurer PMA Capital Insurance to "Ba1″ from "Baa1″ and the insurance financial strength rating of PMA Insurance Group companies to "Baa2″ from "Baa1″. It also lowered the long-term debt ratings of the holding company PMA Capital Corp. to "Ba3″ from "Ba1″. Moody's said all ratings remain on review for further possible downgrades.

Its ongoing review process, Moody's said, will encompass several issues, including: a detailed assessment of the reserve strengthening; the charge's impact on regulatory risk-based capital requirements; and a review of loss reserves and reinsurance recoverables at PMA operating units.

Moody's said it will also closely monitor PMA's business plan for the reinsurance business and primary insurance operations and assess how all these changes would impact the overall financial flexibility of the holding company.