A.M. Best Completes Year-End Review Of California Workers' Compensation Carriers.

Business Editors/Insurance and Legal Writers

OLDWICK, N.J.--(BUSINESS WIRE)--May 26, 2000

A.M. Best Co. has completed its year-end review of insurance carriers with concentrated exposure to the volatile California workers compensation market.

The review culminated in the downgrades of three large carriers in this market over the past two weeks: State Compensation Insurance Fund of California; Zenith National Insurance Group; and Argonaut Insurance Group.

A.M. Best continues to monitor financial strength and reserving trends in the California workers' compensation market, which has exhibited tremendous financial volatility and greater market instability than any other property/casualty business segment. A.M. Best is particularly concerned about specialty mono-line writers, given their business concentration in this difficult market, exposure to significantly under-priced business written in 1998 and 1999 and rapid deterioration in workers' compensation claim severity trends. These concerns are amplified by the California Workers' Compensation Rating Bureau's recent projection that the industry's loss-reserve deficiency within the segment could exceed $4 billion.

The downgrade of the State Compensation Insurance Fund of California to B++ (Very Good) from to A- (Excellent) reflects the continued deterioration of the fund's operating performance and aggressive premium growth in the volatile California market. The fund, which holds a 25% share of this market, has exhibited very weak underwriting results, as evidenced by an average combined ratio of 142 over the past five years. The resulting business concentration led to operating losses in 1998 and 1999, and further losses are expected. While the fund has exhibited more stable reserve trends than its competitors, it has been hurt by the competitive pricing environment. In addition, as a nonprofit government agency, the fund's access to the capital markets and ability to diversify its products and territory are limited.

The fund's shift to an agency- and broker-based business model is expected to increase its expense position, and premium production has increased significantly in 2000. This growth adds uncertainty to the fund's loss-reserve position and future profitability, given the volatility and rising loss trends in the market.

Offsetting these negative rating factors are the fund's strong capital position and dominant market presence. The rating also acknowledges the fund's capacity to provide a permanent workers' compensation market in California while maintaining a high level of service, profit sharing with its policyholders and strong capitalization. Management has demonstrated specialized underwriting expertise and the ability to successfully expand and contract business during highly variable market conditions. The fund also benefits from its exemption from federal income tax.

The downgrade followed the recent downgrades of Zenith National Insurance Group and Argonaut Insurance Group to A (Excellent) from A+ (Superior).

Zenith's downgrade--which applies to its three pool members--reflects continued deterioration in the group's underwriting results, sub-par operating returns and increased workers compensation business concentration following the sale of CalFarm Insurance Co. Further, Zenith's results are dampened by its high expense ratio as a result of a significant drop in its premium volume which does not support the group's current expense structure following its market retrenchment and disciplined approach to competitive market conditions.

Zenith's poor 1999 underwriting results were further affected by increased catastrophe losses, system upgrade expenses, and costs incurred in connection with the RISCORP acquisition, including an unusual charge related to losses above an arbitrator-established level at the time of the transaction.

Offsetting these negative rating factors are Zenith's strong capitalization and its disciplined operating strategy, which has produced a consistent accident-year loss ratio advantage for the group. Rates in California have increased in 2000, which should help alleviate some of the underwriting pressure. The group also benefits from the financial strength and flexibility of its parent, Zenith National Insurance Corp., with $1.6 billion in total assets and $355 million in shareholders equity. Given Zenith's conservative operating philosophy and solid market position, the group is better positioned than most other California carriers to deal with the volatile conditions of the California workers' compensation market.

The downgrade of Argonaut--which applies to its five pool members--reflects the deterioration of Argonaut's underwriting performance, poor cash flow and the competitive conditions in the workers' compensation market, the group's core line of business.

Loss severity in the California workers' compensation market has increased materially since 1995, resulting in large reserve deficiencies as carriers were slow to identify the trend. Argonaut responded by strengthening loss reserves for prior years $32 million and $85 million in 1999 and 2000, respectively. A.M. Best remains concerned with the ongoing profitability of Argonaut's core book of business. However, the strengthening in the first quarter of 2000 is expected to protect Argonaut from further prior-year loss development. Management now intends to focus on increasing production in its more profitable niches, generating a positive cash flow for the first time in over five years.

Offsetting these negative rating factors are Argonaut's strong capitalization and favorable market position in the workers' compensation market, particularly in the wrap-up segment. Argonaut benefits from its conservative underwriting leverage and an excellent reputation for a high level of service and profit sharing. Argonaut maintains strong relationships with its primary distribution force, regional and national brokers and continues to enhance its Internet service capabilities. The rating also reflects the financial strength and flexibility of the publicly traded parent, Argonaut Group Inc., which has more than $625 million in stockholders equity and no outstanding debt.

Other rating actions that A.M. Best has taken place since March 1 include:

--Superior National Insurance Group, Calabasas, Calif., to E (Regulatory Supervision) from B (Fair) under review with negative implications.

--Fremont Compensation Insurance Group, Glendale, Calif., to B++ (Very Good) from A- (Excellent);

--PAULA Insurance Co., Pasadena, Calif., to B (Fair) from B++ (Very Good);

--HIH Insurance Group, San Francisco, Calif., to B+ (Very Good) from B++ (Very Good)

--Western Growers Insurance Co., Irvine, Calif., to C++ (Marginal) from B- (Fair).

Most of the remaining California workers' compensation specialty carriers had their ratings affirmed with negative outlooks. These carriers included: Republic Indemnity Group, Encino, Calif.; Majestic Insurance Co., San Francisco; and Sierra Insurance Group, Las Vegas, Nev.

A.M. Best is encouraged that prices are beginning to firm considerably in the California workers' compensation segment this year. This should help offset ongoing adverse reserve development experienced by carriers in this marketplace, and help stabilize the financial strength of many of the carriers.

Nevertheless, A.M. Best remains concerned that rising loss severity and uncertainty in claim frequency will translate into unstable reserve trends for the intermediate term. A.M. Best will continue to evaluate individual carriers' reserving and claims emergence trends and take appropriate rating actions.

A.M. Best Co., established in 1899, is the world's oldest and most authoritative insurance rating and information source. For more information, visit A.M. Best's Web site at http:\\www.ambest.com .