Moody's has downgraded the senior debt ratings of GE Insurance Solutions Corp (GE Insurance Solutions) to Baa1 from A1. Moody's has also downgraded the insurance financial strength rating of Employers Reinsurance Corporation to A1 from Aa2. GE Insurance Solutions is an indirect subsidiary of General Electric Co. The rating actions conclude a review for possible downgrade that was initiated on 5 January 2005, following the group's announcement of a $1.2bn pre-tax charge taken in 2004 to cover adverse loss reserve development -- continuing the trend of recording large reserve charges in each of the past 5 years. The outlook for the ratings is now stable.
According to Moody's, the two-notch downgrade of the insurance financial strength to A1 reflects a view that the operating performance of the insurance group has been, and is expected to continue to be, at a level well below that expected of a Aa-rated (re)insurer, as well as Moody's re-evaluation of the prospect for future ownership and support from the ultimate parent, GE. The downgrade of GE Insurance Solutions also reflects an expectation for additional, although more moderate, reserve development and lingering concerns about the embedded profitability of both in-force and prospective business, as the property & casualty market continues to soften.
Elaborating further, Moody's noted that continued significant adversereserve development on business written during the soft market heightensthe risk that business priced during the most favorable part of the market cycle may not be as profitable as anticipated. There continues to be uncertainty about the reserve adequacy of GE Insurance Solutionsbecause the group writes significant amounts of long tail business --including professional liability, workers' compensation, and excess casualty reinsurance.
The rating agency said that the downgrade positions the ratings of GEInsurance Solutions at a level more reflective of their intrinsic creditstrength which Moody's believes is appropriate given the parentcompany's statements about the strategic repositioning of the P&C and reinsurance operations. Moody's believes that GE may look to sell or spin-off GE Insurance Solutions at a time when its financial performance has improved and there is market interest. It is important to note, that despite the downgrades, the current ratings still benefit -- though to a lesser degree -- from GE's ownership and history of support.
The downgrade of the holding company's senior debt by three notchesresults in there now being three notches between the primary operatingcompanies' insurance financial strength ratings at A1 and senior debt at the holding company at Baa1, which is consistent with Moody's typical notching practices for priority of claim at insurance groups. A key driver in widening the notching for GE Insurance Solutions is Moody'sre-evaluation of parental ownership and implied support and ascribing it less value. The rating agency commented that although GE InsuranceSolutions has some level of revenue and earnings diversification betweenprimary P&C, P&C reinsurance, and life reinsurance, as well as between various geographic regions, the level of diversification is not sufficient to warrant narrower notching because of the relatively high correlation of these businesses.
The insurance financial strength and debt ratings of the GE InsuranceSolutions group reflect the company's diversification across businesssegments with very good product breadth, its solid investment portfolioand good capitalization, as well as its market position as one of the five largest reinsurers in the world. This leading market positionenhances the ultimate franchise value and market presence of the companyin relation to its global customer base. Other strengths include the substantial financial capacity and demonstrated support of GE. These strengths are tempered by weak operating earnings, the continuedpotential for adverse loss development on prior year's long-tailbusiness, and substantial tiering of regulatory capital.
Moody's stable outlook reflects our expectations that operating earnings will improve such that over time the average return on premium will exceed 5% while maintaining current operating and underwriting leverage metrics. The current ratings also consider that potential adverse reserve development, particularly on the 1997 to 2001 accident years, will be less than 5% of net carried reserves. We also expect financial leverage (debt + minority interest + preferred stock/ total capital) to fall and be maintained below 25% over the near term while return on equity rises closer to 10%. In addition, we anticipate that pretax operating earnings coverage of interest and preferred dividends rises to around five times over the medium term and unencumbered statutory dividend capacity coverage of interest and preferred dividends remains above two times. Lastly our ratings contemplate that GE is likely to continue to provide financial support, if necessary, until such time as the performance of GE Insurance Solutions and its operating companies improve.
