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Rating Action:

Moody’s affirms Farmers Insurance Group's ratings; outlook remains negative

14 December 2020


New York , December 14, 2020 – Moody's Investors Service has affirmed the A2 insurance financial strength (IFS) rating and the Baa2 (hyb) surplus note rating of Farmers Insurance Exchange, a reciprocal insurance exchange and the lead member of Farmers Insurance Group (Farmers). The rating agency also affirmed the A2 IFS ratings of other members of Farmers' intercompany pool including Fire Insurance Exchange, Truck Insurance Exchange and Mid-Century Insurance Company, among other affiliated insurers. The rating outlook for Farmers is negative. The Exchanges are provided non claims administrative and management services by Farmers Group, Inc. (FGI), an unaffiliated management company owned by Swiss-based Zurich Insurance Group (Zurich), whose lead operating company is Zurich Insurance Company Ltd. (IFS rating Aa3 stable).

These rating affirmations follow Zurich's announcement that FGI together with Farmers will acquire the US property and casualty (P&C) insurance business of MetLife (NYSE: MET) for total consideration of $3.94 billion in cash. Zurich will contribute $2.43 billion of the purchase price through FGI and Farmers will pay $1.51 billion in cash for substantially all of the business. The parties expect to complete the transaction in the second quarter of 2021, pending regulatory approvals.

RATINGS RATIONALE

The rating agency said that Farmers' acquisition of MetLife's P&C business will diversify the group's premiums, earnings and distribution channels. MetLife's P&C business has grown steadily over the years producing solid profitability. The acquisition significantly increases Farmers' geographic diversification given MetLife's good presence on the East Coast and helps offset Farmers' exposure to California and Texas catastrophes. Additionally, much of the MetLife's business is written through worksite marketing programs as well as independent agents, which will complement Farmers existing exclusive agency channel. As part of the transaction, Farmers will maintain a 10-year exclusive distribution agreement with MetLife Group Benefits. Based on pro forma 2019 net premiums written, the combined company will be the sixth largest personal lines insurer in the US.

However, the transaction will likely increase Farmers already high operating leverage and carries significant execution and integration risks given the sizable transaction. Farmers is likely to adjust its quota share reinsurance program, consistent with prior acquisitions, to help mitigate the increased operating leverage. Giving effect to the proposed transaction, Moody's estimates Farmers will have a pro forma adjusted financial leverage in the mid-30s, and earnings coverage in the mid-single digits, based on Moody's adjustments and assumptions.

According to Moody's, the affirmation of Farmers' ratings reflects the group's strong franchise as the seventh largest US personal lines insurance group; its cost effective, largely captive agency distribution system; its high quality investment portfolio; and support provided by Zurich. Offsetting these positives are the group's weak profitability, meaningful exposure to natural catastrophes (mitigated by outward reinsurance), loss accumulations from smaller, more frequent events (e.g. localized storms, wildfires), and aggressive operating and financial leverage.

FGI collects considerable management fees from Farmers, making this operation valuable to Zurich but somewhat limiting Farmers' ability to generate capital. The negative rating outlook reflects Farmers' weak profitability and persistently high operational and financial leverage relative to peers. While Farmers has made good progress improving its personal auto underwriting results by raising rates and implementing underwriting actions, surplus has grown slowly and earnings have been weak. For the first nine months of 2020, Farmers reported gross written premium of $15.3 billion, down 2.9% from the prior year period, due largely to premium returns from the reduction in auto loss frequency due to the coronavirus pandemic. The group's combined ratio through the first nine months of 2020 was 103.7%, which included 12.4 points of catastrophe losses from California wildfires and Midwest storms.

Moody's expects that Farmers will continue to receive implicit and explicit support from Zurich, including through surplus notes and reinsurance arrangements. Farmers' ratings benefit from its relationship with FGI and Zurich, resulting in a single notch of uplift from Farmers' standalone credit profile.

The surplus notes are subordinate to all policy claims and senior indebtedness of the Exchanges. Interest and principal repayment on these surplus notes are subject to prior approval of the Insurance Commissioner of the State of California.

FACTORS THAT COULD LEAD TO AN UPGRADE OR DOWNGRADE OF THE RATINGS

Factors that could return the outlook to stable include: (i) stronger, less volatile earnings (returns on policyholders' surplus above 4%); (ii) improved risk-adjusted capitalization; (iii) lower adjusted financial and operating leverage (below 40% and 7x, respectively); (iv) rating upgrades of major Zurich affiliates.

Factors that could lead to a downgrade include: (i) failure to maintain mid-single digit returns on policyholders' surplus; (ii) continued high financial and operating leverage (remaining above 40% and 7x, respectively); (iii) decline in policyholders' surplus of greater than 10% over a year due to outsized losses (e.g., from catastrophes, reserve development); (iv) rating downgrades of major Zurich affiliates.

Moody's affirmed the following ratings:

Farmers Insurance Exchange -- insurance financial strength at A2, surplus notes at Baa2 (hyb);

Farmers Insurance Company of Oregon -- insurance financial strength at A2;

Truck Insurance Exchange -- insurance financial strength at A2;

Fire Insurance Exchange -- insurance financial strength at A2;

Mid-Century Insurance Company -- insurance financial strength at A2;

Farmers Exchange Capital -- surplus notes at Baa2 (hyb);

Farmers Exchange Capital II -- surplus notes at Baa2 (hyb);

Farmers Exchange Capital III -- surplus notes at Baa2 (hyb).

The outlook on each entity remains negative

Farmers Insurance Group, located in Los Angeles, California provides personal lines and small commercial insurance in the United States. Through nine months of 2020, Farmers reported gross premiums written of $15.3 billion. Policyholders' surplus was $6.0 billion as of December 31, 2019.

The principal methodology used in these ratings was Property and Casualty Insurers Methodology published in November 2019 and available at https://www.moodys.com/researchdocumentcontentpage.aspx?docid=PBC_1187352 . Alternatively, please see the Rating Methodologies page on www.moodys.com for a copy of this methodology.

REGULATORY DISCLOSURES

For further specification of Moody's key rating assumptions and sensitivity analysis, see the sections Methodology Assumptions and Sensitivity to Assumptions in the disclosure form. Moody's Rating Symbols and Definitions can be found at: https://www.moodys.com/researchdocumentcontentpage.aspx?docid=PBC_79004.

For ratings issued on a program, series, category/class of debt or security this announcement provides certain regulatory disclosures in relation to each rating of a subsequently issued bond or note of the same series, category/class of debt, security or pursuant to a program for which the ratings are derived exclusively from existing ratings in accordance with Moody's rating practices. For ratings issued on a support provider, this announcement provides certain regulatory disclosures in relation to the credit rating action on the support provider and in relation to each particular credit rating action for securities that derive their credit ratings from the support provider's credit rating. For provisional ratings, this announcement provides certain regulatory disclosures in relation to the provisional rating assigned, and in relation to a definitive rating that may be assigned subsequent to the final issuance of the debt, in each case where the transaction structure and terms have not changed prior to the assignment of the definitive rating in a manner that would have affected the rating. For further information please see the ratings tab on the issuer/entity page for the respective issuer on www.moodys.com.

For any affected securities or rated entities receiving direct credit support from the primary entity(ies) of this credit rating action, and whose ratings may change as a result of this credit rating action, the associated regulatory disclosures will be those of the guarantor entity. Exceptions to this approach exist for the following disclosures, if applicable to jurisdiction: Ancillary Services, Disclosure to rated entity, Disclosure from rated entity.

The ratings have been disclosed to the rated entities or their designated agent(s) and issued with no amendment resulting from that disclosure.

These ratings are solicited. Please refer to Moody's Policy for Designating and Assigning Unsolicited Credit Ratings available on its website www.moodys.com.

Regulatory disclosures contained in this press release apply to the credit rating and, if applicable, the related rating outlook or rating review.

Moody's general principles for assessing environmental, social and governance (ESG) risks in our credit analysis can be found at https://www.moodys.com/researchdocumentcontentpage.aspx?docid=PBC_1243406.

The Global Scale Credit Rating on this Credit Rating Announcement was issued by one of Moody's affiliates outside the EU and is endorsed by Moody's Deutschland GmbH, An der Welle 5, Frankfurt am Main 60322, Germany, in accordance with Art.4 paragraph 3 of the Regulation (EC) No 1060/2009 on Credit Rating Agencies. Further information on the EU endorsement status and on the Moody's office that issued the credit rating is available on www.moodys.com.

Please see www.moodys.com for any updates on changes to the lead rating analyst and to the Moody's legal entity that has issued the rating.

Please see the ratings tab on the issuer/entity page on www.moodys.com for additional regulatory disclosures for each credit rating.

Michael Dion, CFA
VP-Senior Analyst
Financial Institutions Group
Moody's Investors Service, Inc.
250 Greenwich Street
New York, NY 10007
U.S.A.
JOURNALISTS : 1 212 553 0376
Client Service : 1 212 553 1653

Sarah Hibler
Associate Managing Director
Financial Institutions Group
JOURNALISTS : 1 212 553 0376
Client Service : 1 212 553 1653

Releasing Office :
Moody's Investors Service, Inc.
250 Greenwich Street
New York, NY 10007
U.S.A.
JOURNALISTS : 1 212 553 0376
Client Service : 1 212 553 1653

© 2020 Moody’s Corporation, Moody’s Investors Service, Inc., Moody’s Analytics, Inc. and/or their licensors and affiliates (collectively, “MOODY’S”). All rights reserved.

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