Overview -- FFIC's operating performance through Sept. 30, 2012, was significantly weaker than historical levels, primarily because of large adverse reserve developments. -- We have lowered our ratings on FFIC to 'A' from 'A+'. The outlook is stable. -- We continue to view FFIC as strategically important to its wholly owned parent. Rating Action On Dec. 4, 2012, Standard & Poor's Ratings Services lowered its long-term counterparty credit and financial strength ratings on Fireman's Fund Insurance Co. and its affiliates (collectively FFIC) to 'A' from 'A+'. The outlook is stable. Rationale The rating actions are based on FFIC's significantly worse operating performance and overall financial profile through Sept. 30, 2012, compared with historical levels. FFIC's statutory combined ratio averaged 104.9% during the past five years (2007-2011), but deteriorated in the past three years, primarily because of frequent large adverse reserve developments. In addition, the company's capital adequacy deteriorated as of Sept. 30, 2012, from year-end 2011, though it still supports the rating. The decline in capital adequacy was caused mainly by a $189 million drop in statutory surplus as of Sept. 30, 2012, from year-end 2011, and a keep-well surplus adjustment we made in our capital adequacy model. The company receives these keep-well receivables from its parent, Allianz Group, under current and past keep-well commitments in the form of a long-term receivable rather than cash. These receivables are given full surplus credits based on two statutory accounting practices permitted by the California Dept. of Insurance that do not conform to standard statutory accounting practice. The keep-well portion of the statutory surplus was 22.8% as of Sept. 30, 2012, and has been growing in recent years. To adjust for the quality of capital, we cap these keep-well surplus credits up to 15% of reported statutory surplus. We deduct any amounts in excess of that from the reported surplus in evaluating the company's capital adequacy. We continue to feel the company has a good competitive position, albeit slightly diminished from prior levels. The company had a 50% quota share reinsurance agreement with Rural Community Insurance Co. (RCIC) until 2012, which will be reduced to 20% beginning in 2013. This will cause a sizable drop in the company's already declining premium volume as seen in recent years. However, the company is making progress in getting some rate increases across most lines, which will alleviate the lower premium volume somewhat. As of Sept. 30, 2012, the company reported a statutory combined ratio of 123.5% compared with 119.4% for the same period in 2011. Prior-year reserves contributed 18.4 points to 2012 results, compared with 13.3 points in 2011. Catastrophe loss through the first nine months of 2012 contributed 4.1 points to the 2012 results, in contrast to 9.5 points in 2011. Outlook The stable outlook reflects our expectation that FFIC will continue to improve the quality of risks in its overall business portfolio through careful risk selection and good pricing discipline. We expect FFIC's statutory combined ratio excluding Hurricane Sandy to be 125%-130% in 2012 assuming no further major catastrophe losses in the fourth quarter. We expect Hurricane Sandy losses to add several percentage points to this combined ratio. We expect the company to make gradual improvements in underwriting results in the next few years as it goes through its current restructuring plan to identify and target profitable business. Beginning with 2013, we expect to see a gradual improvement in the statutory combined ratio to about 104%-106%, including about 4-5 percentage points for catastrophe losses and no material adverse reserve development. A gradual firming of commercial-lines pricing should also benefit underwriting results and slow the decline in commercial-lines premiums. With stable net investment income from its conservative fixed-income portfolio the company will likely generate good returns as determined by a statutory ROR of 4%-6% in the next two years. In addition, we expect the company to maintain its capital adequacy at a level appropriate for the current rating, and we do not expect capital quality to improve significantly in the next one to two years. Failure to meet these expectations and any material adverse reserve developments or decline in capital adequacy as determined by our capital model in the next couple of years could result in negative rating actions. At the same time, it's very unlikely that we would raise the ratings in the next two years because we believe the company's competitive position is somewhat limited in terms of product lines and that its performance has to be in line with its peers'. Related Criteria And Research Interactive Ratings Methodology, April 22, 2009 Ratings List Downgraded To From Fireman's Fund Insurance Co. National Surety Corp. Interstate Fire & Casualty Co. Fireman's Fund Insurance Co. of Ohio Fireman's Fund Indemnity Corp. Chicago Insurance Co. Associated Indemnity Corp. American Insurance Co. American Automobile Insurance Co. Counterparty Credit Rating Local Currency A/Stable/-- A+/Stable/-- Fireman's Fund Insurance Co. National Surety Corp. Interstate Fire & Casualty Co. Fireman's Fund Insurance Co. of Ohio Fireman's Fund Insurance Co. of Hawaii Inc. Fireman's Fund Indemnity Corp. Fireman's Fund County Mutual Insurance Co. Chicago Insurance Co. Associated Indemnity Corp. American Insurance Co. American Automobile Insurance Co. Financial Strength Rating Local Currency A/Stable/-- A+/Stable/-- Rating Withdrawn To From American Standard Lloyds Insurance Co. Fireman's Fund Insurance Co. of Louisiana Fireman's Fund Insurance Co. of Georgia Financial Strength Rating Local Currency NR/-- A+/Stable/-- Complete ratings information is available to subscribers of RatingsDirect on the Global Credit Portal at www.globalcreditportal.com. All ratings affected by this rating action can be found on Standard & Poor's public Web site at www.standardandpoors.com. Use the Ratings search box located in the left column.