A.M. Best Co. has downgraded the issuer credit ratings (ICR) of Missisauga, Ont.-based Kingsway Financial Services Inc., and its U.S. subsidiary Kingsway America Inc. The ratings have been placed under review with negative implications.

Concurrently, A.M. Best has downgraded the financial strength rating (FSR) and the ICR of Kingsway Financial’s subsidiary, Lincoln General Insurance Co. These ratings remain under review with negative implications.

Additionally, A.M. Best has downgraded the debt ratings on Kingsway Financial’s $78 million 8.25% senior unsecured debentures due 2007, Kingsway Financial’s US$125 million 7.5% senior unsecured notes due 2014 and its US$74.1 million 7.12% senior unsecured notes due 2015. These debt ratings have been placed under review with negative implications.

In addition, A.M. Best has assigned a debt rating of “bb” to Kingsway General Partnership’s $100 million, 6% senior unsecured debentures, due July 2012. This rating has been placed under review with negative implications.

The rating downgrades are a result of Kingsway Financial’s weakened risk-adjusted capitalization, continued adverse reserve development, softening market conditions and operating performance, which is significantly below expectations. The recent reserving action in Lincoln indicates a continuation of a long pattern of increases on prior accident years.

In A.M. Best’s opinion, recent reserving increases primarily are a result of a systemic problem within the organization as a result of Lincoln’s rapid growth in 2002 and 2003. Given the significant reserve deficiencies that Lincoln has exhibited, A.M. Best has concerns about current pricing levels and the challenge the company will face to increase rates or select better risks in the current soft market. Moreover, Lincoln is highly dependent upon Kingsway Reinsurance Corp. of Barbados for reinsurance protection as a primary source of capital support. Because of the concentration of risk in the affiliated reinsurer, Lincoln’s capitalization is highly susceptible to changes in the financial position of Kingsway Reinsurance and the overall capitalization of Kingsway Finanical.

In addition, the reserve increases in 2007 on prior accident years have put current year earnings significantly under projections, and the overall capitalization of Kingsway Financial has been weakened. Furthermore, Kingsway Financial has relied more heavily upon debt financing in recent years to raise capital to support its operation. While the company’s debt leverage is not excessive, it is a concern when viewed with the continuing pattern of loss reserve development and diminishing earnings performance.