OREANDA-NEWS. Fitch Ratings says Zurich Insurance Company Ltd's (ZIC; IFS rating AA-/Stable) ratings may come under pressure from an increase in debt leverage if it issues debt to help fund a potential acquisition of RSA Insurance Group plc (RSA; main operating entities' IFS rating A/Negative). ZIC is evaluating a potential offer for RSA and has until 25 August 2015 to decide whether to proceed.

ZIC has previously said that it has about USD3bn available for M&A. This sum compares with a market valuation of RSA of around USD8bn. ZIC has also indicated that it has an appetite to issue more hybrid debt, so Fitch expects ZIC, if it proceeds, would fund the acquisition with a combination of existing resources and new debt.

Fitch reiterates that an increase in ZIC's Fitch-calculated financial leverage (adjusted debt-to-total capital ratio) to above 30% is the strongest trigger for a negative rating action. ZIC's financial leverage was at 23.2% at end-2014 and the 30% level would potentially be breached if ZIC raises USD5bn or more of additional debt to help finance the acquisition.

A decline in ZIC's capital strength under Fitch's Prism factor-based capital model - which is likely if the acquisition goes ahead - could also lead to a downgrade. While ZIC's capital position might benefit from the added diversification of RSA's business, it could be significantly weakened, in Fitch's assessment, by goodwill associated with the purchase.

Finally, deterioration in ZIC's profitability following an acquisition could also lead to a downgrade, although ZIC has emphasised that any investment must yield at least a 10% return on equity.

With annual premium income of about USD11bn in 2014, RSA is much smaller than ZIC (USD74bn revenues). However, RSA would give ZIC access to attractive markets where it does not yet have a presence, such as Scandinavia, and strengthen its position in the UK and Latin America.

RSA has encountered some significant issues in recent years, most notably the reserve strengthening that was required in its Irish business. The group also had to restore capitalisation through, amongst other actions, a rights issue in 2014 that raised GBP748m net of expenses. The Negative Outlook on its ratings reflects risks associated with the execution of its strategic plan which aims to reduce costs and to rebalance its underwriting portfolio. We believe that gaining a larger, more diversified and higher-rated parent would ultimately be positive for RSA's rating, as it could help it to address the outstanding issues weighing on its credit profile.