Fitch warns Lloyd’s on underwriting performance, catastrophe exposure

Ratings agency Fitch has issued a stark warning to the Lloyd’s of London insurance and reinsurance market, turning its rating outlook to negative, citing the market’s deteriorating underwriting performance and its increasing exposure to catastrophe risk.

Fitch has calculated the Lloyd’s market combined ratio at 98%, which it calls a “significant deterioration from recent performance” and down to both the softened insurance and reinsurance rate environment, higher expenses, as well as a return to more normal levels of catastrophe activity.

Fitch warns that this level of combined ratio needs to come down, saying that “A downgrade may occur if the net combined ratio remains above 97% for a prolonged period.”

Fitch also warns on the Lloyd’s markets exposure to natural catastrophe risk, which it sees as higher than peers. In fact it sees the markets catastrophe exposure as increasing, “In the context of continuing pressure on both risk-adjusted premium rates and expense ratios at Lloyd’s.”

“Fitch believes that exposure to catastrophe risk has increased in recent years despite declining margins on this line of business. However, Fitch believes that Lloyd’s exposure management, through the group’s modelling capabilities and the reinsurance in place, allows the market to mitigate tail risks to some extent,” the rating agency explained today.

But Lloyd’s strong business profile and position as one of just a handful of premier providers of insurance and reinsurance does support the markets ratings, Fitch said.

As long as losses fall with expected limits Fitch believes the capital structure at Lloyd’s can continue to support the markets needs.

Fitch also notes that underwriting discipline means that Lloyd’s has been scaling back in some lines of business and would expect this to continue while the market remains so under pressure.

As well as warning of a possibly downgrade if the combined ratio remains elevated above 97%, Fitch also warns that downgrades to Lloyd’s ratings could be considered if it suffers an extended period of underperformance or a proportionally larger net catastrophe loss compared to competitors or its market share.

Given the continued softening of reinsurance, the increasing competition from alternative and capital markets, the threat that broker facilities can pose, and major global reinsurers desire to originate risk more directly and to underwrite primary specialty or large commercial lines, it’s hard to see market conditions getting any easier for Lloyd’s.

The market is doing its best to become more efficient, just in recent days announcing a 10% head count cut for the Corporation, but perhaps now is the time that Lloyd’s needs to look more deeply at the return requirements of its capital providers, and ask whether there is more efficient third-party sources out there today.

That could assist in improving the markets underwriting performance, by enabling a higher margin to be booked perhaps, while greater use of third-party capital on the other side, to hedge its own growing catastrophe risk, could also assist with the other key issue that Fitch highlights today.

Fitch said today that it has revised the Lloyd’s of London (Lloyd’s) and Lloyd’s Insurance Company (China) Ltd’s Outlook to Negative from Stable, but affirmed the Insurer Financial Strength (IFS) Ratings at ‘AA-‘. It also revised the Outlook for the Society of Lloyd’s to Negative from Stable while affirming the Long-Term Issuer Default Rating at ‘A+’.

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