S&P revises Lloyd’s to Stable. Expects reinsurance price pressure to hit

Demonstrating that nobody is immune to reinsurance market pricing trends, as the softening witnessed in recent months deepens and is expected to be a major feature of the upcoming January renewals, S&P has revised its outlook on Lloyd’s to stable.

The Lloyd’s of London insurance and reinsurance market, the largest specialist re/insurance market of its kind, is just as exposed to reinsurance pricing pressure, the risk of losing market share and the risk of being marginalised, as any of the independent reinsurers.

With this update to its rating outlook for the market, Standard & Poor’s shows that it expects reinsurance market conditions will become more difficult before any improvement is seen and that this is expected to affect everyone in the marketplace, irrespective of size, breadth of diversity or ability to switch focus to other lines.

Standard & Poor’s revised its outlook on The Society of Lloyd’s and Lloyd’s to stable from positive, at the same time affirming its ‘A+’ insurer financial strength rating on Lloyd’s and its ‘A+’ long-term counterparty credit rating on The Society of Lloyd’s.

Not a downgrade as such, rather an expectation that the outlook is not going to improve anytime soon for Lloyd’s, S&P’s change should perhaps be seen as a warning for many traditional reinsurance players. The rating agency is clearly ready to enact rating downgrades on any company whose ability to ride out the soft reinsurance market looks suspect.

S&P said that the competitive environment across the reinsurance sector and in Lloyd’s key lines of business in particular, is increasingly unfavorable. S&P acknowledges that the Lloyd’s market has seen strong results recently and has god capitalisation, but the fundamental market trends are set to weigh on it going forwards.

“Surplus capacity, the inflow of new capital, and changing buyer demand mean that we anticipate continued negative pressures on profitability and revenues in Lloyd’s core business sectors: reinsurance and specialty lines,” explained S&P.

At the same time individual Lloyd’s players, or syndicates, are also at risk of being marginalised as some of the smaller syndicates will face difficult in maintaining their market shares, in S&P’s opinion.

S&P said that it does maintain its view that Lloyd’s has a very strong competitive position, helped by its franchise, loyal customer base and strong diversification by line of business. However, increased competition in the global reinsurance market will force Lloyd’s to focus on defending its competitive position, believes S&P, particularly the market shares of smaller and more narrowly focused syndicates.

S&P notes that the Vision 2025 strategy that Lloyd’s announced is positive, in terms of broadening the market into new regions and opening the doors to new capital providers, but right now this remains very much a work in progress.

S&P gives the following forecast for Lloyd’s:

In our base-case scenario, we expect Lloyd’s to continue to exhibit strong earnings to sustain its extremely strong capital adequacy. We forecast a combined (loss and expense) ratio of 88%-90% in 2014 and 98%-102% in 2015-2016, assuming average catastrophe loss levels. Historically, such losses have contributed about 12 percentage points to the combined ratio. In our view, over 2014-2016, Lloyd’s should generate a return on capacity of 12% and a return on revenue of 10%-15%. We base these projected returns on strong net income of £2.8 billion in 2014 and £1.5 billion-£2.0 billion in 2015-2016.

In revising the outlook to stable from positive, we are indicating that we consider an upgrade unlikely in the next 12-24 months.

An upgrade would require a marked improvement in the reinsurance sector’s pricing environment.

We do not regard a downgrade as likely in the next two years because of Lloyd’s competitive and capital strengths. However, a return to the more volatile performance of pre-2002 could prompt a negative rating action, as could a catastrophe loss that was significantly outside Lloyd’s expectation or tolerance levels.

Lloyd’s, like every other reinsurance company, is going to have to learn to navigate the current tricky market environment, by embracing innovation, adapting its business model and perhaps even increasing efficiencies, as it seeks to deliver adequate returns to stakeholders.

The reinsurance market pricing pressure we’ve been documenting for over a year is set to hit players like Lloyd’s now. That suggests that the pressure is now affecting every player and we could begin to see some evidence appearing if it is not being dealt with, or responded to, intelligently through the rest of 2014 and into the key January renewals.

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