S&P Upgrades Lloyd’s Ratings to ‘A+’

April 24, 2007

Not so long ago it was beginning to look like “A” ratings were an endangered species. However, after a lot of belt tightening (and a benign year for nat cats in 2006), the rating agencies have been raising, rather than lowering ratings.

The latest happy occurrence came with yesterday’s announcement that Standard & Poor’s Ratings Services has raised its insurer financial strength rating on the Lloyd’s insurance market to “A+” from “A.” S&P also raised its counterparty credit rating on The Society of Lloyd’s to “A+” from “A,” and assigned all of the ratings a stable outlook.

“The upgrade reflects the recent successful conclusion of phase 1 of the Equitas group’s (Equitas; not rated) transaction with National Indemnity (NICO),” which, as part of Berkshire Hathaway, basks in the sunshine of an “AAA” rating.

S&P also cited the “progress with regard to phase 2; and the unstoppable momentum behind improving London Market business processes (See also IJ web site April 23).

S&P explained that “in the Equitas transaction, NICO will provide up to £3.8 billion ($7.0 billion) of reinsurance for Equitas’ loss reserves, rendering the likelihood of a future Equitas deficit and any related contribution from Lloyd’s remote. Phase 1 involves a £3.1 billion [$6.2 billion) reinsurance, and phase 2 involves a novation of liabilities from Lloyd’s members to Equitas and the provision of a further £0.7 billion [$1.4 billion] of reinsurance.”

In addition the rating agency pointed to “Lloyd’s strong competitive position, strong operating performance, strong capitalization, and strong financial flexibility,” as positive factors. However S&P said these are partly offset “by relatively high reinsurance reliance and continuing operating performance volatility. The consistency and effectiveness of strengthened catastrophe risk controls are also yet to be tested.”

S&P listed a number of “Major rating factors,” which are summarized as follows:
— Lloyd’s competitive position is strong, supported by the positive attributes associated with its unique brand, attraction as the world’s largest subscription market, London’s continued position as a major international insurance and reinsurance market, and policyholder loyalty.
— Lloyd’s prospective operating performance will be strong. Extremely benign catastrophe loss experience led to the Market posting a combined ratio of 83.1 percent and record profit before tax of £3.7 billion for 2006, in stark contrast to the 111.8 percent combined ratio and £103 million loss recorded for 2005. Although pricing levels have passed their peak, the Market still provides an attractive underwriting– Capitalization is strong, supported by strong and improved capital adequacy and the expected continued efficacy of capital-setting processes.
— Lloyd’s financial flexibility is strong, being principally derived from capital providers’ continued support. This was most recently demonstrated by capital providers’ response to the capital and liquidity demands generated by the 2005 hurricane season and recent Market capacity increases.
— The 2005 performance of some Lloyd’s franchisees highlighted some catastrophe risk control deficiencies that appeared to be common to the reinsurance and insurance industries. Management action in the intervening period has sought to address highlighted weaknesses, but its consistency and effectiveness is yet to be tested following the benign nature of 2006.

In assigning a “stable outlook S&P cited the following expectations:
— Subject to normal catastrophe loss experience for 2007, Lloyd’s will post a combined ratio below 95 percent and ROR greater than 12 percent. Performance will weaken in 2008 in line with an anticipated continuing softening operating environment.
— Lloyd’s main capital providers will remain committed to the Market.
— There will be further rapid improvement in the London Market’s administrative processes. Momentum should continue to build with regard to claims processing, accounting and settlement, and policy placement, and legacy issues will start to be addressed.
— Catastrophe-related operational weaknesses will prove to have been successfully strengthened.
— Capital adequacy will remain strong, as reflected in central assets available for solvency purposes remaining at about £1.75 billion and Lloyd’s solvency ratio remaining above 300 percent.
— Operating performance of the continuing Market will not be negatively affected by further net deterioration in technical reserves. The drag on Lloyd’s from run-off syndicates will continue to decline.
— Undertakings given to insolvent members will continue declining (charge for undertakings was £114.6 million in 2006).
— Equitas will successfully complete phase 2 of the NICO transaction.

However, S&P indicated that an “outlook revision to positive is unlikely in the medium term, and would depend on Lloyd’s significantly outperforming targets over a sustained period.”

It also indicated that an outlook revision to negative is unlikely, but, if it were to happen, “would likely be driven mainly by operating performance returning to levels recorded prior to 2002, reflecting poor management of the softening underwriting cycle. Failure to complete the administrative process reform would also result in a negative outlook.”

Lloyd’s management was obviously pleased by S&P’s upgrade. Chief Executive Richard Ward said it was “another significant achievement” for Lloyd’s, adding that “it recognizes the progress that Lloyd’s has made over the last six years, particularly in the areas of financial strength and security and business process reform.”

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