Best Affirms Lloyd’s of London’s ‘A’ Ratings

July 14, 2011

A.M. Best Europe – Rating Services Limited has affirmed the financial strength rating of ‘A’ (Excellent) and issuer credit rating (ICR) of “a+” of Lloyd’s of London and Lloyd’s Insurance Company (China) Limited (LICCL).

Best also affirmed the ICR of “a” and the debt ratings of “a-” on the subordinated loan notes issued in two tranches in November 2004 (6.875 percent subordinated notes of £300 million [$484.66 million] maturing 17 November 2025 and 5.625 percent subordinated notes of €253 million [$358.5 million] maturing 17 November 2024), as well as the 7.421 percent £419 million [$676.88 million] junior perpetual subordinated loan notes issued in June 2007 of the Society of Lloyd’s.

The outlook for all of the ratings is stable.

Best said that Lloyd’s capitalization is “expected to remain strong into 2012, underpinned by a stable central capital base. Central assets for solvency purposes rose 8 percent in 2010 to £3.046 billion [$4.92 billion] and are likely to remain close to this level throughout 2011. The exposure of central resources to insolvent members continues to diminish as run-off liabilities decline. In addition, the Corporation’s robust risk-based approach to setting member level capital, as well as its close monitoring of the various syndicates’ performance and catastrophe exposure, should reduce the risk of material draw downs on the central fund from future member insolvencies.”

However, Best also indicated that Lloyd’s earnings in 2011 are “expected to deteriorate from the solid £2.195 billion [$3.538 billion] reported in 2010, reflecting above average catastrophe losses in the first half of the year, and to a lesser extent, challenging market conditions for casualty business.”

Best cited the earthquake and tsunami in Japan, with overall net claims to Lloyd’s estimated at £1.22 billion [$1.97 billion], the earthquake in New Zealand estimated at £750 million [$1.211 billion] and the flooding in Australia at £406 million [$655.75 million] as the largest loss events so far this year. However, Best also noted that, although these loss estimates remain subject to considerable uncertainty,” they do not exceed Best’s “expectation for Lloyd’s exposure to such events, and central capital is unlikely to be affected.”

Best’s analysis concluded that it remains possible for Lloyd’s to post a net profit this year “in spite of the difficult start to the year, with the support of prior year surpluses and investment earnings.” But Best is anticipating an underwriting loss for the year, which it said “is likely to be modest in the absence of above average catastrophe losses in the second half of the year.”

Lloyd’s pre-tax £2.195 billion profit in 2010 and its £3.868 billion profit in 2009 – the all time record – were both excellent. The reduction in earnings in 2010 reflected the impact of the year’s catastrophes, particularly the Chilean and New Zealand earthquakes and the Deepwater Horizon oil rig explosion.

In addition Best noted that the results “benefited from an overall reserve release of £1.016 billion [$1.64 billion] (2009: £934 million [$1.5 billion]), “despite the adverse development of motor reserves and lower surpluses on casualty reserves.

“Lloyd’s benefits from an excellent position in the global insurance and reinsurance markets,” Best continued. “The collective size of the market and its unique capital structure enable syndicates to compete effectively with large international insurance groups under the well recognized Lloyd’s brand.

“Good financial flexibility is enhanced by the diversity of capital providers, which include corporate and non-corporate investors. Although a number of traditional Lloyd’s businesses have established other underwriting platforms in locations such as Bermuda, the United States and Switzerland, their commitment to the market remains strong. In addition, Lloyd’s continues to attract international businesses, drawn by its capital efficient structure and global licenses.”

With the imposition of the EU’s Solvency II regulations for the insurance industry looming ever closer, Best indicated that Lloyd’s should achieve a “smooth transition” when they come into force in 2013, “including the approval of a Solvency II compliant internal capital model.” Best described this as being “crucial if Lloyd’s is to retain its unique capital efficiencies. The calibration of the Solvency II standard formula has yet to be finalized, but the fifth Quantitative Impact Study (QIS5) provided some insight into the capital burden that may result if internal model approval is not achieved.

“Preparations are well advanced at both Corporation and managing agent level, but Lloyd’s is working to a tight timetable and published deadlines must be met if compliance and model approval are to be achieved.”

Best’s ratings of LICCL reflect its “explicit support from Lloyd’s in the form of quota share retrocession contracts that transfer all reinsurance risk underwritten to syndicates that elect to write business through LICCL. In addition, the ratings take into account the operating model that LICCL will use to write direct insurance business employing mechanisms that comply with local regulatory requirements but that transfer the greater part of the risk to Lloyd’s.”

Source: A.M. Best

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