Best Affirms Lloyd’s UK, China ‘A’ Ratings; Outlook Stable

July 26, 2012

A.M. Best Europe – Rating Services Limited has affirmed the financial strength rating (FSR) of ‘A’ (Excellent) and issuer credit ratings (ICR) of “a+” of Lloyd’s and Lloyd’s Insurance Company (China) Limited (LICCL), as well as the ICR of “a” of the Society of Lloyd’s and the debt ratings of “a-” on the subordinated loan notes issued by the Society in two tranches in November 2004 (6.875 percent subordinated notes of £300 million [$471 million] maturing 17 November 2025 and 5.625 percent subordinated notes of €253 million [$311 million] maturing 17 November 2024), and the 7.421 percent £392 million [$615 million] junior perpetual subordinated loan notes issued in June 2007.

The outlook for all of these ratings is stable.

“Lloyd’s capitalization is expected to remain strong into 2013, underpinned by a stable central capital base,” said Best. “Central assets for solvency purposes rose over 2 percent in 2011 to £3.095 billion [$4.8573 billion] and are likely to remain close to this level throughout 2012.”

Best pointed out that the “exposure of central resources to insolvent members continues to diminish as run-off liabilities decline. In addition, Lloyd’s robust risk-based approach to setting member level capital, as well as its close monitoring of syndicates’ performance and catastrophe exposure, should reduce the risk of material draw downs on the central fund.”

Moreover, Best said it believes that “Lloyd’s internal capital model, which is intended to be used to determine its solvency capital ratio under Solvency II, enhances Lloyd’s understanding of the likelihood and potential magnitude of claims being made upon central assets from future member insolvencies.”

In a recap of the Lloyd’s market’s performance in 2011, Best noted that it “recorded a pre-tax loss of £516 million [$810 million], in contrast to the profit of £2.195 billion [$3.444 billion] reported in 2010.” Best then explained that, “although this appears to be a weak performance overall, it represents a good result given the number and magnitude of the year’s catastrophe events, which continued the catalogue of natural disasters started in 2010 and included further flooding and Cyclone Yasi in Australia, earthquakes in New Zealand and Japan, tornadoes in the United States and floods in Thailand.

“While the results were supported by a significant release from prior year reserves, the on-going low interest rate environment meant that the overall investment return of 1.9 percent was insufficient to offset the underwriting losses completely,” Best added.

Assuming a more normal year for natural catastrophes after the severely catastrophe-affected years of 2010 and 2011, Best indicated that it expects Lloyd’s “to produce a good profit in 2012, supported by prior year reserve releases and investment income. An improvement in the combined ratio to approximately 95 percent from 106 percent in 2011 is anticipated so as to give an outcome more in keeping with Lloyd’s recent history of good results.”

Lloyd’s also benefits from an excellent position in the global insurance and reinsurance markets. Best explained that 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.”

As far as Solvency II is concerned, Best indicated that the change in regulatory regime “poses a threat to Lloyd’s unique capital efficiencies, pending approval of the Lloyd’s internal capital model (LIM).” However Best also said a “smooth transition to the new regime seems likely.

“Preparations for Solvency II are well advanced at both the Corporation of Lloyd’s and managing agents, and, in spite of a very tight timetable, development of the LIM was completed on schedule in readiness for submission to the Financial Services Authority’s approval process at the end of July 2012. Lloyd’s continues to work towards completion of all development work this year, even though implementation of Solvency II has been deferred to 2014.”

Best said its ratings on Lloyd’s China subsidiary, LICCL, “reflect 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 uses 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.

“Continued strong operating performance and capitalization could lead to positive rating actions, while an unexpectedly weak performance or significant erosion of capital would put downward pressure on the ratings.

In conclusion Best noted that it has “withdrawn the FSR of ‘A’ (Excellent) and ICRs of “a+” of Underwriters at Lloyd’s London (IL) (Illinois) and Underwriters at Lloyd’s London (KY) (Kentucky) as these offices do not issue insurance policies.”

Underwriters taking advantage of the U.S. licenses for the Lloyd’s market in these states, as well as in the United States Virgin Islands, issue policies on behalf of Lloyd’s. These policies are supported by the financial strength of the Lloyd’s market.”

Source: A.M. Best Europe

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