Best Affirms Lloyd’s, Lloyd’s (China) Ratings; Outlook Positive

July 28, 2014

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

Best also affirmed the ICR of “a” of 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 (£153 million [$260 million] 6.875 percent subordinated notes maturing 17 November 2025 and €214 million [$287.5 million] 5.625 percent subordinated notes maturing 17 November 2024), as well as the debt rating of “bbb+” on £392 million [$665. 6 million] 7.421 percent junior perpetual subordinated loan notes issued in June 2007.

The outlook for all of the ratings remains positive.

Best explained that the positive outlook “reflects Lloyd’s strong operating performance in recent years, in spite of the exceptional record of natural catastrophes in 2010 and 2011, together with Best’s assessment of the robust oversight of the market by Lloyd’s and its demonstrable success in reducing earnings volatility. The outlook also recognizes the steady improvement in the market’s risk-adjusted capitalization.

As an offsetting factor Best’s report cited “the increasingly challenging conditions in Lloyd’s core markets, particularly for reinsurance business.” Best said it would “continue to monitor closely the impact of deteriorating rates, together with changes in terms and conditions, on Lloyd’s underwriting performance.”

Best also explained that the “stability of Lloyd’s central capital base” supports its view that “capitalization will remain strong in 2014 and into 2015. Central assets for solvency fell by 2 percent in 2013 to £3.157 billion [$5.36 billion], reflecting a buy-back of approximately £180 million [$305.6 million] of subordinated debt in May 2013, but are likely to remain close to this level throughout 2014.

“Lloyd’s intentions regarding the potential buy-back of approximately £178 million [$302.2 million] of euro-denominated debt at its call date in November 2014 have not been finalized at this stage.”

Best’s report also noted 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, reduces the risk of material drawdowns on the central fund.”

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

“When setting the member level capital requirement, Lloyd’s applies a 35 percent economic capital uplift to each syndicate’s solvency capital requirement. This level of uplift has been retained for 2015,” but, Best added that should it change in the near future, the rating agency would “review the implications for risk-adjusted capitalization and react accordingly.”

Best also described Lloyd’s 2013 profit – £3.205 billion [$5.4417 billion] – as “excellent,” indicating that it reflected a “generally benign year for natural catastrophes,” and that the result was also “supported by prior-year reserve releases of £1.575 billion [$2.674 billion].”

The report indicated, however, that the “low interest rate environment continued, depressing investment returns. Assuming a normal year for catastrophe events, performance in 2014 is expected to be marginally weaker than in 2013.”

Best also noted that there “have been some significant losses in the first half of 2014, but a combined ratio between 90 percent and 95 percent is anticipated (2013: 85 percent). Underwriting results are again likely to be supported by prior year reserve releases, albeit at a more modest level than in recent years.

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

Best said the ratings of LICCL “acknowledge the explicit support it receives from Lloyd’s in the form of quota share retrocession contracts that transfer all reinsurance risk underwritten to syndicates that elect to write reinsurance business through LICCL.

“In addition, the ratings take into account the operating model 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.”

In conclusion best said “Lloyd’s continued strong operating performance and capitalization could lead to positive rating actions, but an unexpectedly weak performance or a lower level of capital would put downward pressure on all ratings.

Source: A.M. Best

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