Since January the rating agencies have become increasingly negative on their outlook for ratings in the reinsurance sector overall, while in practice affirming or even increasing individual reinsurer* ratings. Standard and Poor’s move to take Lloyd’s rating outlook down from ‘positive’ to ‘stable’ is the first explicitly negative reaction by an agency to the market environment, according to a commentary from Litmus Analysis, the company that helps the industry understand insurance ratings.
Weak pricing driven by too much capital supply is a challenging mix for the agencies, whose job is to rate prospective, not simply current, financial strength, i.e., at what point does the comfort blanket of too much capital yield to a concern over insufficient future profits (or worse)? Litmus continued.
But the real news […] is S&P’s earnings forecast for the Lloyd’s market and what that implies for its other ratings on those writing reinsurance, said Litmus.
S&P is by far the most explicit of the agencies in defining its forward looking performance assumptions when assigning individual ratings. To date, for the 23 groups in its global reinsurer cohort, these forecasts had all been for year-end 2014 and 2015 numbers. With rare exceptions the agency had been predicting 95 percent combined ratios or below for both years (subject to normal cat losses).
By contrast, for Lloyd’s, while S&P expects a robust 88-90 percent combined ratio for 2014, it is predicting a 98-102 percent range for both 2015 and 2016 (again subject to normal cat. loss experience).
S&P’s annual review cycle for Lloyd’s falls relatively late in the calendar year, Litmus noted. This means that its 2015 forecast can reflect more experience of the current soft market and its likely development through 2015 than was available with many of its reinsurer rating announcements earlier in the year. This is also why Lloyd’s is now the first to see a 2016 forecast from the agency (which operates on a “two years forward” horizon for earnings forecasts).
Of course each of the global reinsurance groups has its own unique blend of business lines (including primary market exposures for most and life reinsurance for a few). But it’s tough not to see a Lloyd’s forecast as a proxy for the agency’s latest view of “reinsurance & specialty” sector overall.
Moreover S&P assesses Lloyd’s competitive position as “very strong.” This part of the analysis reflects specifically the agency’s view of the relative ability to cope with a downturn versus peers. Since only 7 of the other 22 groups achieve either this or the highest “extremely strong'” assessment it’s hard to imagine Lloyd’s will be the only group (as it is treated for rating purposes) materially active in reinsurance & specialty to see its rating, or at least its outlook, hit by the soft market in the coming months.
Rated groups can tend to assume that it is their capital profile, rather than their business profile, which really drives their rating, but both are critical, Litmus said. And in this environment in particular they will need to present a strong case to persuade S&P both “how” and “why” their competitive and managerial strengths, combined with the quality of their ERM, will help them to profitably navigate the soft market.
*Litmus used the 23 groups included in S&P’s “global reinsurer” cohort as its base case. Most of these also have significant primary market exposures.
Source: Litmus Analysis
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