S&P’s forecast for Lloyd’s results; the first explicit sign of a much more bearish view of sector earnings.

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. S&P’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.

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)?

Lloyd’s – we have to say –  would not have been anywhere near the top of our list of candidate reinsurers to be first to be feeling any agency heat from the current environment (indeed Fitch recently upgraded the market to the rarefied ‘AA-‘ level and the A.M. Best rating of ‘a+’** remains on positive outlook). The background to the market’s S&P rating is quite a complex ratings story (see July’s Litmus Ratings Review). Moreover the removal of the potential for an S&P upgrade to ‘AA-‘ from its current ‘A+’  in reality still means the affirmation of a strongly positive fundamental view about the market’s strength. To some degree the agency will have felt a need to ‘resolve’ the outlook simply because of the time it had been in place (over 2 years).

But the real news is not the arcane world of rating outlooks; it’s S&P’s earnings forecast for the market and what that implies for its other ratings on those writing reinsurance.

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% 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% combined ratio for 2014 it is predicting a 98-102% range for both 2015 and 2016 (again subject to normal cat. loss experience).

It just so happens that S&P’s annual review cycle for Lloyd’s falls relatively late in the calendar year. Meaning 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 & speciality’ 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 & speciality 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.  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.

*We are using the 23 groups included in S&P’s ‘global reinsurer’ cohort as our base case. Most of these also have significant primary market exposures

**This is the Best “Issuer Credit Rating, ‘ICR’’ for the market (which it issues using the S&P type rating scale)

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