Rating firm Standard & Poor's (S&P) has assigned its preliminary 'A-' counterparty credit and financial strength ratings to UK-based single-peril reinsurer Flood Re.
The outlook is stable.
S&P judged Flood Re’s competitive position as adequate, based on its direct sourcing of policies from insurance companies, offset by a significantly undiversified product offering.
Flood Re will source its entire premium direct from insurance companies writing home insurance in the UK. S&P expects Flood Re to build up its premium base quickly, over a period of three to four years, as more insurers seek to compete for business in flood-prone areas without incurring exposure to flood risk.
“We expect that by the end of its third year of operation, about 400,000 polices will be held with Flood Re, providing gross written premium of £80 million - £90 million,” said S&P.
It added: "As a single-peril reinsurer based in just one country, Flood Re's ability to generate returns going forward depend on the UK's flood experience. This limits our view of Flood Re's competitive position.
“We do not expect Flood Re to expand its mission and start insuring small businesses.”
S&P said its overall view of Flood Re's business risk profile is restricted by its dependence on reinsurance in its business model. Flood Re's gross written premium will be intended to be kept below market rates - as a result, its reinsurance utilisation rates will be over 100 percent.
S&P said that although Flood Re is likely to be declared a public body, it does not consider it to be a government-related entity.
“We do not expect that Flood Re would receive any financial support from the UK Government if it was in any financial difficulty; its ability to raise a discretionary levy mitigates the need for this support,” the rating agency said.
“As such, Flood Re does not benefit from any additional notches of support from governmental support.”
S&P said it views Flood Re's business risk profile as satisfactory and its financial strength profile as strong, based primarily on its assessment of its prospective capital and earnings as very strong. It has combined these factors to derive an anchor of 'a-', which it said is the starting point for assigning a rating.
S&P said Flood Re's business risk profile is limited by its dependence on significant amounts of reinsurance for its business model to operate successfully.
It assesses Flood Re's management and governance as fair and its enterprise risk management as adequate. These assessments are in line with S&P’s normal practice for start-up companies that have little or no track record to demonstrate strategic risk management.
Flood Re faces intermediate industry and country risk, according to S&P, reflecting its exposure to moderate risk in the non-life insurance market in the UK and very low country risk. This reflects S&P’s positive opinion of the UK’s institutional framework.
“Our assessment of product risk in the non-life sector in the UK is largely based on unpredictable claims levels from bodily injury claims,” said the firm.
It added: “Although this is not an issue for Flood Re, the moderate industry risk does reflect its exposure to catastrophe risk from floods in the UK.”
S&P said that even when it uses proxy to derive a market-consistent written premium, the reinsurance utilisation rate is over 60 percent. As a result, it considers that Flood Re experiences a lack of
control over a major part of its business operations and we would therefore not assess its business risk profile above satisfactory.
S&P expects Flood Re to build up its capital base over the next three years and maintain 'AAA' levels of capital adequacy according to its risk-based model.
“We expect that almost all of Flood Re's total adjusted capital will comprise retained earnings, which we consider to be strong in quality,” said the firm.
It added: “We do not give credit in our capital model for Flood Re's ability to raise a further discretionary levy (referred to as levy 2) as we include this ability when we assess its financial flexibility.
“As Flood Re aims to provide affordable home insurance for those in flood-exposed areas, we expect that it will be loss-making on an underwriting basis.”
S&P added that it does not expect to raise the ratings in the next three years because Flood Re will still have a limited track record of operations. It would only consider an upgrade when if it is more confident regarding Flood Re's control over the volatility of its capital and earnings.