S&P Lloyd’s outlook the first of many

Rating agency Standard & Poor’s (S&P) recent revision of its Lloyd’s market outlook to stable from positive could be the first warning of more negative actions and downgrades for the wider reinsurance industry.

This is according to Stuart Shipperlee, partner at ratings analytics firm Litmus Analysis, who believes reinsurers are also likely to face negative rating actions or negative changes to their outlook in 2015.

“The change in Lloyd’s outlook reflects the pressure from the negative outlook for the reinsurance industry and a significantly worse earnings forecast to essentially break even on underwriting for both 2015 and 2016,” Shipperlee said.

“It’s hard to see why that would not be a similar experience for a number of other reinsurers. We are expecting more negative rating actions or at least negative changes to outlooks through 2015.”

S&P has assessed Lloyd’s competitive position as ‘very strong’. A recent report by Litmus said that this part of the analysis reflects specifically the agency’s view of the Lloyd’s market’s relative ability to cope with a market downturn versus its peers.

“Since only seven 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 and speciality to see its rating, or at least its outlook, hit by the soft market in the coming months,” said the report.

In January this year, S&P downgraded the reinsurance market’s outlook as a whole to negative. It was soon followed by downgrades from AM Best and Moody’s, although Fitch has remained with its stable outlook.

“We’ve been noticing a disconnect between the very negative sentiment about pricing in the reinsurance market, particularly in the US property-catastrophe market, and earnings forecasts that are only moderately worse than reported earnings for last year,” Shipperlee said.

“Not only had we not seen any negative specific rating actions on noteworthy reinsurers, but the 2015 forecasts that both the companies and rating agencies provided were only marginally worse, with typically a better than 95 percent combined ratio expectation assuming ordinary cat losses in 2015.”

Litmus said that Lloyd’s would not have been anywhere near the top of its list of candidates to be hit by a negative rating action.

“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,” said the report. “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 two years).”

The report added: “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, ie, at what point does the comfort blanket of too much capital yield to a concern over insufficient future profits (or worse)?”

Litmus added that the real news here was not rating outlooks, but S&P’s earnings forecast for the market and what it 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 percent combined ratios or below for both years (subject to normal cat losses),” said the report.

Although S&P expects a 88–90 percent combined ratio for 2014, it has predicted a 98–102 percent range for both 2015 and 2016, subject to normal cat losses.

Shipperlee explained that S&P’s annual review cycle for Lloyd’s falls relatively late in the calendar year.

“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),” said the report.