Lloyd’s on the cusp of ‘AA’ range ratings; this could be a game-changer

During the summer both A.M. Best and Fitch assigned ‘positive’ outlooks to their current Lloyd’s market ratings. S&P did so last year.

Translating the A.M. Best rating scale to the one used by S&P and Fitch this means that Lloyd’s is rated ‘A+’ with a positive outlook by all three agencies.

While a subsequent upgrade from any one agency is not a given this suggests (absent a – truly – major loss) that a ‘AA’ range rating from one or more of the agencies is very likely in the not too distant future.

This would be both a notable step in the long-run post R&R transformation of Lloyd’s and also a profound event for the global reinsurance and specialty lines sector.

If the latter point seems like hype, consider this; only eight of the largest 40 reinsurance groups in the world have a major reinsurance carrier rated in the ‘AA’ range by S&P*. Lloyd’s paper would be rated equivalent, or close, to the strongest globally available from professional reinsurers. Yet organisations can transact business via Lloyd’s who could never begin to achieve that rating level independently.

Writing at Lloyd’s for any re/insurance group with an ability to also write via its own carriers is often seen as a ‘trade-off’. The market costs and Franchise Board oversight are seen (by some at least) as negatives, while the licences, (potential) capital efficiencies, distribution and brand are positives. The current rating is an important positive for many – but not all – and not so much that it is the overwhelming factor for much of the market’s capacity.

BUT, if the decision to trade at Lloyd’s also means the ability  to offer ‘AA-‘ paper then it becomes a whole new ball game.

Even very well known ‘A’ or ‘A+’ rated groups (for their non-Lloyd’s carriers) that are active at the market might now say “of-course we can offer you ‘AA-‘ paper via our Lloyd’s platform if you prefer”. We could even finally see some true ‘credit risk’ based pricing spreads emerge. And those not active at the market would be faced with a very different ‘cost/benefit’ scenario about whether to pursue participation.

Of course, we should not confuse this with the idea that a rating is, per se, the only way re/insurers, brokers, or buyers should communicate or evaluate financial strength. At Litmus we have long argued that a balanced set of inputs should be considered. Nonetheless, there’s no avoiding the fact that a ‘AA-‘ rating in the reinsurance market is a very powerful card.

How Lloyd’s might react to any flood of participation interest is itself an issue. The rating agencies have heavily bought into the ‘selectivity’ and oversight of the Franchise Board in getting to the current rating levels (along with the demonstrated robustness of the ‘market level’ capital model). So, from both a ‘market’ and a ‘ratings protection’ perspective the Franchise Board is likely to be very cautious about any ‘upgrade driven’ participation interest.

Nonetheless the market wants risk spread in the world’s growth economies and what better way to get it than by being able to say ‘if you meet our standards you can offer ‘AA-‘ paper to your clients’; a rating level higher than that of the sovereign in most of those markets.

* Source: S&P’s Global Reinsurance Highlights 2013

Stuart Shipperlee, Analytical Partner

The Litmus First XI – Top Tips for Managing the Relationship with your Rating Agency

The Numbers

1.       Make sure the agency capital model is completed properly

Obvious, but we’ve seen a number of examples where there were errors that weakened the result and/or key strengths that could have been highlighted but were missed.

2.       Prospective earnings are crucial, but you have to make a compelling case for them

Both AM Best and S&P have always seen prospective earnings as fundamental to the rating and S&P’s recent criteria change* makes this even more explicit.  It’s partly about your track-record but also the ‘why’ of how your market position, competitive advantages and underwriting controls will deliver the results you are forecasting.

3.       They are NOT asking you to diversify!

It might seem like this and they might even appear to suggest it (although they shouldn’t as that would be ‘advice’) but this is just a confusion of the analytical point. Namely, concentration risk is a fact of life for specialists and you get penalised for it if that is your profile. That is not ‘solved’ by ‘diversification for diversification’s sake’, unless it’s into areas you can demonstrate you really understand well and that you will not be ‘buying business’ (both of which they will be concerned about).

4.       Reserve adequacy is always a concern

It’s the hardest thing for a third-party analyst to be confident about. If you think you over-reserve provide as much supporting evidence (succinctly!) that you can. If you have under-reserved in the past they are bound to be worried, so address it.

The People and the Process

5.       Remember ratings are decided by committees (not individuals or computers)

The analysts you meet are your communication channel to the members of the committee. Not only do you need them to believe in the strength of your profile they need to be able to effectively explain this to a committee whose job is – in part – to be sceptical.

6.       Why don’t they believe us?

Claiming future success (even given a strong track-record) is not enough. It might seem galling that they won’t just accept what you say at face value but that’s their job. Give analytical reasons for believing in your strengths (market share, distribution channel strengths, underwriting controls, specialist knowledge, strength of client relations etc.) and data/research that support them.

7.       Don’t look to rely on ‘comments’ you make at the management meeting

If it’s important, put it in the presentation. Even if they accurately note all your verbal comments and responses to questions, they may not remember the exact rationale. That will not work with the committee.

8.       Understand the point of each part of the criteria and address all their questions

Each part of the rating criteria has a point to it in terms of deciding the rating. The better everybody involved understands what that is the more likely you are to successfully explain your strengths in that context and/or address any perceived weaknesses.

9.       Make sure the message is clear and memorable

If you believe you have a good story to tell on any part of the analysis put the message in the slide heading (don’t leave it as the final point at the bottom of the slide!).  If something is subjective use memorable anecdotes to illustrate the point.

10.   Graphs and diagrams are good but don’t be too clever, or cute, with them

Use graphs to clearly show the important trend, fact or process. But don’t make them too complex or the power of the point will get lost. And don’t be ‘cute’ with the years you select or the ‘axes’ of a graph. They will probably spot it (or, worse, they will miss it but somebody at the committee will notice).

11.   ERM is a strategic process

Make sure you cover your ERM function specifically but also make sure it’s clear how it informs strategy, derives from the board and is embedded across your operations.

*Litmus’ next training course on S&P’s new rating criteria is in London on September 18^th. A few places remain.

This Litmus summary guide was first published in the Intelligent Insurer daily newsletter at the Monte Carlo Rendezvous on Sunday 10^th September 2013

Litmus Analysis Quick Reference Guide – to non-life re/insurer key metrics and ratios

Analysing a non-life re/insurer can be a complicated process; however some of the most important information is the data in the public accounts.

This quick reference guide gives an overview of the more commonly used metrics and ratios. by its nature the guide summarises the descriptions provided.

Litmus Quick Reference Guide_2013

For a complimentary copy of the full Litmus Ratio Guide please contact: info@litmusanalysis.com

 

 

The Perils of Ineffective Use of Ratings

This article, in the pdf accessed through the link below, gives guidance to re/insurance practitioners on the basics of ratings and how to use them effectively.

The perils of ineffective use of ratings

An abbreviated version of the article, without diagrams, can also be found here – www.youtalk-insurance.com