Standard & Poor's Affirms Lloyd's Market 'A+' Financial Strength Rating

Standard & Poor's has affirmed its single-'A'-plus insurer financial strength rating of the Lloyd's insurance market (the Market). The rating is based on the Market's very strong business position and recent profitability, together with a strong capital base, strong prospective financial flexibility and strong regulatory management. According to Standard & Poor's, these positive factors are partly offset by weaker earnings prospectively, which are, in part, affected by the cost of financing the aftermath of a program of Reconstruction & Renewal. The Market suffered severe losses between the years of account 1988 and 1992 inclusive necessitating R&R, which was finalized in 1996.

The rating reflects Standard & Poor's view of the financial security offered to policyholders by the Lloyd's Market, regardless of the syndicates involved. Lloyd's insurance business is underwritten by syndicates, each of which is backed by its own unique capital base, but policyholder security is also supported by a partial mutualization of Market capital via a Central Fund. The rating applies currently and prospectively to each policy issued by Lloyd's for years of account after 1992.

The rating does not apply to the policy obligations of Equitas Limited, a company established exclusively to accept the reinsurance of Lloyd's outstanding claim liabilities for the years prior to 1992, although the potential for Equitas' loss reserves to deteriorate significantly has a bearing on the rating assigned to Lloyd's.

Major rating factors include:
Very strong business position: Lloyd's has 'capacity' to write UK10.2 billion of gross premiums for 1998. Class, type and territory diversify its business quite widely. It has probably the strongest brand name and license network in worldwide insurance and reinsurance and its client loyalty has proved itself to be exceptionally strong. Partly offsetting these factors, the brand has been somewhat tarnished by the events leading up to R&R, especially in the U.S.

Lloyd's has a share of approximately 1.6% of worldwide non-life premiums and has strong market shares in many of its chosen classes. Lloyd's leadership in marine, energy, aviation and satellite business is widely recognized. Much of the global market infrastructure for these lines resides in London making it the "natural" home for these markets. Lloyd's is also recognized for expertise in directors' & officers' and professional liability business, high hazard property business and reinsurance generally.

Very strong but declining earnings: Lloyd's post-R&R earnings have been very strong, although they are now declining. Lloyd's syndicates earned an aggregate UK1.15 billion before tax for the most recently 'closed' 1995 year of account, representing an estimated return on revenue of 18%. Standard & Poor's estimates that Lloyd's members earned returns on capital averaging between 17% and 19%. This level of profitability represents outperformance of most sectors of the global insurance market.

In the immediate future, Lloyd's operating performance is expected to continue to decline from 1997 levels but will remain acceptable. Given that Lloyd's is well capitalized and is expected to be writing at modest levels of capacity for 1998 and 1999, returns on capital will be relatively modest compared to peers. This is partly due to the intense competition in lines of business where Lloyd's is particularly strong and partly due to R&R costs. Loss making of 1992 and prior years proportions is highly unlikely for the foreseeable future given the greater underwriting discipline and tighter Market controls in existence today.

Very strong regulatory management: Corporation of Lloyd's regulatory management is very strong and independent minded and the lessons of the recent past have been well learned. The Market is being controlled in an increasingly conservative manner. The regulatory team has access to good Market- and syndicate-level data and operates strong regulatory disciplines and processes, including regular detailed reviews of syndicates and managing agents and careful monitoring of underwriting transactions.

Strong capital adequacy: Lloyd's overall capital adequacy is consistent with a single-'A' category rating. The total capital at risk in the Lloyd's Market is at an extremely strong level using Standard & Poor's standards applied to insurance companies. However, Lloyd's has a complex capital structure making direct comparison with companies, which have a single pool of capital, inappropriate. In forming its views on capital, Standard & Poor's has made allowance for Lloyd's contingent exposure to Equitas. If Equitas were to become insolvent, Lloyd's would not be legally bound to meet any shortfalls. However, the pressure that policyholders and regulators may be able to bring to bear could lead to the ongoing market providing some financial support to Equitas.

Strong prospective financial flexibility: Financial flexibility was fully tested and utilized at the time of R&R. Lloyd's has a unique structure which provided that flexibility and its rebuilding is well under way. Unlike stand-alone insurance companies, the Market has solvency mechanisms that "automatically" adjust for planned growth and under capitalization at individual member level. Lloyd's financial flexibility is limited only by the continued viability of the businesses of its participants.

Standard & Poor's expects good profitability for the open years of account 1996 (approximately UK600 million giving returns on revenue and capital of 12.8% and 11%-13% respectively) and 1997 (UK360 million, 11%, 8%-9%). Profitability will be lower again for 1998, but in the absence of major catastrophe losses during the remainder of the year, still acceptable. Earnings will be adversely affected by claims arising from Year 2000 exposures in common with many other insurers.

Standard & Poor's expects Lloyd's long-term earning capacity to be high relative to leading insurance companies. This compensates for an expected level of earnings volatility that is higher than those companies because of the risk profile of the business Lloyd's syndicates write.