S&P warns of tougher times for P&I clubs

But strongly capitalised mutuals expected to continue premium returns to members

Tougher times lie ahead for the protection-and-indemnity clubs with premium income falling and claims becoming more expensive.

The Standard & Poor’s (S&P) ratings agency predicts underwriting could tip into loss for the policy year that ended on Wednesday, although it is expecting a strong investment result to be reported by several clubs, ensuring overall profitability.

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Despite market pressures, S&P remains generally upbeat about the P&I mutuals, noting that restrictions on price competition between the 13 International Group clubs help insulate them to at least a degree from wider insurance market pressures.

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However, Mark Nicholson, the lead analyst on S&P’s annual review of the P&I market, expects the clubs will continue to return premium to members — by not collecting deferred calls in full or through other means.

He suggests there will be continuing pressure to give something back to members even if rates are softening.

This week saw the second consecutive renewal without any club seeking a general increase, with Nicholson viewing this as fuelling an expectation there need not be future across-the-board rate rises.

“Two years without general increases makes it more difficult for the clubs to return to general increases in the future. But this is not to say there couldn’t be general increases if there were significant losses,” said Nicholson.

But the S&P ratings director also admits that looking ahead to future renewals, when the ink is not yet dry on this year’s, is entering the realm of speculation.

“General increases are just the starting point for discussions,” he noted.

The competitive position of eight of the clubs is regarded as strong, with nine having a rating in the A range.

“The P&I clubs remain highly rated for entities of their size and specialisation,” declared S&P, warning that the ratings of the stronger clubs are comparable to major international composite insurers, such as Aviva, RSA, Mapfre Insurance or the Lloyd’s of London market.

Even after several clubs returned capital to members, 10 of the 13 International Group clubs are above the AAA threshold of S&P's capital model, up from seven at February 2017. Capitalisation has strengthened as a result of the clubs’ free reserves growth. But paradoxically, shrinking premiums can also have a positive impact on capital, as a result of the way the S&P model works.

S&P said it expects P&I club profits to come under pressure, with premium income 5% to 8% down for the year to February 2018 on the $3.8bn of the previous year.

The rating agency’s assumption is that premiums will continue to fall, with a tentative turnaround in shipping markets leading to newer, larger vessels paying lower rates. Claims frequency is also down but the average size of claim is increasing, while the incidence of the biggest claims will remain volatile.

S&P puts the club’s return on equity — or more specifically the return on capital, which in the P&I clubs case is the free reserve — at 6%, down from over 10% for the year to February 2017.

The return is expected to remain around the 6% for the coming year, with the combined ratio for both last year and the coming year around the 100% break-even level.

Prospects for the International Group clubs are seen as generally stable with no significant rating changes expected over the next 12 months, although the Swedish Club was recently raised to a positive outlook.

There have also been a number of lesser changes, including the UK Club's enterprise risk management score upgraded to adequate with strong risk controls from adequate. Britannia's and Skuld's liquidity scores both changed to exceptional from strong.

Somewhat earlier, the North of England’s score was raised from intermediate to very strong, while the "anchor" or base rating of the Shipowners’ Club moved from A- to a straight A.

S&P said it believed the P&I clubs were “well positioned to withstand a repeat of the financial crisis, even if asset values and underwriting returns were to be impacted negatively at the same time”.

Nicholson doubts that the recent volatility of financial markets will have significant impact, even though the P&I clubs are more invested in equities than most other insurers.

“They are long-term investors, so our view of the clubs has not changed.”

However, S&P has dropped financial flexibility from its published P&I club score sheet criteria this year but still takes this into consideration in the determination of ratings.

The reason is the P&I clubs have broadly similar flexibility, with only the UK Club, which has a $100m subordinated loan that qualifies as hybrid capital, in a somewhat different position.

Meanwhile, S&P remains sanguine about the impact of Brexit and in particular how it will affect the six UK-domiciled clubs.

“We do not expect Brexit to make a significant difference to the clubs' operations or ratings. The UK-domiciled clubs are preparing for the possibility of a 'hard Brexit' by establishing subsidiaries in European Union countries. However, while this is a regulatory burden and an additional expense, we do not think that their business models will change significantly,” said the ratings agency.

The S&P report makes no mention of merger interest in the P&I market or developments in the fixed-premium sector, but notes that diversification “has not always proved profitable for the clubs”.

HOW STANDARD & POOR'S SCORES THE P&I CLUBS

Competitive position Business risk profile Capital & earnings Risk position Financial risk profile Anchor Management & governance Enterprise risk management Liquidity Financial strength rating Outlook
Gard Strong Strong Extremely strong Intermediate Extremely strong A+ Satisfactory Strong Strong A+ Stable
Britannia Strong Strong Very strong Intermediate Very strong A Satisfactory Adequate Exceptional A Stable
North of England Strong Strong Very strong Intermediate Very strong A Satisfactory Adequate with strong risk controls Strong A Stable
Shipowners' Strong Strong Very strong Moderate Strong A Satisfactory Adequate Exceptional A Stable
Skuld Strong Strong Strong Intermediate Strong A Satisfactory Adequate Exceptional A Stable
Standard Strong Strong Very strong Moderate Strong A Satisfactory Adequate with strong risk controls Exceptional A Stable
Steamship Mutual Strong Strong Very strong Moderate Strong A Satisfactory Adequate with strong risk controls Exceptional A Stable
United Kingdom Strong Strong Very strong Intermediate Strong A Satisfactory Adequate with strong risk controls Exceptional A Stable
West of England Adequate Satisfactory Very strong Moderate Strong A- Fair Adequate Exceptional A- Stable
Swedish Adequate Satisfactory Strong Moderate Moderately strong BBB+ Satisfactory Adequate with strong risk controls Exceptional BBB+ Positive
Japan Adequate Satisfactory Moderately strong Moderate Upper adequate BBB+ Fair Adequate Exceptional BBB+ Stable
London Less than adequate Fair Moderately strong Moderate Upper adequate BBB Fair Adequate Exceptional BBB Stable
American Adequate Satisfactory Upper adequate Moderate Less than adequate BBB- Fair Adequate Exceptional BBB- Stable

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