P&I Clubs Have Seen A Sharp Turnaround In Underwriting Fortunes
For the first time since 2018, protection and indemnity (P&I) clubs have on average recorded an underwriting profit at half-year. S&P Global Ratings expects that for the full year the clubs’ average combined ratio will be 95%-100%. The change in underwriting fortune has primarily been driven by a complete lack of new pool claims for the policy year 2022-2023 to date. While the second half of the year tends to see a higher amount of pool claims, so far there are still no new claims notified to the pool. The 13 members of the International Group (IG) share claims of $10 million to $100 million with other members of the IG under an excess-of-loss pooling system.
The lack of pool claims is highly unusual for the sector and especially so after four years of comparatively high levels of claims (with 2021-2022 breaking records at half-year). We therefore anticipate the 2022-2023 policy year will likely see a below-average pool cost for the clubs, suggesting the high levels in preceding years were not the start of a new normal. The improved underwriting result is also a consequence of the hard line clubs took at the last renewal where they asked for an average 11.5% increase, the highest in over a decade. Many clubs also tightened terms and significantly increased the level of deductibles as the market hardened. We believe that for most clubs this has helped reduce the cost of their own mutual claims book. A drop off in claims related to COVID-19 has also helped reduce the claims burden. Against these positives, inflation has eroded some of the underwriting margin that the clubs’ significant increases at renewal should have generated.
Despite the significant turnaround in underwriting fortunes, we expect nearly all 13 IG clubs to record overall bottom-line losses for the year ending February 2023, placing further strain on clubs’ capital adequacy. Significant moves in interest rates during 2022 have led to sizable drops in the values of both the equity and bond markets. As the clubs mark-to-market their investment portfolios we expect that all will show significant unrealized losses that will offset the gains made on the underwriting side. Economically, the losses on clubs’ bond portfolios are less significant because falls in values are largely offset by an increased discount rate on clubs’ liabilities. The clubs will also benefit in the future from a higher yield on their bond portfolios as they re-invest in new higher yielding bonds. That said, following four years of poor underwriting performance and the investment losses in 2022 many clubs’ capital positions are under strain, with several falling below our ‘AAA’ benchmark. Robust capital adequacy has traditionally been a strength for the sector, but many clubs will need a strong 2023 to rebuild previous levels of adequacy.
Clubs Face A Rates Challenge At Renewal
We expect the clubs will again be asking for rate increases at renewal. The average general increase is unlikely to be in the double digits, but instead come in at about 7%. While this is down on the prior year’s 11.5% it is still at the upper end of increases we have seen over the last decade. We believe that rates in the mutual P&I sector are still below the technical level clubs would wish for despite the strong underwriting performance this year. While the clubs have had to increase reserves for previous years’ pool claims, the lack of new claims to the pool has provided a boost to underwriting that is unlikely to be repeated in the upcoming years. With inflation in developed economies at its highest for decades, the managers of clubs will also be keen to ensure that they receive sufficient premium to offset any significant increase in the cost of claims over 2023. As nearly all mutual P&I premium incept on Feb. 20, IG clubs are unable to adjust premium throughout the year like most other insurers, leaving them somewhat exposed to a rapid acceleration in inflation.
We expect that, despite the likely lower general increase for 2022-2023 compared to the prior year, the clubs will likely face a tougher renewal conversation than last year. Whereas this time last year the clubs were looking at another underwriting year loss and a record half-year on the pool, this year sees the majority making solid underwriting profits with a well-below-average cost from the pool. As the P&I clubs pass the cost of the pool excess of loss reinsurance straight through to their P&I members, the likely increase in rates at the 2023 renewal will further increase costs for members. We expect that shipowner members may also be feeling less congenial this year. At the time of renewal discussions last year, many shipowners were enjoying the best conditions seen in the market for over a decade as the supply-chain fallout from COVID-19 boosted containership freight rates in particular. This year we have seen rates for containerships and bulkers return to more normal levels.
Rating Actions Continue To Be Skewed To The Negative
The year to October 2021 was the most active for rating actions on the P&I clubs in over a decade. Twelve months ago, nine of the 13 clubs were on negative outlook, mostly because of declining technical profitability leading us to question their competitive positions in the market. Seven of these clubs have remained on negative outlook over the last 12 months. While rate increases were put through in the 2022 renewals and technical results have generally improved in the current year, this is in the context of very low major claims. We would need to see a longer period of improved results before feeling more confident in the stability and profitability of the market.
We took four rating actions in the sector between November 2021 and October 2022:
• In November 2021 we downgraded U.K. Club to ‘A-‘ from ‘A’. Its technical result had been below our expectations and behind peers’ for some time.
• In March 2022 we revised our outlook on Gard to stable from negative and affirmed our ‘A+’ rating. The company’s performance had improved against our expectations and peers, justifying maintaining the rating.
• We revised the outlook to negative on our ‘BBB-‘ rating on American Club in January 2022, not so much because of its technical performance but rather its increasing reliance on unbudgeted supplementary calls to support its capital.
• Japan Club had previously bucked the negative rating trend, being rated /– until July 2022. However, large claims affected its capital base. We placed the rating on CreditWatch with negative implications and then lowered it to ‘BBB’ in July 2022.
Currently, eight clubs have a negative outlook and five are stable.
We did not take any rating actions on the North or Standard clubs following the announcement of their planner merger. We already rated both clubs ‘A’ with negative outlooks for similar reasons. While the merger would create a larger entity with potential longer term benefits, these will take time to realise.
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