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London carriers to feel the heat in H1

Despite coming under pressure from various headwinds, London-listed carriers still look set to deliver a fairly solid performance for the first half of 2014 given the moderate catastrophe losses so far this year, but profits overall will likely be down.

In a commentary published last week (17 July), Keefe, Bruyette and Woods (KBW) analyst Chris Hitchings predicted a median 7.4 percent decline in H1 2014 pre-tax profits for the group of seven London-listed (re)insurers, citing "creeping attritional loss ratios, reducing reserve releases and adverse currency impacts".

Despite rating headwinds spreading from cat reinsurance, group-wide H1 2014 gross written premium growth (excluding Lancashire which is an outlier due to its acquisition of Cathedral) is expected to be 3.9 percent - slightly higher than the 3.7 percent expansion reported in H1 2013.

Nevertheless, Hitchings said he expected potentially gloomy market commentary surrounding the rating environment on both the primary and reinsurance sides of the spectrum.

Attritional loss ratios widen

Although the impact from natural catastrophes was fairly modest in H1 2014, London-listed carriers are likely to pick up losses from a number of large man-made disasters during the period.

These include the Korean ferry disaster, an $800mn+ industry loss from a fire at Russian oil company Rosneft's Achinsk refinery and the loss of Malaysia Airlines flight MH370.

In their Q1 interim management statements, Amlin, Brit, Catlin, Hiscox and Novae all mentioned that they have exposure to MH370 albeit to varying degrees.

Hitchings predicted that combined with a slippage in pricing in 2013, this could cause an average 2 percentage point increase in attritional loss ratios.

According to KBW projections, Hiscox and Lancashire are expected to report the largest deterioration in attritional loss ratios for the first half of this year, with a considerable 4.9 point rise year-on-year to 53 percent and 31.2 percent respectively.

Furthermore, Hitchings forecast a smaller tailwind from favourable prior-year development in H1 2014, with reserve releases expected to provide an average benefit of 4.7 points to the combined ratio in contrast to 7.3 points in H1 2013.

For certain carriers, this will be partly due to further adverse reserve development on the Costa Concordia loss. The Insurance Insider exclusively revealed earlier this month that the total loss tally for the marine disaster had inflated by another $250mn to $1.44bn on account of increased wreck removal costs.

While expense ratios are expected to improve by a median of 1.1 points, this would not be enough to offset the aforementioned headwinds, meaning that H1 combined ratios could be 2.5 points worse year-on-year.

Hitchings predicted that just two London carriers will generate combined ratios above 90 percent for H1 2014 (Beazley: 91.3 percent, Catlin: 93.7 percent).

While Lancashire is projected to produce the best combined ratio of 71.1 percent, this represents a significant 12.3 point increase on the prior-year period - the largest anticipated deterioration within the composite.

In contrast, rivals Amlin and Novae are expected to report combined ratio improvements of 1 point and 4.4 points respectively.

FX hit

One of the largest headwinds is expected to be adverse currency translation effects due to the weakening of the US dollar.

Hitchings noted that the USD/GBP exchange rate in H1 2014 averaged 8 percent higher than H1 2013, which could trigger a £104mn composite-wide adverse swing in exchange effects resulting in an aggregated £40mn loss.

Based on his predictions, Amlin is anticipated to take the largest hit with £20mn of foreign exchange losses in H1 2014 - down from the £13.7mn of gains in the prior-year period.

Hiscox could see the largest swing with a forecast deficit of £15mn for the first half of 2014 versus a £34.9mn profit in H1 2013.

Investment returns

Although interest rates remain at historic lows, Hitchings noted that a further rise in bond yields during the second quarter, coupled to some recovery in equities and alternatives, should boost investment returns.

Based on KBW estimates, investment yields are pencilled in at an average of 1.6 percent for London-listed (re)insurers - modestly up from 1.3 percent a year prior.

Following its IPO at the end of March, new addition Brit is expected to trump its peers with a 2.8 percent investment yield.

Similarly, Catlin is anticipated to generate a 2.2 percent return - 11x the 0.2 percent yield produced in H1 2013.

Catlin downgraded to 'sell' after further loss threats

Peel Hunt analyst Mark Williamson last week (18 July) downgraded Catlin's stock rating from hold to sell following reports of fresh potential aviation and war losses arising from another Malaysia Airlines disaster and political violence at Tripoli airport.

The loss of Malaysia Airlines flight MH17 - which was shot down last Thursday (17 July) over Ukraine - will cost the aviation market hundreds of millions of dollars, impacting both the all-risks and war policies.

The latest loss comes just months after the disappearance of Malaysia Airlines flight MH370 caused a significant hit to the (re)insurance industry.

Williamson said it was likely that some of the MH17 loss would make its way into the Lloyd's market. With Catlin already mentioning MH370 as a "large single loss" in its Q1 interim management statement, Williamson predicted another big hit.

The analyst also noted that the outbreak of fighting between rival militias at Tripoli Airport in Libya had resulted in more than $200mn of damage to aircraft and would be covered by a war policy led by Catlin.

He also pointed to Catlin's exposure to the $250mn deterioration to the Costa Concordia loss tally, for which it has exhausted its reinsurance protection.

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