The recapitalisation challenge for Lloyd’s (& ILS) while Covid-19 persists

As our sister publication Reinsurance News reported yesterday afternoon, Lloyd’s has asked its members that have been hit by sizeable losses as a result of the Covid-19 coronavirus pandemic to accelerate capital injections with the goal of stabilising the markets capital position.

Rating agency S&P Global Ratings explained that currently losses from Covid-19 falling to Lloyd’s are thought to remain an earnings event, rather than a capital hit, but it is still early days and the losses are only going to continue to flow.

“The market might experience more substantial losses if the COVID-19 pandemic were to extend for a more significant part of 2020,” S&P warned.

While some governments begin to talk about how to end the global lockdown of people and business activity, it is hard to envision a world getting back to normal by the end of this year at this time, suggesting ongoing flows of coronavirus losses remain possible.

At the moment S&P highlights that, “Lloyd’s has endured losses on its underwriting portfolio, mainly relating to event cancellation cover and pandemic business interruption cover.”

The range of business lines facing losses is much broader though and there is a likelihood that losses begin to fall into other areas of the insurance and reinsurance market over time.

Alone, these may not be significant, but on an aggregated basis, across the Lloyd’s insurance and reinsurance market, it seems likely the coronavirus claims volume will be significant right through 2020 and perhaps beyond.

Add to this the investment side losses, which while moderated by some market gains in recent days are likely to also persist, particularly in the bond markets and areas where re/insurers put their float assets.

“Lloyd’s request to now-undercapitalized members to accelerate capital injections is a practical measure to maintain the market’s pre-COVID-19 levels of capital in uncertain times,” S&P said.

But just how easy is that going to be?

Lloyd’s does have a recapitalisation process in place for members, but how willing are the financial backers and investors going to be to re-up their allocations into syndicates that may have been struggling to deliver any sort of reasonable performance over the last few years anyway?

Lloyd’s players face a similar issue to the ILS market, that the wider capital markets and many sources of financing are acutely nervous right now, given the evident contagion risk across asset classes seen as the coronavirus pandemic took hold.

With global economic growth expected to decline, perhaps stagnate and a global recession viewed as a certain outcome, perhaps already taken hold, are investors going to be enamoured with the prospect of recapitalising Lloyd’s players that have struggled to perform in recent years, are now hit by a deluge of pandemic claims which there is little ability to predict how bad this flow of losses could get going forwards?

It’s also worth considering the level of correlation of a Lloyd’s syndicate, when world-changing events such as a pandemic occur. Syndicate’s returns, being partly reliant on an investment portfolio, are far more correlated than most insurance-linked securities (ILS) fund strategies.

That’s not to mention the efficiency questions. How easy is it to move capital into and out of Lloyd’s and what is the cost of the expense drag of operating there, in terms of a hit to potential capital returns?

Likely much higher than the potential drag and expense associated with an ILS fund, even considering lock-ins to strategies and other factors. Of course investors are locked into Lloyd’s investments as well.

But at the core of this issue, which is driven by the wider economic effects of the pandemic, recapitalising for Lloyd’s is likely to be as challenging as it will be for ILS funds right now.

With uncertainty one of the major drivers of this.

Who knows yet what the potential wider impacts of business interruption from this pandemic could be, or where claims may leak to from multiple lines of business?

We still don’t know how long the pandemic will run, we have no idea how bad the aggregate industry claims burden will be and we don’t yet appreciate how long economies will be in recession or what the long-term impacts on asset classes and capital markets will be.

In such a scenario, those looking to recapitalise had better have a good story, be able to demonstrate their performance over time and what return the current portfolio, or more importantly perhaps at this time the target portfolio, will bring.

But if you’re a player in a market beset by performance issues, lacking in efficiency, with extremely broad insurance and reinsurance line of business exposure to the coronavirus pandemic, as well as an investment side impact to deal with (such as Lloyd’s), unless you’re right up in the top-tier of performers it is hard to imagine that this recapitalisation process will be simple. Far from it perhaps.