Ratings

Formed in 1996, Equitas was the culmination of Lloyd's Reconstruction and Renewal project. Its purpose was to reinsure and manage the run-off of the liabilities of the Market's capital providers (Names) for all syndicate underwriting years 1992 and prior (excluding life syndicates).

Exposure to Equitas has been a consistent drag on our rating on Lloyd's ever since coverage of the Market was first initiated in 1997. This is founded on a belief that Equitas is insufficiently capitalized to run off successfully in some scenarios. Owing to the credit-sensitive nature of Lloyd's client base and core broker distribution channel, we consider that confidence in Lloyd's among these constituencies is extremely important. As a result, were the perceived risk of an Equitas shortfall to grow, followed by a prolonged period of hiatus, market confidence--and thereby Lloyd's competitive position--would be damaged.

Standard & Poor's is in the process of conducting detailed due diligence of the Equitas–NICO transaction structure in the context of Equitas' liabilities. We recognize that, based on what has been disclosed to date, the transaction may remove any realistic potential for Equitas reserve inadequacy to undermine confidence in Lloyd's. As a result, in conjunction with meeting a number of other expectations (including further improvement with regard to the London market's administrative processes), we may raise our 'A' rating on Lloyd's over the medium term.

A higher rating on Lloyd's would particularly reflect an enhanced view of the Market's competitive position and its general attractiveness to clients and brokers. Without the shadow of Equitas and the prospect of much improved business administrative processes, existing competitive strengths would come into starker relief.

Lloyd's brand, built over centuries, carries worldwide very strong name recognition and positive attributes among insurance buyers. Attractive traits include a track record of claims payment following significant catastrophes, high risk tolerance, flexibility, innovativeness, and underwriter accessibility.

Lloyd's is the world's largest subscription insurance market. Although its franchisees operate as independent businesses, the size and diversity of underwriting capacity Lloyd's can potentially provide in support of a Market lead allows it to compete robustly with the largest global insurance groups.

The London market and Lloyd's have maintained their critical mass of relevant underwriting, broking expertise, and support services, remaining the "natural" home of diverse specialist underwriting niches such as marine, energy, aviation, and certain nonmarine classes.

Significant policyholder loyalty results in attractive business continuing its historical flow to London, enticing capital to support and sustain the Market. This is despite intense competition from other international insurance markets, particularly Bermuda.

Standard & Poor's would expect that an enhanced competitive position would potentially have at least three direct results:

• Enhanced long-term operating performance prospects for existing Lloyd's franchisees resulting from improved access to attractive business.
• Increased interest from overseas, particularly Bermuda, in the use of the Lloyd's platform. In our September 2006 article, "The Rise Of The Global (Re)Insurance Nomad," we discussed the appeal of London to Bermuda-domiciled organizations. In order to put the capital they have raised effectively to work, Bermuda businesses have to substantially deploy this capital off the island, usually onshore in the U.S. and/or in the London market. Both offer access to attractive, diverse, and typically more labor-intensive business unavailable or unserviceable in Bermuda. To date, however, Lloyd's attractions seem to have been overlooked or offset by reasons that include perceptions regarding potential legacy liability exposure. If the Equitas–NICO transaction successfully allays concerns about legacy issues, Lloyd's competitive position- and capital efficiency-related attractions (capital providers can back underwriting with LOCs) could help the Market regain its position as the preferred European destination for businesses considering expansion overseas.
• Increased M&A activity at Lloyd's. Supported by the emergence of strong earnings from the current hard market, this could stem from two sources. First, the recent moves to Bermuda by certain Lloyd's franchisees have in part been driven by a desire to diversify their operations and reduce their reliance on the Market. This rationale still makes sense, and we believe the likes of Catlin,   Amlin,  and Hiscox will by no means be the last traditional London-based organizations to consider a Bermuda move. The Equitas–NICO transaction may, however, remove the urgency felt by some franchisees to geographically diversify operations and encourage a willingness to consider M&A within Lloyd's. If well executed, this could provide an alternative route for a business to strengthen itself through enhanced portfolio diversification. The recent announcement by Catlin that it is in discussions regarding a potential cash and shares offer for Wellington Underwriting PLC (see "Catlin Insurance Group Ratings Unaffected By Discussions With Wellington Underwriting PLC") may be only the first of such deals. Second, Lloyd's franchisees may now be more attractive to organizations seeking to diversify. As a result, some, such as members of the Bermuda classes of 2001 and 2005, may seek to follow in the steps of ACE and XL, to name but two, in purchasing Lloyd's operations.