The proposed acquisition of Brit plc by Fairfax Financial Holdings is “credit positive” for Fairfax, according to Moody’s, which noted that the deal will significantly boost Fairfax’s underwriting capacity at Lloyd’s in a recently published report.
Also citing the benefits of greater business and geographic diversification, Moody’s said the deal will only marginally increase Fairfax’s financial leverage, in its publication “Credit Outlook: Credit Implications of Current Events,” issued on February 26.
The ratings agency affirmed Fairfax’s Baa3 rating and stable outlook in a statement published on February 20.
Following the acquisition, Fairfax’s gross written premiums will increase by 27 percent and the group will have a top-five presence within the Lloyd’s market, Moody’s said, noting that Brit wrote nearly five times the 2013 gross written premium of Fairfax’s two existing Lloyd’s syndicates, Newline and Advent.
“Brit has a good track record in terms of underwriting and operating profitability. Although performance has been slightly below the Lloyd’s market average, Brit’s combined ratio has been better than the consolidated combined ratio of Fairfax’s insurance subsidiaries,” Moody’s said.
Brit Management Team
“Although integration risks exist with any acquisition, they will be lower in this case because we expect Brit’s management team to remain in place,” the ratings agency continued. “Fairfax also already owns a legacy Brit run-off portfolio and therefore is familiar with the company and its management.”
Brit underwrites a portfolio of specialized insurance risks that constitute nearly three-quarters of its business, with the remainder in property catastrophe and casualty reinsurance, Moody’s said.
Insurance coverages include marine (11 percent of gross written premium), energy (8 percent), US specialty (10 percent), specialist liability (9 percent), accident and health (6 percent) and terrorism, political and aerospace (7 percent).
Fairfax intends to partially fund the acquisition with a CAD650 million equity issuance ($521.9 million)*, a CAD200 million ($160.6 million) preferred share offering and a CAD350 million ($281.1 million) senior notes issuance, Moody’s notes.
“We expect Fairfax to fund the remainder with internal capital and other sources of financing that we do not expect will significantly change the company’s current capital structure,” the Moody’s report said. “This financing arrangement is reasonably in line with the company’s current capital structure. Post-transaction, we expect Fairfax’s financial leverage ratio to modestly increase to 32.8 percent from 32.4 percent at 31 December 2014.”
Weaker Pricing at Lloyd’s
Although this transaction is positive for Fairfax, Moody’s expects aggregate performance at Lloyd’s to weaken over the next year because of weaker pricing and deteriorating underwriting results.
Property-catastrophe and casualty reinsurance rates are under pressure as a result of global excess reinsurance and alternative capacity, Moody’s said, which will affect Brit’s catastrophe reinsurance business, Moody’s indicated.
In addition, consistent and material reserve releases have been a feature of Lloyd’s results in recent years. As a proportion of premiums, Brit’s reserve releases averaged 6 percent over the past 10 years and favorable development as a portion of pre-tax operating income has averaged 54 percent over the past five years, both of which are consistent with the property and casualty market globally. However, Moody’s expects reserve releases to diminish as rate adequacy declines.
“We also expect that Brit’s asset risk will increase given Fairfax’s active investment strategy,” the Moody’s report said
The transaction is subject to customary closing conditions, including the approval of the Prudential Regulation Authority in the UK, Lloyd’s of London and the Financial Services Commission of Gibraltar.
[*Exchange rate as of February 27, 2015]