Canopius Managing Agents - Syndicate 4444

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1 January 23, 2009 Canopius Managing Agents - Syndicate 4444 Primary Credit Analyst: Eoin Naughton, London (44) ; eoin_naughton@standardandpoors.com Secondary Credit Analyst: Kevin Willis, London (44) ; kevin_willis@standardandpoors.com Table Of Contents Lloyd's Syndicate Assessment Financial Strength Ratings And Lloyd's Syndicate Assessments Major Assessment Factors Rationale Outlook Syndicate Profile: Midsize, Focusing On Short-Tail Risks Competitive Position: Good, Strengthened By Recent Acquisition Activity Management And Corporate Strategy: Focus On Developing Business Through Managing Cycle And Diversifying Distribution And Product Offering Enterprise Risk Management: Adequate With Strong Risk Controls Accounting: First Time Adoption Of IFRS At Group Level Operating Performance: Continued Stable Performance, 2008 Affected By Catastrophes 1 Standard & Poor's. All rights reserved. No reprint or dissemination without S&P's permission. See Terms of Use/Disclaimer on the last page

2 Table Of Contents (cont.) Investments And Liquidity: Conservative Investment Strategy Supported By Strong Credit Quality Capitalization: Improved Due To Equity Injection Offsetting Additional Requirements From RITC Of Syn Financial Flexibility: Constrained By Dependence On Private Equity Ownership Standard & Poor s RatingsDirect January 23, Standard & Poor's. All rights reserved. No reprint or dissemination without S&P's permission. See Terms of Use/Disclaimer on the last page

3 Lloyd's Syndicate Assessment 3-/Stable Financial Strength Rating None Financial Strength Ratings And Lloyd's Syndicate Assessments Standard & Poor's Ratings Services' insurer financial strength rating on Lloyd's (the Market; A+/Stable) remains the primary indicator of the level of financial security afforded to a policyholder of any syndicate trading in the Market. Lloyd's Syndicate Assessments evaluate, on a scale of '1' (very high dependency) to '5' (very low dependency), the extent of a given syndicate's dependence on the Market rating. Major Assessment Factors Strengths: Good competitive position Good operating performance Conservative investment strategy Weaknesses: Limited financial flexibility of the holding company Exposure to potential large loss events limits capital adequacy Rationale The Lloyd's Syndicate Assessment (LSA) on Canopius Managing Agents - Syndicate 4444 (Canopius or Syndicate 4444) reflects its good competitive position, good earnings, and conservative investment strategy. The assessment is constrained by the limited financial flexibility of the holding company, and the company's exposure to large loss events, which have the potential to constrain capital adequacy. The syndicate's competitive position is good, based on its size ( 410 million capacity for 2008) and well-diversified underwriting portfolio. The successful acquisition of Creechurch Holdings Ltd. and new underwriting teams have enhanced the syndicate's scale and diversification, which in turn enhance its competitive position. In addition, the syndicate has a good lead position in many of its key lines, and strong renewal business retention. Syndicate 4444's operating performance is considered good in light of improved results in 2006 and for Its adequate track record since launch in 2004, represented by an average combined ratio of 100.1%, reflects the strains of start up and a high incidence of natural catastrophes in 2004 and Performance in 2008 is likely to be negatively affected by hurricane and single property losses, but we expect the syndicate will continue to be profitable at the underwriting level. The syndicate has a conservative investment portfolio, which has generated consistent returns to partially offset previous underwriting losses, and to enhance the performance last year. Most invested assets are held in highly rated 3

4 fixed income investments, with more than 70% being rated 'AAA', or are cash deposits with highly rated institutions. The venture-capital nature of much of Canopius Group Ltd.'s (CGL) backing means that the focus for much of the capital backing is relatively short term. Reliance on reinsurance support for capacity has diminished, and we expect it to continue to do so in the medium term. While Englefield has been consistently supportive of CGL, the nature of the company's support constrains our assessment of financial flexibility. In addition, the syndicate writes a material amount of catastrophe affected business. While historical catastrophe losses have been in line with peers and not material in the context of Canopius' overall capitalization, there remains the potential for a significant loss to cause a significant reduction in capital adequacy. This concern is partially allayed by the syndicate's strong catastrophe risk controls. Outlook The stable outlook reflects Standard & Poor's expectation that the syndicate's operating performance will continue to remain good for 2008 and beyond. In addition, we expect the syndicate's competitive position to remain good, and for any additional investment risk assumed not to have a material negative impact on capital adequacy. Operating performance is expected to show some deterioration compared to 2007, but with the syndicate generating a positive underwriting result. This year is expected to revert to a performance in line with 2006 and 2007 assuming a normal catastrophe loss experience. The syndicate's maturing enterprise risk management program is expected to continue to play an important role in the management and strategic direction of Canopius, and become further embedded in the organization. Syndicate 4444's competitive position will remain good with the syndicate building on its new platforms in Bermuda and Singapore to seek profitable underwriting opportunities. Cycle management will remain the key factor in supporting the syndicate's future competitive position and longer-term profitability. The outlook may be revised to negative if the syndicate fails to generate consistent underwriting profits, or if any future acquisition leads to strain on the syndicate's backers' capital adequacy. There is limited upside potential for the syndicate assessment in the medium term. Syndicate Profile: Midsize, Focusing On Short-Tail Risks Syndicate 4444 began trading at Lloyd's for the 2004 underwriting year, having been created from a management buyout of the operations of the Trenwick managed syndicate 0839, which ceased business in It is managed by Canopius Managing Agents Ltd. (CMA), a wholly owned subsidiary of Canopius Holdings UK Ltd. (Canopius Holdings), which is itself a subsidiary of CGL. During 2006, the group acquired Creechurch Holdings. The managing agent continues to manage former Creechurch syndicates 1607 and 3786; these no longer write business and are expected to reinsure to close into Syn in The managing agent also managed life syndicate 44. This was sold during For 2008, the group assumed the reinsurance to close of Syn. 0839's 2001 and prior years of account. The group's non-lloyd's activities include Canopius Ireland, which writes structured transactions into the group's class 3 Bermuda reinsurer. Standard & Poor s RatingsDirect January 23,

5 Syndicate 4444 writes a diverse account, with a focus on short-tail direct risks (see chart 1 for the split of gross premium written to third-quarter 2008). (See chart 2 for the geographical distribution of premiums planned for 2009.) Around three-quarters of the syndicate's book is short tail, and about 75% is direct insurance. Chart 1 5

6 Chart 2 Competitive Position: Good, Strengthened By Recent Acquisition Activity Within the Lloyd's context, Syndicate 4444 has a good competitive position, based on its size ( 410 million capacity for 2008, ranking in the top quartile at Lloyd's by capacity) and well-diversified underwriting portfolio, which is inclined toward small-to-midsize risks. The syndicate's competitive position has been enhanced in recent years through acquisitions of underwriting resources, as well as the Creechurch acquisition in These acquisitions have increased the size and scope of the Canopius offering. The syndicate was able to retain the majority of Creechurch's business and underwriters. In addition, the syndicate has acquired underwriting teams in property and crisis management, among others. The syndicate has a good lead position in many lines, and particularly strong positions in some of its key lines. While the syndicate led just over 60% of total business in the first half of 2008, it led almost all the business in its largest class, U.K. Property, and three-quarters in its next largest line (North American Facilities). The syndicate tends to act as a following market in global property and reinsurance risks. In addition, the syndicate has high renewal retention rates across all classes of business. The syndicate's competitive position is enhanced by its expanding distribution platforms. In addition to sourcing business through traditional Lloyd's brokers, the syndicate has acquired or developed various other distribution capabilities. With the Creechurch acquisition, the group acquired two U.K.-focused service companies, Impact, and Charrington, which offer Accident and Heath, Professional Indemnity, and General Liability business into the syndicate. These have been merged and renamed Canopius Underwriting Ltd. While these have continued to source business for the syndicate since acquisition, a strategic review aimed at improving their offerings and generating Standard & Poor s RatingsDirect January 23,

7 operational efficiencies will enhance their role in the syndicate's competitive position. In addition, the syndicate has utilized Lloyd's Singapore to offer treaty reinsurance. This is currently a very competitive market, but represents a long-term opportunity for the syndicate. The syndicate also has two underwriting agencies. Arista, a joint venture with Equity Insurance (not rated), sources U.K. small and midsize enterprises through a network of regional offices. Growth in this entity has been slower than management expectations, which reflects the very competitive nature of this market. However, Arista represents a long-term opportunity to establish a regional distribution capability in lines integral to the syndicate. In 2008, the group established Canopius Underwriting Bermuda Ltd., a managing general agency writing excess casualty and treaty reinsurance business for Syn Again, the Managing General Agency (MGA) has written below its planned budget, reflecting the pricing environment in its key lines. However, positive rate movements and reductions in capacity from competitors mean the MGA will likely increase its premium significantly in Canopius' ongoing focus with regard to its competitive position is to continue to grow its book when and where market conditions allow. Growth is expected as market conditions improve, the extent of growth in the near term will be dependent on the extent of improvement in rate adequacy and the company's ongoing acquisition and recruitment policies. Management And Corporate Strategy: Focus On Developing Business Through Managing Cycle And Diversifying Distribution And Product Offering Canopius' management team is considered a supporting factor for the assessment, having effectively managed the various strategic developments made by the group in the past few years. The successful integration of Creechurch, additional equity raising and acceptance of the reinsurance to close (RITC) of Syn reflect positively on our view of management. Management aims to increase the syndicate's scale and diversity while remaining committed to consistent profitability. Given an increasingly competitive market environment, management's focus shifted for 2008 away from growth toward managing the cycle. During a more competitive market environment, the syndicate's strategy has been to expand and enhance the distribution and underwriting capabilities at the syndicate. While growth in new operations, such as Canopius Underwriting Bermuda Ltd. and Singapore has been limited, the actions taken will create the infrastructure to scale up operations when rates improve. Standard & Poor's considers management to be risk aware and have a rational, achievable strategy for targeted profitable expansion. Operational management The syndicate is managed along traditional divisional lines, with the group underwriting director responsible for all underwriting departments. Following a restructuring during 2007, the underwriting reporting line is to the syndicate chief executive directly, with all other functions reporting to the chief operating officer. During 2008, the syndicate's actuarial function was brought in house following an expansion of the actuarial team. Previously, the syndicate had used external consultants for setting overall reserves. Maintenance of underwriting discipline through the softening underwriting cycle has been identified as the key challenge for the syndicate going forward; previous investment in management and risk systems should leave the syndicate well placed to do this. 7

8 Financial management The company's individual capital assessment process has resulted in investment in risk modeling capability. The syndicate allocates funds by line of business, although with a qualitative overlay focusing on rate adequacy. Canopius monitors and forecasts risk pricing by line of business and sets minimum required pricing, regardless of the competitive environment. Enterprise Risk Management: Adequate With Strong Risk Controls Enterprise risk management (ERM) is viewed as adequate with strong risk controls. The syndicate has strong control processes for all its major risks, namely underwriting (pricing and reserving) and catastrophe risks. Standard & Poor's considers ERM to be of moderate importance to the rating, given the company's potential exposure to large losses and the number of disparate types of insurance written. Underwriting risk controls are considered strong. Underwriting risk is controlled through the use of clear limits for underwriters, which are linked to the underwriting policies and procedures and the individual divisions' risk registers. All risks are peer reviewed, and an additional level of expert review exists to enhance controls over underwriting. An exception reporting system is in place to flag any potential issues. Weekly meetings between the divisional underwriters ensure controls are consistently applied throughout the syndicate. Other underwriting risks, such as those coming from delegated authorities, are controlled through an internal audit process. Reserving risk is controlled through quarterly review of reserve adequacy, the results of which are discussed through regular meetings of the reserving committee. Catastrophic risks are controlled through the use of aggregate monitoring across business lines and the integration of catastrophe modeling expertise in the underwriting process. The syndicate has a developing, but as yet unseasoned, strategic risk management framework. The continued development of the individual capital assessment model has allowed the syndicate to align the business planning process with its capital requirements and costs. However, business decisions are not yet based on risk-reward trade-offs based on the capital modeling process. The syndicate is working on upgrading its modeling capability to integrate it into the day-to-day decision making process. This could be a trigger for upward movement in the ERM assessment. Accounting: First Time Adoption Of IFRS At Group Level Capital adequacy analysis for the syndicate is based on the financial resources of the ultimate holding company, CGL. For 2007, the group adopted International Financial Reporting Standards for the first time. The result of adoption was an increase of 6 million in net assets, primarily as a result of immediate recognition of negative goodwill arising from the Creechurch acquisition. In trying to establish a current capital adequacy level for the group, Standard & Poor's has made several adjustments to the year-end capital adequacy to reflect post balance sheet transactions, which have had a material effect of capital available and capital requirements. These included recognizing the 59.2 million of equity capital received from Englefield in February 2008, identifying the capital required to support the assets and liabilities of Syn and recognizing as capital the negative goodwill arising from the related acquisition of several companies affiliated with Syn Standard & Poor s RatingsDirect January 23,

9 Operating Performance: Continued Stable Performance, 2008 Affected By Catastrophes The syndicate's operating performance has improved after a marginal start. The combined ratio for 2007 improved to 93% from 95% in the prior year. This second year of good performance reflects another benign year for catastrophic losses, although the syndicate did suffer significant losses arising through the U.K. homeowners' book from the U.K. floods in summer The three-year simple average combined ratio is 98.5% as a result of the catastrophe affected 2005 year. The syndicate continues to lag the Lloyd's market as a whole; the market recorded a combined ratio of 84% in However, this reflects the less-volatile nature of the business underwritten by the syndicate compared with many Lloyd's peers, in particular the U.K. homeowners' and North American facilities books, which are the syndicate's largest. Profitability is expected to deteriorate in 2008, reflecting an increase in large property claims as well as the impact of hurricanes Ike and Gustav. As a result, the syndicate is expected to show an underwriting result for 2008, which is just positive, excluding foreign exchange gains and losses on nonmonetary items. A positive investment result will lead to an acceptable bottom-line result for the syndicate. The increasingly competitive market had put the syndicate's operating performance under pressure, especially using a combined ratio metric, due to the syndicate's high cost base. There are some indications that the rating environment in many of the syndicate's key lines is improving, however, it is too early to tell the extent of this improvement. Successful cycle management remains the key factor for the syndicate's longer-term profitability. Investments And Liquidity: Conservative Investment Strategy Supported By Strong Credit Quality The investment portfolio is strong and highly liquid. This reflects Lloyd's membership requirements for funds to be readily liquid and placed in low-risk investments--typically highly rated bonds and international bank deposits. As at Dec. 31, 2007, the syndicate's investment portfolio consisted of primarily fixed income securities and cash. The absence of equity investments reduces potential volatility in investment income. The credit quality of fixed income investments was very strong, with all the syndicate's fixed income holdings being at least investment grade, and over 70% being rated 'AAA'. This conservative asset allocation philosophy has produced a positive return to date in 2008, in spite of the current turmoil in capital markets. Given the reduction in yields on the types of asset the syndicate currently holds, the syndicate may take more credit and market risk going forward. The syndicate does not strictly match the duration of its assets to that of its liabilities, but the current maturity duration of its investments, about 2.5 years, is consistent with the predominantly short-tail risks underwritten. Capitalization: Improved Due To Equity Injection Offsetting Additional Requirements From RITC Of Syn Overall capitalization is considered good, supported by CGL's good capital adequacy. The additional capital injection of 59.2 million from the majority owner in February 2008 is supportive of capital adequacy. The venture-capital nature of much of CGL's backing had given a short-term focus to capital backing, and this concern 9

10 has alleviated to some extent. The syndicate still supports about a quarter of capacity through quota share reinsurance support, although this amount is decreased and Canopius believes they could support 100% of the syndicate capacity. In addition, reliance on bank facilities to support capacity has reduced materially. Reserves Reserving appears good. The loss-settlement trends by continuing lines of business have generally positive results, increasing our confidence in our assessment of Canopius' reserving techniques. Reserves for major events have typically been stable, although there was some deterioration in losses arising from Hurricane Wilma in Some benefit is likely to accrue from the syndicate bringing its reserving function in house during Reinsurance The overall level of underwriting risk protection afforded to the syndicate by its reinsurance program is good, reflecting a highly diversified and strong security rating structure. Canopius' strategy is to underwrite for gross profit. The reinsurance program is therefore designed to provide protection from extreme events by each line of business, and was effective in minimizing the syndicate's U.K. flood losses in The program is heavily weighted toward nonproportional excess-of-loss covers. The largest single-event exposure for the syndicate is a Gulf of Mexico windstorm, with net exposure to such an event estimated at about 12% of Canopius' 2008 capacity, well below the 20% ceiling set by Lloyd's, and containable within current capital adequacy. Credit quality The credit quality of the syndicate's reinsurance counterparties is strong. In 2006, most program participants were rated in the 'A' category or above by Standard & Poor's. Financial Flexibility: Constrained By Dependence On Private Equity Ownership Canopius is largely funded by venture capital provided by Englefield to CGL. The likely medium-term nature of Englefield's investment in CGL is mitigated by its consistent track record in supporting Canopius' growth with additional capital when required, and willingness to fund future growth at the syndicate, as seen at the start of However, the syndicate remains dependent on Englefield for additional funding, if required. Canopius Managing Agents - Syndicate 4444/Financial Statistics (%) Combined ratio Loss ratio Expense ratio Return on revenue (5.6) (4.3) Premium retention ratio Loss retention ratio Reserves/net premiums written Receivables ratio Liquidity ratio Ratings Detail (As Of January 23, 2009)* Canopius Managing Agents - Syndicate 4444 Standard & Poor s RatingsDirect January 23,

11 Ratings Detail (As Of January 23, 2009)*(cont.) Holding Company Domicile Canopius Group Ltd. United Kingdom *Unless otherwise noted, all ratings in this report are global scale ratings. Standard & Poor's credit ratings on the global scale are comparable across countries. Standard & Poor's credit ratings on a national scale are relative to obligors or obligations within that specific country. Additional Contact: Insurance Ratings Europe; InsuranceInteractive_Europe@standardandpoors.com Additional Contact: Insurance Ratings Europe; InsuranceInteractive_Europe@standardandpoors.com 11

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