After the poor underwriting results of the past two years, protection and indemnity (P&I) mutuals were probably hoping for a better year in 2020-2021, but the early signs are not good. The few mutuals that report half-year figures (Skuld, Shipowners, and Swedish Club) recorded underwriting losses and an average combined ratio of 108%, about the same as that of the prior year (see chart 1). One of the reasons clubs cite for the poor performance is heightened pool claims. Skuld, for example, recorded claims of $37.2 million compared with just $10.4 million in the year before, a more than 3x increase.

Chart 1

While there is a direct link between COVID-19 and pool claims, it is limited, with only three (all related to cruise ships--Ruby Princess, Diamond Princess, and Grand Princess) likely to generate large gross losses. However, some clubs have told S&P Global Ratings they believe there may be an indirect link to increased claim costs and COVID-19-related to crew exhaustion. With many countries restricting port access, ship operators have found it harder to change crews, leading to fatigue and stress for crew members (many of whom have been on a vessel for over 12 months) that could lead to navigational errors. COVID-19 has also affected clubs' top line as they return premium to members because vessels are put into lay-up (effectively out of use). The returned premium should not materially affect earnings because we expect this to be largely offset by a reduction in the frequency of claims.

We believe the clubs that do not report half-year figures are more likely to be more significantly affected than the three that do. Shipowners, Skuld, and Swedish all have a material amount of nonmutual P&I business (Skuld and Swedish offer hull and other marine related lines and Shipowners have a significant fixed premium business) that help dilute the impact of the increased pool claims on the pure mutual business. We believe P&I mutuals focusing largely on mutual covers are more exposed to the pool and therefore will record higher combined ratios. In our estimate, the average combined ratio across the sector for the full year will likely be 113%. While investment portfolios suffered in the immediate wake of COVID-19, markets have bounced back somewhat, meaning many clubs are now at least recording a positive investment return.

Decision Time

In October, the P&I clubs announce the level of general (premium) increase members can expect in renewing policies. This year's renewal discussions are likely to be challenging for both insurers and insureds. The clubs will need to balance their underwriting accounts with rate increases knowing that their current underwriting performances are unsustainable, particularly considering the worsening trend. However, shipowner members will point to worsening conditions in the shipping market (see chart 2) as COVID-19 reduces global trade volumes and the clubs' generally healthy capital positions (we expect that, despite likely losses in 2020-2021, 11 of the 13 clubs will have capital above our 'AAA' benchmark at year-end) as justification for maintaining pricing levels.

Chart 2

We expect the announced general increases will be higher than those of 2019 (on average, 5.6% compared with 5.2%) but still some way of the general increases in 2013 and 2014 (see chart 3). However, we believe that it is likely that rate increases at this level will continue at the 2022 renewal. We believe we will see very few, if any, clubs returning premium or capital to members in 2020-2021.

Chart 3

Will The Credit Benefits Of Diversification Show Themselves In 2020?

We expect those clubs with more diversified books of business to outperform those clubs where most of their premium base comes from mutual P&I business in 2020-2021. Clubs that write material books of hull and energy business will, in our opinion, be more able to offset this year's significant losses from the pool with profits from their mutual lines of business. Hull lines in particular have seen significant rate increases since Lloyd's began its "decile ten" work that led to significantly reduced capacity in the hull and cargo markets. Many Scandinavian marine insurers have seen significant growth in these areas, which we expect will contribute positively to the bottom line in 2020-2021, with further rate increases likely in 2021. While hull- and marine-related energy lines mean diversification for P&I clubs, we do not give any explicit credit in our competitive position assessment for these lines, because we consider all marine-related. However, clubs with significant nonmutual P&I books are somewhat less exposed to the pool's fortunes. We believe the pool is a large contributor to sector volatility and is one of the key reasons we score most of the clubs as having a moderately high risk exposure score (only two of the 13 are scored at moderately low: Gard and Skuld). We will continue to monitor the clubs' exposure to the pool both in terms of their pool share and mitigating lines as part of our risk exposure analysis.

Rating Actions So Far In 2020, And What Lies Ahead

We took only one rating action on the 13 P&I clubs we rate in the past 12 months. In June 2020, we revised our outlook on Standard Club to negative from stable while affirming our 'A' rating. The club's technical performance had underperformed its peers and relative to our expectations and so placed our competitive position assessment under pressure. We believe the club's ability to improve its technical performance over 2020-2022 is a key credit risk.

Of our other ratings, The London Club remains at 'BBB' with a negative outlook as its operating performance continues to lag that of the sector. And contrary to the sector trend, our 'BBB+' rating on Japan Club remains on positive outlook reflecting the club's growing capital strength and recent good relative operating performance. While our other P&I ratings are on stable outlook, the sector's operating environment remains challenging and the outlook for the sector overall, negative. While most clubs continue to enjoy strong capital bases, often with buffers above the 'AAA' level, continuing high combined ratios could stress some competitive position scores within our rating framework.

We recognize that the clubs function as genuine mutuals of their owner-members rather than as profit-maximizers. Nevertheless, our competitive position scoring is an assessment of an insurer's market power and its ability to influence pricing conditions in their market. Significantly, we believe clubs recognize the need to improve technical performance. In 2020-2021, we will look for their ability to realize this aim. Given the competitive pressures between clubs and the shipping sector's wider issues, this could prove difficult.

Chart 4