S&P Global Ratings expects most, if not all, of the P&I clubs to record bottom-line losses in the financial year ending Feb. 20, 2022 (FY2022). All 13 of the P&I clubs in the IG--which underwrite 90% of the world's oceangoing fleet liability insurance--have once again been hit by a high level of pool claims and COVID-19-related claims. Strong investment performance helped to soften the blow for clubs in FY2021, but the markets seem unlikely to provide an outstanding return in FY2022.

Claims of $10 million to $100 million are shared between the members of the IG under an excess-of-loss pooling system. Because of record-high claims, operating performance in the P&I sector has deteriorated even more than we predicted 12 months ago. Combined ratios for FY2021, were significantly worse at 117% than the 113% we had forecast. (Lower combined ratios indicate better profitability. A combined ratio of greater than 100% signifies an underwriting loss.) Results from the clubs that publish half-year results suggest that FY2022 will be worse (see chart 1).

In our opinion, the sector remains well-capitalized, but at many of the clubs, their excess of capital at the 'AAA' level has been significantly eroded and, for some, it will disappear entirely. Diminished capitalization was one of the main factors prompting us to take negative rating actions over the past 12 months. That said, these capital pressures coincide with improving conditions in some shipping markets, which should allow clubs to achieve significant rate increases at the 2022 renewal.

Chart 1

Drowning In Pool Claims

The first half of 2021 has seen claims recorded in the pool reach a record dollar amount. Although the frequency of claims is still below the recent average, the size of the claims was unprecedented. In March, the Suez Canal was blocked for six days when the Ever Given grounded. This event, insured by the U.K. Club, may have grabbed the international headlines, but we do not consider it the half-year's largest loss. May's X Press Pearl containership fire (insured by the London Club) and the August grounding of the Crimson Polaris (Japan P&I Club) are estimated to cost more.

The record half-year pool follows two heavy years in 2019 and 2020. Again, we saw increased severity of claims hit the pool, including the 2019 grounding of the Golden Ray (North of England). This was one of the most expensive claims to hit the clubs since Costa Concordia in 2012. The second half of the year has already brought the possibility of another large pool claim, relating to an oil spill affecting Huntingdon Beach in Southern California. All of these losses will have a significant impact on the IG's reinsurance purchase in 2022, although traditionally any increases are passed straight through to members.

The question that troubles the clubs' management is whether the increase in pool costs is the "new normal" or just a return to normality, after five years of lower costs between 2014 and 2019. The increased severity of large claims could be just bad luck, or it could have other causes, such as jurisdictions becoming more demanding about the clean-up of wrecks and the ever-larger size of containerships.

Last year, clubs that had a more diversified product offering beyond mutual P&I business avoided the worst of the losses. Lines of business such as energy, hull, or "fixed premium P&I" (where there is no exposure to the pool) helped offset the mutual P&I losses. This year, results have been more mixed. Although Shipowners and Gard still benefitted from their diversification strategy, the Swedish Club and Skuld did not. Shipowners has a significant fixed premium book, Gard and Skuld both offer hull and energy covers, and the Swedish Club offers hull covers.

Chart 2

Pandemic losses have also remained an issue for many clubs. The first half of FY2021 saw a series of pool claims relating to the cruise ships hit by the virus. No COVID-19-related pool claims have yet been recorded in FY2022, but many clubs are seeing frequent claims relating to crew illness from COVID-19. Unfortunately, the take-up of vaccinations in crew members has been slowed by the logistics of receiving two vaccination shots a sufficient amount of time apart. We anticipate that the situation should improve in the second half of FY2022 as efforts by the P&I clubs and their shipowner members prompt governments to prioritize getting seafarers vaccinated because of their crucial role in the global economy.

A Turnaround May Be Coming

We believe that performance at the 13 P&I clubs will reach its low point in FY2022; most now seem to be committed to significantly improving rates for the 2022 renewal. West of England and U.K. Club have already announced significant general increases for the 2022 renewal, of 15% and 12.5%, respectively. We expect that most other clubs will follow their lead and announce double-digit increases. Although one or two clubs may announce minimal increases, or no increase at all, the sector average is likely to exceed 10%. This will be the highest level of announced general increases in recent years (see chart 3). In our opinion, clubs are likely to maintain the rate increase into the 2023 renewal period and will seek to increase deductibles (the amount of the claim that shipowners have to meet before their cover kicks in) for shipowners that have large fleets.

Chart 3

In our experience, P&I clubs have generally not achieved the rate increases they ask for publicly, but we expect that they will have a stronger hand at the 2022 renewal than in the past. For the first time in many years, parts of the shipping industry are enjoying buoyant market conditions. Supply chains have been unable to keep up with the significant leap in demand after governments eased social restrictions and the global economy opened up. This has led to a spike in the cost of transporting containers. For example, S&P Global Platts states that the cost of sending standard 40-foot containers to the West Coast of North America from North Asia has increased to $9,000 in October 2021; it was $4,900 in January 2021. As a result of this surge in rates, we expect shipowners in the containership and bulker markets may be more receptive than usual to an increase in the cost of their insurance.

Rating Actions In The Past 12 Months

Our ratings on P&I clubs have come under intense pressure during the past few years. We revised the outlook on our 'BBB' rating on the London Club to negative in 2019, because of concerns that its capitalization, the core strength of the rating, was being eroded. Our outlook on Standard was revised to negative in June 2020. In October 2020, we revised to negative the outlooks on our ratings on the U.K. Club, North of England, and Gard. In March 2021, we added our rating on West of England to the list of those with a negative outlook, making six in all of the 13 P&I clubs. Other than those on the London Club, all these ratings were experiencing similar pressures. The prolonged period of soft rates, coupled with significant pool losses in FY2020 and FY2021, had impaired their technical performance, as measured by high combined ratios.

Although we recognize that the P&I Clubs function as mutuals and do not seek to maximise profit, we nonetheless consider technical performance (setting aside the volatility of investment return) to be a symptom of a healthy competitive position within the marine market. The P&I market has long been prone to volatile results because a small number of large losses can have an outsize impact on clubs' results. Consequently, we would not take negative rating actions simply because of a string of large pool claims in a single year; to a degree, that is to be expected of the sector.

That said, we do consider that the technical losses of FY2018 and especially FY2019 and FY2020 affect our rating. We see no prospect of improvement in FY2021, and there has been a step change in the underlying profitability of many clubs within the sector. As a result, we questioned our assessments of competitive position within our ratings framework, leading to negative actions. Our assessments of the clubs' competitive strength do not only consider competition between the clubs themselves, but also their performance against our wider universe of rated insurers, across many sectors and geographies.

Because of these concerns, in October 2021 we took negative rating actions on four P&I Clubs:

• We revised the outlook on the 'A' ratings on Britannia, Skuld, and Steamship to negative; and
• We revised the outlook on the 'A-' rating on the Swedish Club to negative.
• The ratings on Gard, North of England, the Standard Club, and the West of England still have negative outlooks.

In all of these cases, weaker than expected technical performance was the key ratings driver, although in some cases premium shrinkage and the proximity of capital thresholds were also relevant.

The ratings on the London and Japan clubs have followed a different path. The London Club, which had had a negative outlook since 2019, recently announced an unbudgeted supplementary call. This allayed our concerns regarding the erosion of its capitalization. We consider that the potential impact on its market position of making an unbudgeted supplementary call is already captured within the rating.

Alone among the P&I ratings, the Japan Club has a positive outlook. It has reported improving performance and a strengthening capital position over several years.

Chart 4