The downgrades reflect the agency's increased concern over the group's ability to execute its strategy over the next 18 months, which is necessary to return its capital position to levels consistent with an 'A' range rating. On 11 November 2002, the group's ratings were lowered and placed on Negative Outlook reflecting the high execution risk of the group's wide-ranging strategy, and the concern that sufficient capital would not be raised (or released through restructuring) to support the prior ratings, and that earnings would not improve as expected over the cycle. Since November, Fitch has highlighted a number of areas of concern in the industry, all of which, in the agency's view, will make it more difficult for the group to execute its strategy as planned. The areas of increased concern are shown below:
Casualty Reserving - Fitch recently announced that during 1H03 it will heighten its focus on loss reserve adequacy for insurance and reinsurance companies with respect to their U.S. casualty risks written between 1997 and 2001. The group has already stated that total general business provisions may need to be increased by approximately GBP250m (net of tax and discount) in 4Q02. Fitch is concerned that future reserve strengthening above this level may be required, and plans to focus closely on year-end 2002 reserve data in its ongoing review.
Asbestos and environmental provisions - With respect to asbestos claims, Fitch established a survival ratio target of 16x in July of 2002. The survival ratio is a simple measure of relative reserve adequacy that compares the level of asbestos reserves to average claims payments. Fitch awaits updated disclosure from the group on 6 March but is concerned about the group's ability to set adequate reserves as a 4Q02 increase of GBP150m (USD225m) would follow the asbestos reserve strengthening of GBP371m (GBP239m, net of discount) reflected in the 2001 earnings.
Group Pension Fund - Fitch recently stated that the size of UK insurance company pension scheme deficits represents a further challenge to capitalisation for an industry already facing a number of short-term negative pressures. Under the controversial accounting standard FRS17, companies are required to reveal the level of any pension fund deficits in their 2002 year-end results.
The group's own pension funds showed a net pension deficit at year end 2001 of GBP128m with 71% of pension scheme assets invested in equities. The deficit is likely to have increased significantly during 2002 following a fall in global equity markets of around 30%. The agency is aware, however, that the deficit may be lower than implied due to a number of possible actions that may have been taken to reduce the impact of falling equity markets. The group closed its pension funds to new members during 2002. A substantially increased deficit would reduce financial flexibility both by acting as a future drag on earnings and potentially by reducing the ability of the group to raise capital. It should be noted that the financial flexibility of the group is already severely compromised given the current uncertainty in the capital markets, its own ratings and the lack of investor confidenc