After a great December for this sector, less of the shares in it are at obviously stupid prices but some, I think, still are.
2002 has been a year of happy coincidences for Lloyd's - high rates in conjunction with no really big catastrophe losses. As a result, I expect most of these companies to beat analysts' forecasts when 2002 results are announced in April. The market's realisation of this prospect should provide some continued impetus to the sector during the first quarter. The increasing media coverage and small investor interest as the sector becomes fashionable again will also help.
That said, it is more than likely that one or more will disappoint, perhaps big time. The most obvious candidates are SVB (prior year reserves), Highway (prior year reserves), Wellington (WTC) and Hiscox (WTC). For the first three of these, these specific risks are, at least to some extent, in the price. For Hiscox, however, I don't think that their exposure to WTC losses through carrying negative IBNR in respect of that event has been recognised by the market.
In addition to these specific exposures, one or more of the ILVs could be hit by reinsurer failure. Reinsurer downgrades are an almost daily occurrence at the moment, and it would be surprising if all the "solvent" reinsurers are ultimately able to pay their debts. A sizeable reinsurer becoming insolvent does not have an even impact on the sector but will hit those ILVs with a disproportionate concentration of reinsurance recoverables from that reinsurer severely.
Finally, any mega-catastrophe event will inevitably hit the sector hard, although note that exposure to terrorism losses is now much less significant than at 9/11.
Against this background, I believe that a diversified play on the sector is likely to be profoundly rewarding in 2003.
