If anyone harbors doubts that the insurance industry runs in cycles, they should examine Lloyd’s of London. It’s been through more cycles in its 316 years than any insurer. Some of the lowest points occurred relatively recently.
In the late ’80s and early ’90s, the London market was practically bankrupted by asbestos claims and huge catastrophe losses (Hurricane Andrew, Exxon Valdez, Piper Alpha, etc.). The six-year bottom between 1996 and 2001 led to serious questions about whether the losses would ever end, and if they didn’t could Lloyd’s survive? The final blow, the Sept. 11 attacks, could well have been fatal—estimated claims of £1.98 billion ($3.64 billion in today’s dollars). In six months, Lloyd’s had to come up with more than $2 billion in cash or equivalent to bring its U.S. reinsurance trust fund up to 100 percent of those estimations. The overall loss for the year was a whopping $4.257 billion.
Then a miracle happened, or at least a miraculous turn of events in the form of a very respectable return to profitability. In 2002, Lloyd’s earned an overall profit of £834 million ($1.3 billion at the time). While other reinsurers had a good year in 2003, Lloyd’s had a great one. In its earnings release on April 7, Lloyd’s projected 2003 profits on an annualized basis of $3.387 billion. On the old three-year accounting system, the 2003 underwriting year posted a projected profit of $3.186 billion.
Three factors seem to have come together at the right moment to produce this happy outcome. One, the introduction of corporate capital in 1994 (it now provides more than 85 percent of Lloyd’s capacity). Two, strong management in the form of Chairman Lord Peter Levene, CEO Nick Prettejohn, and until recently CFO Andrew Moss. And three, a real and ongoing commitment to achieve underwriting profits on the part of the syndicates and meaningful efforts to modernize Lloyd’s cumbersome structure and procedures.
The first provided the capital—disciplined capital as the companies providing are frequently publicly traded. The second provided the direction, and the third made use of the money and the organization to achieve the profits.
“Lloyd’s is in good shape after a year of strong progress. However, there is no room for complacency,” Levene stated in the earnings announcement. “We get daily reminders of just how risky our world is, and that is where Lloyd’s comes in. This market is founded on providing a shelter against worldwide risks.”
Prettejohn added that the “results represent an encouraging underwriting performance and a further strengthening of the market’s balance sheet following last year’s return to profit. The 2003 result benefited from favorable external conditions, with strong premium rates and a low financial impact on the market of catastrophic loss. These results are good news for our U.S. customers and capital providers.
“We are proud to serve the U.S. market, which is critically important for Lloyd’s, and accounts for more than one-third of our business.”
After noting the progress Lloyd’s has made, Prettejohn warned against complacency, indicating that, “the task now is to build on that progress. Consistently good performance, balance sheet strength and attractive returns for capital providers can only be achieved if businesses continue to write for profit and price risk adequately. The continuing increases to reserves across the industry, and conditions in the capital markets, mean that the need for an underwriting profit is as strong as ever.”
He no doubt took into account those prior years, which Lloyd’s also reported due to the overlap of its traditional three-year accounting basis with the new annualized reporting system it introduced in 2002. The 2001 loss is still quite prominent in those figures, but taken with the profits earned in 2002 and 2003, it seems less devastating. On a three-year basis the 2002 year-of-account is expected to return a profit of $2.991 billion, in line with previous projections.
Those profits have produced beneficial results in a number of areas. As of Dec. 31, 2003, the assets of the Central Fund amounted to $1.273 billion, an increase of $507 million since last year. In normal circumstances, the Central Fund is available, at the discretion of the Council of Lloyd’s, to meet a liability if a member has insufficient resources in its Premium Trust Fund (PTF) and is unable to provide other additional funds.
The results drew comments from the rating agencies.
Standard and Poor’s Ratings Services said its “A” insurer financial strength rating on Lloyd’s would not be affected by the “pro forma annual accounting result.” S&P added that it was “slightly ahead” of what had been expected, and remarked that the “improvement is a result of the very strong pricing environment and the low level of catastrophe losses recorded by the market in 2003. Consequently, the combined ratio improved to 90.7 percent (2002: 98.6 percent). The 2003 combined ratio represents an outperformance of comparable market averages. However, Lloyd’s results have historically been more volatile than its peers and Standard & Poor’s would expect Lloyd’s to outperform at this stage of the cycle.”
In a similar vein Prettejohn pointed out that “Lloyd’s has outperformed our international peer group, as businesses in the market have concentrated on delivering underwriting profit. Lloyd’s Franchise Board took decisive steps in 2003 to strengthen the market, and we will continue that critical work. In particular, we will continue to take strong action where businesses are under-performing.”
Lloyd’s has perhaps greater power over its syndicates to enforce those standards than would be present in a classic insurance company. In 2003, it forced Goshawk to close its loss making syndicate 102. A second syndicate, marine underwriter Dex, left voluntarily when auditors gave notice it would have to reduce its capacity. From 109 syndicates in 1999, there are now just 71, but they are bigger, better organized and better capitalized. Lloyd’s total capacity for 2003 was £14.4 billion ($26.5 billion), and it’s approximately at that level this year as well.
While Levene and Prettejohn remain dedicated to holding the line on pricing and enforcing market discipline, they may eventually become victims of the their own success. A 152 percent jump in profits is impressive, and could well attract additional capital from the companies who provide it to their Lloyd’s syndicates. That capital has to be put to work and it’s unlikely that even Levene and Prettejohn can succeed in keeping premiums at a high level forever. If they do, they run the risk that the capital could be underutilized, and would go elsewhere. If they don’t, well then maybe Lloyd’s hasn’t become immune to the cycle after all.
Whatever the future may hold as far as the dreaded cycle is concerned may be inevitable, but for now Lloyd’s can celebrate its richly earned return to profitability and increased financial stability, which, by most estimates, will continue throughout 2004 and into 2005—barring, of course, “unforeseen events.”