At first glance that statement may seem a little strange, considering that Lloyd’s reported an overall loss for the year of £516 million ($822 million). But considering that overall insured losses for the year from natural catastrophes were between $107 billion (Lloyd’s figure) and $110 billion (Swiss Re’s), and that Lloyd’s handled £12.9 billion [$20.55 billion] in claims – £4.6 billion ($7.33 billion) of them related to natural catastrophes, Lloyd’s CEO Dr. Richard Ward’s words that 2011 was “not a bad result,” are put in a more meaningful context.
Ward cited a prior perspective. “Claims in 2001, the year of the World Trade Center attacks, produced a loss over $3 billion, but the total claims were much less [than in 2011].”
The WTC disaster served as a wake-up call, which led to the creation of a franchise structure at Lloyd’s and the establishment of a “Franchise Board,” now named the Performance Management Board, headed by former Berkshire Hathaway senior executive Tom Bolt.
Ward, who took over as Lloyd’s CEO in 2006, explained that the Board acts as an oversight body, assessing the business plans presented to it by the syndicates that write business at Lloyd’s. “It helps them [syndicates] to determine where best to place business and what kind of business to write.”
It also tries to assure that no syndicate places too much at risk in one particular business sector or geographical area. The process enhances and to some extent controls Lloyd’s underwriting. As Lloyd’s is a subscription market, risks are typically spread among different syndicates. The Board has improved this process, and assures that syndicates don’t place too much emphasis on gaining market share or imperil their capital base. “The real test came in 2005,” said Ward, “and it worked.”
The system also seems to be adapting to the constantly changing conditions in the global insurance market. While Lloyd’s still places around 41 percent of its business in the U.S., Asian markets now account for around 12 percent, and they are growing, along with Latin American and Eastern European markets. This in turn creates new challenges.
“In emerging markets you have to understand both the overall risks, and the risks to individual syndicates,” Ward explained. Whereas catastrophe models exist for most developed countries, “in most emerging markets there aren’t any models,” he said.
The floods in Thailand were a prime example in 2011. “The losses [around $12 billion insured, according to Swiss Re], came as a surprise; they weren’t ‘modeled’ losses.” However, Ward also explained that even so, “they were within the parameters for our aggregate exposures.”
As new markets emerge, and more business is placed there, the need for more accurate modeling will increase. Events such as those that occurred in Thailand as well as the unanticipated destruction experienced from liquefaction in the earthquake in Christchurch, New Zealand, “will encourage the development of new models and a greater understanding of the risks.”
In his remarks on Lloyd’s earnings, Ward stated that he was “disappointed that, given the exceptional level of catastrophes in 2011, insurance rates have not responded more positively.” As most insurers and reinsurers have noted, rates have gone up in certain areas; i.e. those, like Japan and New Zealand, where disasters struck, but they have changed neither the overall soft market, nor the downward trend in the cycle.
Ward’s explanation for this condition rests on economic facts. “Since 2008 the [global financial] markets have been in crisis,” he said. Thus the situation “isn’t the same as in 2001 and 2005, when capital from outside the industry came into the insurance markets.”
Those capital injections – in start-up companies and reinsurance sidecars – softened a hard market in accordance with the ever present cyclical nature of the insurance industry.
“This is not the case in the current market,” Ward said. “We need a market turn, but even a $107 billion loss didn’t change it.” Economically speaking, the insurance industry is in good shape, and “it can offer returns on investment, which, compared to the extremely low returns in the current market, are very attractive, a return on capital investment of around 14 percent – except 2011.”
As a result there is no shortage of capital in insurance and reinsurance markets. If anything, there’s too much, which in turn keeps overall rates low, as re/insurers compete for business.
Although Ward didn’t specifically mention it, the action of the European Central Bank in making €1 trillion [app. $1.33 trillion] in cheap loans available to EU banks is a case in point. The banks were supposed to use these funds to make loans to businesses to stimulate Europe’s economic recovery. To some extent they have done that, but to a greater extent they haven’t.
The reasons are clear. Under Basel III, and related regulations EU banks are required to retain more capital, and to make fewer “risky investments.” Making loans to highly rated corporations, such as major insurers and reinsurers, who are almost universally ‘A’ rated or better, fulfills this requirement, and makes a nice return for the banks at relatively low risk. It also has the concomitant effect of muting the cycle.
While the economy is still an overall preoccupation for 2012, so far it hasn’t produced the same number of natural, or man-made disasters as the year 2011 did. “We’ve had the Costa Concordia and some floods,” said Ward, but “we’re still worried because of the economic conditions, especially in Europe. The economic environment is not as good as it should be; it’s challenging.”
Dr. Ward will be facing those challenges, as he stated categorically: “I have no plans to move on. Lloyd’s is both challenging and extremely rewarding.”