Lloyd’s Director Luke Savage on 2010 Results, Japan, What’s Ahead

His voice was a little husky, but Luke Savage – Lloyd’s Director of Finance, Risk Management and Operations – was still pleased to talk to the IJ about Lloyd’s financial results for 2010, which were released on Wednesday, March 30. They weren’t as good as last year – “only” a little over $3.5 billion, a pretty steep drop from the $6.2 billion Lloyd’s posted in 2009.

Lloyd’s CEO Richard Ward described the results as “solid,” despite the decrease of almost 50 percent. “I think that comment is to put them into context,” Savage explained. “Looking back over, say, the last five years -06, 07 and 09 – we didn’t see any significant catastrophe losses during those three years.” As a result Lloyd’s overall profit was quite substantial.

“By contrast 2008 saw Gustav and Ike, and in 2010 we saw Chile, New Zealand, Transocean [the Deep Horizon oil spill], and the Australian floods.” The difference in how much Lloyd’s makes is directly related to the catastrophes its syndicates cover. The three “benign” years, are balanced against the two years with “quite substantial cat losses.” However, Savage pointed out that Lloyd’s had nonetheless made “substantial profits,” even in those years; he said they were “quite respectable under the circumstances.”

He also explained that Lloyd’s is quite careful before it announces any loss estimates from catastrophic events, which explains why it hasn’t yet made any on the earthquake and tsunami that struck Japan on March 11. However, they’ve been working hard on collecting enough data to do so. “I do have dates for the estimates, and not just on the Japan quake, but also on the second New Zealand quake and the Australian floods,” Savage said.

Lloyd’s had “put out a major loss return to the market, which is expected to be returned by the 20th of April.” However, he added that it will take time to calculate the exposures, and that they would probably “be released around the middle of May, and they will be as comprehensive as possible, and won’t need to be readjusted.”

Savage also noted that with 85 syndicates, each one of which is basically an insurance company, who write almost every kind of insurance and reinsurance coverage, it takes a while to gather the necessary information to make an accurate estimate.

Lloyd’s expects the losses to be substantial, but it is prepared to handle them. Savage explained Lloyd’s use of “realistic disaster scenarios [RDS];” adding that “we do actually have a Japanese quake” as one of them. “That’s based upon a $64 billion or five trillion yen quake, centered on Tokyo, which is where our exposure is most concentrated.” As the current loss estimates are less than half of that, Savage said Lloyd’s expects them “to be substantially less than the RDS.”

He also pointed out that Lloyd’s is probably “in the best financial shape it has ever been in,” which goes back over 300 years. Despite the decrease in income Lloyd’s assets grew by almost 12 percent in 2010 to $3.814 billion. The Central Fund, which backs up claims payments, “is just under two billion pounds ($3.217 billion].” That should see the market through what’s starting out as a difficult year.

We asked about the impending imposition of the European Union’s Solvency II insurance regulations, coupled with the reorganization of financial regulation in the UK as well as the ongoing construction of the Basel III regulations for the banking sector. According to some reports, there are potential problems between the proposed banking regulations, which will require banks to increase capital, and their use of long term bonds to do so. The bonds are a favored investment vehicle for insurers, but Solvency II’s proposed capital requirements give them less value the more long term they are, as they are deemed to be higher risk.

Savage explained that in his opinion the problem has been blown out of proportion, as it would affect only around 20 percent of the insurance market, and mainly smaller insurers. “There may be an element of truth in it,” he said, “but I think it’s missing the point.”

He explained that “under Solvency II there are two ways that you can calculate your capital. One is to use the standard formula, which is effectively kind of ‘haircutting’ your balance sheet.” This would penalize insurers for holding long term corporate bonds. “You’d actually be better off holding Greek government debt, rather the ‘AAA’ corporate.” He added that this hasn’t yet been finalized, and that it may well be “fixed.”

However, he continued, “the second way to count your capital is to completely put aside the standard formula, and instead use your own internal models.” This requires the approval of local, i.e. country, regulators. If approved, then you “calculate your capital based upon your model output.” These types of models, used by practically all of the larger insurers, as well as Lloyd’s, enable them to “actually reflect the risks and the volatility of these instruments. In which case you’ll end up with an entirely appropriate capital charge, rather than an arbitrarily high one,” Savage said.

The models, however, don’t come cheap. “We’re spending something approaching around 250 million pounds [over $400 million] in preparing for Solvency II,” he said, “and as part of that getting our model approved.” In his opinion most other large insurers will be doing the same. Therefore, the “80/20 rule will probably apply.” In other words “the 20 largest insurers by percentage of number probably constitute 80 percent of the [total] insurance balance sheet.”

On speculation that the series of catastrophes might spark the long awaited increase in reinsurance rates, Savage was cautious, indicating that “it’s really too early to tell. Besides,” he concluded, “we’ve still got 9 months to go.”

Topics Carriers Legislation Excess Surplus Lloyd's Japan